Storing bitcoins

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Revision as of 20:18, 14 November 2017 by Belcher (talk | contribs) (→‎Multisignature wallets: fixed mistake)
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This page is a discussion of the different ways of storing bitcoins, whether for investment purposes or as a medium of exchange.

As bitcoin is a digital asset, it can be very un-intuitive to store safely. Historically many people have lost their coins but with proper understanding the risks can be eliminated. If your bitcoins do end up lost or stolen then there's almost certainly nothing that can be done to get them back.

tl;dr The best way to store bitcoin is to either buy a hardware wallet or install a multisignature wallet. Have your wallet create a mnemonic recovery phrase, write it down on paper and store it in a safe place. The wallet should be backed by your own full node.

Introduction

Storage of bitcoin can be broken down in a few independent goals:

  • Protection against accidental loss
  • Verification
  • Privacy / protection against spying
  • Protection against theft
  • Easy access for spending or moving bitcoins

The art and science of storing bitcoins is about keeping your private keys safe, yet them still being easily available to you when you want to transact with them. It also requires verifying that your recieved bitcoins are real, and stopping an adversary from spying on you.

An example mnemonic phrase written on paper
Example mnemonic phrase on paper.

Protection from accidental loss

In the past many people have accidentally lost bitcoins because of failed backups, forgotten hard drives or corrupted SSD devices. Through bitter experience it was found that one of the most practical storage mediums is pencil and paper. The private keys of a bitcoin wallet are encoded into random words from a dictionary which can be written down. If the your hard drive crashes you can find the paper with the mnemonic phrase and restore the entire wallet. All good wallet software ask their users to write down the mnemonic recovery phrase of the wallet. It is worthwhile to keep copies in several locations so that even if your home burns down and nothing remains you can still recover the bitcoins.

Verification and privacy

Storing a mnemonic phrase only stores private keys, it cannot tell you if you have actually received bitcoins and in what quantity. For that you need wallet software.

If you received cash banknotes or gold coins to be stored, you wouldn't accept them without verifying that the banknotes were genuine and that the gold was real. The same is true with bitcoin, payments must be genuine or else you may be slipped counterfeit bitcoins and be left out of pocket. The most secure kind of wallet is one which verifies all the rules of bitcoin, known as a full node. For recieving large volumes it is essential to use wallet software backed by a full node. If bitcoin is digital gold, then a full node is your own person goldsmith who checks that received bitcoin payments are actually real. Lightweight wallets which don't check all of bitcoin's rules are only appropriate for receiving smaller amounts or when you trust the sender. See the article about full nodes.

Your wallet software will also need to learn the history and balance of its wallet. For a lightweight wallet this usually involves querying a third-party server which leads to a privacy problem as that server can spy on you by seeing your entire balance, all your transactions and usually linking it with your IP address. Using a full node avoids this problem because the software connects directly to the bitcoin p2p network and downloads the entire blockchain, so any adversary will find it much harder to obtain information. See also: Anonymity

So for verification and privacy, a good storage solution should be backed by a full node under your own control for use when recieving payments. Note that the full node wallet on an online computer can be a watch-only wallet that does not have the ability to actually spend or steal the bitcoins.

Protection from theft

Possession of bitcoins comes from keep your ability to keep the private keys under your exclusive control. Any malware or hackers who learn what your private keys are can create a valid bitcoin transaction sending your coins to themselves, effectively stealing your bitcoins. The average person's computer is usually vulnerable to malware so that must be taken into account when deciding on storage solutions.

Easy access

Some users may not need to actually move their bitcoins very often, especially if they own bitcoin as an investment. Other users will want to be able to quickly and easily move their coins.

Discussion of wallet solutions

Hardware wallets

Hardware wallets are special purpose security-hardened devices for storing Bitcoins on a peripheral that is trusted to generate wallet keys and sign transactions.

A hardware wallet typically holds the private keys in its internal storage and is designed to be malware resistant. The device signs the transactions internally and only transmits the signed transactions to the computer. The separation of the private keys from the vulnerable environment allows the user to spend bitcoins on an untrustworthy computer with reduced risk.

Unfortunately as of November 2017 no hardware wallet on the market can be easily connected to a full node, so using them usually involves not verifying the rules of bitcoin and querying a third-party server which can spy on you. Hardware wallets are also physical objects that can be found and which prove that you probably own bitcoins. They also cost more than other solutions.

Main article: Hardware wallet

Multisignature wallets

A multisignature wallet is one where multiple private keys are required to move the bitcoins instead of a single key. These private keys can be spread across multiple machines with the assumption that malware and hackers are unlikely to simultaneously infect your laptop, desktop and smartphone. The multisig wallet can be of the m-of-n type where any m private keys out of a possible n are required to move the money. For example a 2-of-3 multisig wallet might have your private keys spread across a desktop, laptop and smartphone; any two are required to move the money but the loss of any one does not result in loss of money especially because they can be restored from paper backup.

Multisignature wallets have the advantage of being cheaper than hardware wallets since they are implemented in software and can be downloaded for free, as well as being convenient as all keys are online and the wallet user interfaces are typically easy to use. Wallet software Electrum and Armory can create multisig wallets.

Main article: Multisignature

Hot wallets

A hot wallet refers to keeping single-signature wallets with private keys kept on an online computer. Most bitcoin wallet software out there is a hot wallet. The bitcoins are easy to spend but are maximally vulnerable to malware or hackers. Hot wallets may be appropriate for small amounts.

Cold storage wallets

A cold wallet generates and stores private wallet keys offline on a clean, newly-installed air-gapped computer. Payments are recieved online with a watch-only wallet. Unsigned transactions are generated online, transferred offline for signing, and the signed transaction is transferred online to be broadcast to the Bitcoin network.

This allows funds to be managed offline in Cold storage. Used correctly a cold wallet is protected against online threats, such as viruses and hackers. Cold wallets are similar to hardware wallets, except that a general purpose computing device is used instead of a special purpose peripheral. The downside is that the transferring of transactions to and fro can be fiddly and unweilding, and less practical for carrying around like a hardware wallet.

Main article: Cold storage

Bad wallet ideas

Custodial wallets

Custodial wallets are where an exchange, broker or other third party holds your bitcoins in trust.

The number one rule to storing bitcoin is this: if you don’t hold the private keys, you don’t actually own the assets. There are many many historical examples of loss due to custodial wallets: Bitcoinica, Silk Road, Bitfloor, MTGOX, Sheep Marketplace, BTC-e, Bitstamp, Bitfinex, Bithumb, Cryptsy, Bter, Mintpal and many more[1]

"Isn't it just like keeping your money in a bank?"

There are trade offs with everything, but let me explain why trusting Coinbase with Bitcoin is not the same as trusting a bank with dollars:
Suppose 5 people are needed to access the funds, within Coinbase, e.g. the CEO, the lead engineer, 3 others, whatever. Suppose one day they wake up and decide to be evil and move all the Bitcoin to some private account of theirs, and perhaps make up a story in the press about how they've been "hacked". You have a serious problem, as you might find there is a protracted legal battle (see MtGox), but you can't actually retrieve the funds unless in some way the company is re-stocked with Bitcoin, or perhaps an equivalent in fiat.
If on the other hand you controlled the funds with a majority of keys in a multisig, then it would always effectively be your bitcoin. But it also means that if you get hacked, you lose.
Now, if your bank gets hacked similarly - 5 key operatives in the bank decide to swipe your money and pretend it was external hackers - SWIFT transfers are made to accounts in Russia and China; here it will always ultimately be at the discretion of legal agencies whether you "actually" still have the money that is stolen. Because dollars are not real, they can be created at a whim, and while reversing international transfers is not quite so simple, very often that reversal can be achieved (e.g. recent SWIFT hank at bangladesh[2][3] bank; $1 billion stolen, all but $80 million "recovered" (just means wire transfers reversed)). Added to that consider insurance, so even when transfers can't be reversed, the money can be "found". If too many banks get hacked all at once the Federal Reserve and the govt together can make up some "fund" that magically reassigns balances any time they like, with sufficient political will (that's essentially what was happening in 2008 TARP etc).
So far no insurance company has ever paid out on a Bitcoin company's claim. Worth considering also.
You might say, since it's risky both ways, why not trust Coinbase? Aren't they more competent in security than me?
Almost certainly, but this argument has two massive holes in it: (1) because they concentrate funds they are a massive target for hackers, while you are not - at all. (2) they are a trusted third party so the situation is strictly worse - not only do you have to trust their security skills, but you also have to trust them not to steal (modulo multisig, as mentioned above) (edited to add: as well as literal stealing, there is things like political confiscation, don't forget).[4]

Web wallets

Web wallets have all the downsides of custodial wallets along with all the downsides of hot wallets (exposed private keys), as well as all the downsides of lightweight wallets (not verifying bitcoin's rules, someone could send you a billion bitcoins and under certain conditions the dumb web wallet would happily accept it)

Paper wallets

So-called paper wallets are an obsolete and unsafe method of storing bitcoin which should not be recommended to newbs to use. They simply store a single private/public keypair on paper. They promote address reuse and require unweildy and complicated live OS system boots to be safe, they risk theft by printers and typically rely on Javascript cryptography.

Paper wallets also do not provide any method of displaying to the user when money has arrived, users are typically driven to use third-party blockchain explorers which can lie to them and spy on them.

A much better way to achieve the job that paper wallets do is to use mnemonic phrases instead.

Main article: Paper wallets

Cloud storage

This means storing your encrypted (or not) wallet file on a cloud storage solution such as Dropbox.

Removable media

This refers to storing wallet files on removable media like SSD or hard drives.

Refer to the warnings from these two links:

Those articles recommend using GPG for encryption or a printer, instead a better solution is mnemonic phrases.

Other ideas

Time-locked wallets

An interesting unconventional solution. The idea is to use time-lock contracts to create a wallet which cannot be spent from until a certain date. One possible use-case might be by a gambling addict who locks up money for paying bills for a month, after a month has passed and their time-lock wallet is opened they use that money for paying bills instead of gambling.

Time lock wallets don't exist yet except for simple javascript pages which rely on Javascript cryptography and are therefore not safe.

Consulting

If you intend to store a very large amount of bitcoins, for example in a business, you should consider paying for security consulting.

Further reading

References

  1. ↑ https://bitcointalk.org/index.php?topic=576337
  2. ↑ https://www.wired.com/2016/05/insane-81m-bangladesh-bank-heist-heres-know/
  3. ↑ https://en.wikipedia.org/wiki/Bangladesh_Bank_robbery
  4. ↑ https://www.reddit.com/r/Bitcoin/comments/5py495/brian_armstrong_controlling_your_own_wealth_as_a/dcve9xx/?context=3
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