My previous article titled Cryptocurrencies – Digital Bearer Assets explained that cryptos are bearer assets where the holder (bearer) controls the rights of ownership over the coins. So if the old adage “whoever holds it, owns it” applies in the world of cryptocurrencies, how exactly does one hold an intangible asset such as Bitcoin?
In order to understand how to hold Bitcoins in your own possession, there first needs to be a basic understanding of the cryptography behind Bitcoin.
Bitcoin is built on what is known as asymmetric cryptography. It uses public/private key encryption where the public key is used to encrypt data and the private key is used to decrypt (unlock) data. In order to access and move Bitcoins, they must be “unlocked” using the private key.
Similar to an email address
A simple analogy is to think of the Bitcoin public key (public address) like your email address. In the same way that anyone who has your email address can send you a message, whoever has access to your public key can send you Bitcoin.
In this analogy, Bitcoin private keys are similar to your email’s password. Anyone who has your password can ‘unlock’ and access your emails and the data contained within them. However, unlike a common email service like Gmail or Hotmail, Bitcoin is a decentralised network with no one in control. Therefore, if a private key is lost or forgotten, then the Bitcoins can never be unlocked and are irretrievable forever. Furthermore, if your private key (password) is compromised, a hacker is able to take possession of your Bitcoins.
Millions of missing coins
It’s interesting to note that of the almost 17 million Bitcoins that have already been mined, it’s estimated that around 4 million of them have been lost forever. Or more accurately, around 4 million coins can never be unlocked, accessed and moved due to the private keys being lost.
So what are some of the ways to hold your Bitcoin? There are a few common storage options, with there being a sliding scale between convenience on one end and security on the other. As a general rule, the more convenient the storage method, then less secure, and vice versa.
The most common way newbies store Bitcoin (and other cryptos) is on an exchange. We’re so used to storing our money and assets with banks, brokers and exchanges. These companies are heavily regulated institutions, whereas in many instances, crypto exchanges are unregulated entities that operate in foreign jurisdictions. Storing your crypto on an exchange involves them holding your private keys on your behalf, which goes against the entire idea of buying into a digital bearer asset to begin with!
Exchanges are susceptible to hacks as well as internal thefts from company employees. So although exchanges are a simple and convenient places to buy cryptocurrencies, it’s ill advised to store your cryptocurrencies on an exchange.
Holding your Bitcoins yourself means that you have to take responsibility for securely storing your private keys in your own Bitcoin wallet. There are two types of Bitcoin wallets, namely hot and cold wallets. The simplest way to describe the difference between a hot wallet and a cold wallet is that hot wallets are connected to the internet, while cold wallets are not.
Downloading a mobile wallet from your phone’s app store is a common way of storing Bitcoins. It’s relatively effortless, and because it’s connected to the internet, allows for easy access to move or spend your Bitcoins.
Similarly, a desktop wallet is an app that can be downloaded from the internet and installed onto your computer. Again, this type of wallet is constantly connected to the internet, allowing for easy access to your coins.
The most common type of cold wallet is a paper wallet. A paper wallet is a physical piece of paper which displays the wallet’s public and private keys. This type of wallet is less susceptible to cyber thefts because the wallet is not stored online. However, the wallet (piece of paper) can still be stolen physically if not properly secured.
A hardware wallet is a physical device which stores your private keys in cold storage. Because only the public key touches the internet, with the wallet’s private keys being generated offline and never touching the internet, this type of device is a very safe and secure way to store your Bitcoins. In fact, Antivirus pioneer and controversial crypto enthusiast John McAfee stated that a hardware wallet is the only way to safely store Bitcoins.
For the average person looking to store Bitcoins, McAfee’s statement is quite true. There are more complex methods for storing Bitcoins in an ultra secure way, however this involves an advanced understanding of computers, and also incurs a significant ongoing cost.
Bitcoin private keys
Future articles will discuss Bitcoin security and wallets in greater detail, but the main takeaway from this article is that anyone who has your private key can decrypt (unlock) your Bitcoins. Hence it is the private key which needs to be protected and secured, so perhaps the old adage “whoever holds it, owns it” should be revised to read “whoever holds the private key owns the Bitcoin.”