When we speak of cold storage of cryptocurrency, we mean storing them offline. They are held on a platform that is not connected to the internet. Obviously, the biggest benefit of this is safety. When your funds are offline, they cannot be accessed by cybercriminals.
The vast majority of cryptocurrency wallets are digital. Most exchanges store the majority of their clients’ funds offline or cold. This way, malicious entities are prevented from accessing assets via traditional means, such as hacking.
A Safe Medium
If your bank or credit card account is compromised, the financial institution can refund your stolen or lost money. If your cryptocurrency wallet or account is hacked and you lose your assets, you can’t recover them. This is because traditional cryptocurrency is decentralized and does not have the backing of the government or the national bank. Stablecoins are more secure, as are central bank cryptos, which more and more countries are starting to issue.
At any rate, you need a secure and safe medium to store any crypto assets, be they in bitcoin, altcoins, or both. A bitcoin wallet is associated with the owner’s public and private keys. The public key is like the name of the account. It’s used to determine where to send the coins. The private key is a unique string of letters and numbers needed to gain access to a user’s assets to spend them or for another reason. If you’re conducting a bitcoin transaction, be it as a buyer or a seller, you must share your public key with the other party. Likewise, they must share it with you. The service or item buyer sends a previously agreed sum to the seller’s address. Transaction validity is verified by the blockchain. This involves determining that the buyer actually has the means to purchase the item or service.
Once the payment has been processed, the recipient or seller uses his private key to access the funds. Private keys need to be kept safe. If they are stolen, the thief can unlock your crypto assets and access them without your knowledge and permission.
Preventing Network Based Theft
If you hold your private keys on a hot wallet, in other words online, they can be stolen. The risk of this isn’t necessarily huge, but it’s there. A single online device is used to perform all of the functions to carry out a transaction with hot wallets. They create and store private keys, communicate the transaction to the network, and sign it digitally using those same private keys. There is an issue here. A cyberthief crawling the networks can access the private key used to sign after the transactions have been broadcasted on the internet.
Cold wallets resolve this issue by using private keys to sign the transaction offline. Transactions initiated online are moved to a cold wallet temporarily. This can be a hard drive, CD, USB, offline computer, and more. Before being retransmitted online, they are digitally signed. Online hackers who access the transaction won’t gete the key because it never comes into contact with a server connected to the internet.
It’s logical to assume the process of cold storage is more cumbersome than the one hot wallets involve. Safety has its price. It can be pesky to transfer data to and from a cold storage device.
Types of Cold Storage
A paper wallet is the most rudimentary form of cold storage. This is a simple document with the private and public keys written on it. It is printed with an offline printer from the crypto wallet tool online. Typically, this document or paper wallet has an embedded QR code that the user can scan and sign easily to carry out a transaction.
This approach has a distinct downside: the risk of losing the document, destroying it, or rendering it illegible. If this happens, the user will never recover his funds because he won’t be able to find his address, much less access it.
Hardware wallets are much more popular than paper ones. In fact, they are perhaps the most common form of cold storage. Hardware wallets use a smartcard or offline device to create private keys offline. A typical example of one is the Ledger USB Wallet. It secures private keys by using a smartcard. In appearance and function, it resembles a USB. You need a computer and an app based on Chrome to store the private keys offline. As with a paper wallet, it is very important to keep this smartcard and USB device in a secure place. Loss or damage can lead you to lose access to your crypto assets.
Cryptocurrency holders can also keep their funds in an offline software wallet. These are similar to hardware ones, only a bit more complicated technically. Software wallets are split in two platforms. The online part stores the public keys and the offline one holds the private ones. New, unsigned transactions are generated by the online wallet. Then, the wallet sends the user’s address to the party on the other end, be it the sender or recipient. After that, the unsigned transaction is moved to the offline wallet and a private key is used to sign it. The transaction is then returned online. The online component of the wallet sends its details to the network.
This way, private keys remain safe because the offline wallet is never brought online. Examples of offline software wallets include Electrum and Armory.
Crypto asset holders need to make sure that the wallet they choose supports the coins they wish to invest in or trade. While wallets are beginning to support more and more kinds of cryptocurrencies, they’re still limited in scope.