When dealing with cryptocurrencies, it is essential to take the necessary precautions. There is no recourse when your crypto assets are lost or stolen. Thankfully, users have a plethora of countermeasures at their disposal to prevent unfortunate events from happening.
Table of contents
- Cryptocurrency Security is A Responsibility
- The Importance Of A Private Key
- Cryptocurrency Seed Phrases Explained
- Hot Wallets And Cold Wallets
- Which Option Is Better?
- Closing Thoughts
Cryptocurrency Security is A Responsibility
What makes cryptocurrencies so intriguing is how they offer all users a degree of self-sovereignty. That complex term translates to “be your own bank and control your own finances.” Every cryptocurrency holder is responsible for their assets and how they are stored. Without proper security measures and practices, your funds will always be at risk of loss, theft, or other unfortunate outcomes.
Learning how to secure digital assets properly is the primary objective for all novice and experienced users. Whether one opts for a straightforward or complex storage solution, protecting one’s assets is of the utmost importance. We will discuss a few options worth exploring, although some of them may require a minor upfront investment.
The Importance Of A Private Key
Before one can begin securing their crypto-assets, it is essential to understand basic cryptography. All cryptocurrencies work with a public key-private key combination. The public key is the “wallet” address for people to send funds to. With a private key, the recipient can prove they are the sole owner of the key and have the privilege of moving funds across the network.
It is worth noting that one can derive a public key from the private key with ease. Doing the opposite is nigh impossible today unless you have access to a quantum computer. For now, the risk of having one’s private key derived from a public key.
One can compare the private key to a key unlocking a door, bike, or car. Whereas one can duplicate physical keys, however, a cryptographic key is unique and cannot be guessed. Two private keys can’t be the same, as they will always be a random collection of numbers and letters.
Learning a long string of numbers and digits by heart is impossible, nor is it required. Instead, users need to protect that private key through various methods, as it is the only information that allows them to spend their cryptocurrency holdings. It is possible to back up this information in text format, although that is not the best option. Keeping such crucial information on a text file is not a long-term solution.
Cryptocurrency Seed Phrases Explained
Unlike the first generation of cryptocurrency wallets, the current versions usually do not rely on one private key. More specifically, most wallets follow the hierarchical deterministic structure, ensuring they can – in theory – hold billions of different keys. These keys can all be tied to the same cryptocurrency or different crypto-assets, depending on which wallet one decides to use.
To protect all of this information, these wallets will let users generate a seed phrase. This is not the same as a private key visually, yet it serves the same purpose: verifying you have access to the stored keys and funds in that wallet. What makes a seed phrase so appealing is the format: human-readable words that are easy to remember. However, they need to be entered in a very specific order, or you will not be able to access your wallets or funds.
Backing up the seed phrase is crucial. Again, this is best not done in a text file unless stored on a device that never connects to the internet. Most hardware wallets will have a paper sheet to note the information, ensuring the data is never exposed to the internet. Storing this data – just like a private key is the only security aspect associated with your wallet – is essential, and we will discuss some viable options later on.
Hot Wallets And Cold Wallets
Two common ways of storing private key or seed phrase information is by opting for a hot wallet or cold wallet. Both types are very different from one another yet can complement the other. Most users have a hot wallet for expenses and a cold wallet for long-term investments. Either approach is viable, yet there are differences as to how they work exactly.
The Purpose Of A Hot Wallet
Different people will have varying expectations for cryptocurrencies. To some, it may be an investment, whereas others want to use it as a payment method. This latter category of users will often need a hot wallet: a software wallet capable of connecting to the internet with [a small amount of] funds inside it to be used for payments. Hot wallets are very user-friendly and require almost no time to set up.
Unfortunately, hot wallets also pose the most significant security risk for those looking to secure their cryptocurrency. As this wallet is connected to the internet, it can become a target for criminals. While hot wallets do not broadcast the private key at any given time, the device hosting the wallet can be hacked or taken over.
As scary as that may sound, hot wallets are not completely insecure nor defenseless. It is a less secure option than cold wallets but can still serve a purpose if you don’t store too much value inside of it. Their ease of use is great to introduce new people to cryptocurrency, after which everyone needs to look one step further to secure their holdings properly.
Why Cold Wallets Are Different
Unlike a hot wallet, a cold wallet is not connected to the internet. It can be installed on an offline computer, older smartphone or tablet, or come as a hardware wallet. Opting for this method negates nearly all attack vectors. Like hierarchical deterministic wallets, a hardware or cold wallet will often be secured by a seed phrase, either 12 or 24 words in length.
On the user-friendliness front, cold wallets rank a bit lower. As these wallets lack internet connectivity, they need other devices to help broadcast transactions. Another device can be a current smartphone, tablet, laptop, or computer. A cold wallet can build the transaction’s “skeleton – data on funds to spend and where it is sent to.
Furthermore, a cold wallet can help prove to the network that you own the funds being transferred via your private key. The private key(s) is/are stored in the cold wallet and are used to sign the transaction. However, a cold wallet will not be able to broadcast the transaction on its own, as it needs to be done via an internet connection.
The Cryptocurrency Hardware Wallet Example
A common example of a cold wallet is hardware wallets produced by manufacturers such as SatoshiChip, Trezor, Ledger, ColdCard, etc. A hardware wallet is a small computer capable of constructing and signing transactions or simply validating that information if a different device generates it. Once a transaction is signed, it can no longer, making hardware wallets a solid choice for taking care of this aspect.
The hardware wallet solutions on the market today make it straightforward for users to secure their cryptocurrency. The user experience is better than ever, and they do not behave all that differently from hot wallets. The only exception is keeping the private keys offline at all times and requiring help from any internet-connected device to broadcast transfers to the network.
A hardware wallet is not free, but it doesn’t have to be expensive either. Most devices can be purchased for $150 or less for the one-time fee and will last you a lifetime.
Custodial Or Non-Custodial?
When looking into cold or hardware wallets, it is essential to determine if the product is custodial or non-custodial. A custodial solution will take control of your funds as a bank would. For those who want complete control over their crypto assets, non-custodial wallets are the better option.
Whereas cryptocurrency exchanges can be considered a wallet solution, they clearly fall into the custodial category. It is impossible to withdraw funds from an exchange right away without the company signing off on the transaction first. It is always possible the exchange will deny the request for any reason, creating a somewhat problematic situation. This trade-off between security and convenience should never be overlooked.
For those who rely on custodial wallets, always make sure to add extra security layers to your account. That includes using two-factor authentication (2FA) and adding a PIN for withdrawals, for example. Different platforms will offer various security measures, but only using a login and password is never sufficient.
Which Option Is Better?
There is no clear-cut answer to this loaded question. Every user has different needs, expectations, and preferences to secure their cryptocurrency today. Some will opt for more convenience, whereas others want complete control and security. Both hot and cold wallets are viable solutions these days, but you need to know the benefits and potential drawbacks.
Depending on your approach to cryptocurrencies – trading, long-term holding, speculation, or otherwise – a cold or hot wallet may prove the better option. Active traders and speculators will need access to liquidity at any given moment, removing the need for cold or hardware storage solutions.
Those who approach Bitcoin and other cryptocurrencies as a long-term investment want to prioritize security or convenience. Using hardware or cold wallet solutions is essential, as they are suited for long-term storage and safekeeping of funds. However, one should always test using such a wallet with smaller amounts first, as they can take a while to get accustomed to.
If you are unsure which approach to take today, opt for a mixture between the two. Experiment with a hot and cold wallet solution, see which fits your needs, and take it from there. Additionally, it is equally crucial to figure out whether your asset has proof-of-stake capabilities or is a DeFi token with other use cases. Educating oneself is always the first step along the path.
There is a lot to learn about the cryptocurrency industry before worrying about how to secure crypto assets. Although that is an essential step along the way, it can only become a valid point once you decide which currencies to acquire for which purposes. Foraying into cryptocurrency requires careful planning and knowledge, as this industry can be brutal and unforgiving otherwise.
Once you are ready to explore the world of storage solutions, experiment with the different options. It never hurts to keep some spending money in a hot wallet, although the majority of funds- unless used for staking rewards or DeFi yield farming – should never be in an internet-connected wallet in the first place.