After chatting the basics about bitcoin, two of the most common questions I hear include (1) “So if I decide to get some bitcoin, where do I put it?” and (2) “What about Mt. Gox? Didn’t that show bitcoin could get hacked?” The answers to each question relies on a proper understanding of wallets.
Public and Private Keys
A cryptocurrency wallet functions with the use of both a public key and a private key. If Tom has a bitcoin wallet and shares his public key with Sue, Sue can send Tom bitcoin by directing the bitcoin to be sent to the address shown by the public key. In that sense, the public key is similar to a bank account number. However, having Tom’s public key does not allow Sue to withdraw bitcoin from Tom’s wallet. Only Tom can send bitcoin from his wallet by using his private key. Some providers of cryptocurrency wallets create the wallets in such a way that the providers have a copy of, or access to, their users’ private keys. Other providers of cryptocurrency wallets do not ever have a copy of, or access to, its customer’s private keys.
Hot and Cold Wallets
The blockchain ledger runs via the internet as a cryptographic, time-stamped, electronic ledger of peer-to-peer transactions. A wallet that is actively connected to the blockchain network (ie, the internet) is said to be a hot wallet. A cold wallet, by contrast, places a gap between itself and the blockchain network. Examples of cold wallets would include wallets you print out and store on paper, or wallets you download to a USB drive that you keep disconnected from the internet. Hot wallets are considered more susceptible to hacking, because you can access hot wallets from the internet anywhere, whereas with cold wallets you would need physical possession of the storage device.
“Hosted” vs. “Software” Wallets
A “hosted” wallet is essentially a bitcoin bank account. When you place cash in a bank, you no longer hold the funds – the bank holds your funds for you. Likewise, a company that provides a hosted wallet services stores your bitcoin in a centralized place for you. Hosted wallets that provide guaranteed cold storage to their customers may provide an appealing options for people who have limited understanding of how to secure their own bitcoin. However, when you store your bitcoin in a centralized repository, you have to trust that the company holding your bitcoin will, in fact, place your bitcoin in cold storage. Moreover, in a large repository, the combined value of bitcoin is much higher, making it a more likely target for hackers, particularly if not all bitcoin is placed in cold storage. This is exactly why Mt. Gox was hacked, and how people lost their bitcoin as a result.
Another reason to avoid the use of hosted wallets is that one of the greatest value propositions bitcoin brings to the world is the ability to be your own bank. Storing your funds in a bitcoin bank neutralizes (or negates, even) the innovation the technology provides in that regard. Some companies, including blockchain.info, provide what I call “software” wallets. These companies do not host their customer’s bitcoin, but rather they provide wallet software that enables non-computer-geniuses, such as myself, a means of interacting directly with the blockchain network to push transactions.
So, what’s in your (bitcoin) wallet?
This post was originally published here.