After you make your first Bitcoin purchase, you might start to wonder how to store it. Do you have to leave it on the exchange where you bought it? Are there even other options?
The answer depends on how much you know about Bitcoin. If you bought Bitcoin for the first time without understanding how it works or why it’s valuable, you might want to leave it where it is while you learn more about Bitcoin.
For everyone else however, the answer is yes, there are other options.
Part of the reason why Bitcoin storage is confusing for many people is that there is nothing else quite like Bitcoin. When we buy stocks from regulated brokers, the stocks stay in our brokerage accounts. You can’t send stocks to people or even easily transfer them from one account to another. That’s because it’s the brokerage that holds the actual stock, even if it’s in your name.
Even the money in our bank accounts doesn’t work the way Bitcoin does. Money in the bank is simply a promise that the bank will give you your money if you ask for it. Again, the bank is the actual custodian of the money.
Bitcoin is a bearer asset, the same way that gold or paper cash is. Once you hold the asset itself, ownership is truly yours. There has never been a digital bearer asset before Bitcoin, which is why the concept can seem foreign to some of us at first. As opposed to modern banking, which requires intermediaries to transact digitally, Bitcoin is fully peer-to-peer with no custodians required. This means that when you hold BTC in a Bitcoin wallet, it’s like keeping paper cash in a physical wallet, not like checking your account balance at a bank. In other words, Bitcoin is able to be stored by individual users.
With this great power comes great responsibility though. Much like cash or gold, if you lose your Bitcoin, there’s no one you can run to for help, which means that you need to think carefully about how you handle it.
When using one of the many Bitcoin wallets available, each user is given a randomly generated 12 or 24 word phrase – called a mnemonic phrase. This phrase allows you to mathematically generate the private keys that give you control of the Bitcoin.
A mnemonic phrase is a group of words that Bitcoin wallets can use to mathematically generate your private keys. Other names for a mnemonic include ‘backup phrase’ and ‘seed phrase’. When using a Bitcoin wallet for the first time, the wallet software will generate a random seed phrase and instruct the user to carefully store the words. If the user’s computer breaks or their hard drive becomes corrupted, they are able to download the wallet at any point in the future and use the seed words to get access to their bitcoin back. The mnemonic phrase is the actual key to your Bitcoin, while the wallet software is really just an interface to interact with the network.
There are four main types of Bitcoin wallets. These wallets do not “hold” your actual Bitcoin, but are mechanisms to help you store or “use” the keys which give you control of your private keys.
I’ve ordered them from the least to most secure, below:
Leaving Bitcoin on an exchange is only suitable for buyers who do not understand what Bitcoin is or how it works. Bitcoin held on an exchange is not equivalent to holding funds in your own wallet. Bitcoin on an exchange is more akin to leaving your money in a bank, but with fewer guarantees.
It’s understandable why a person would want to leave their Bitcoin on an exchange. Exchange accounts are a familiar interface for users. Nearly every aspect of our digital lives is protected by a username and password. Even our banks work that way. If you can store your life savings with a bank, then shouldn’t a username and password be sufficient for storing your Bitcoin?
The answer is no. If a bank account is hacked, the bank would be able to freeze and recall funds that were stolen. This is because banks own the ledgers keeping track of depositor’s money, which means that they own the actual money. If a hack of a bank account were to occur, the bank can simply reverse the transactions.
This cannot happen with Bitcoin because the network is autonomous and immutable. With Bitcoin, there are no recalls and frozen funds. Once an account is hacked and Bitcoin is stolen, that Bitcoin is likely lost forever. This means that there is far less room for error when it comes to protecting your Bitcoin. Bitcoin’s immutability is one of its core benefits and is a key component of the network’s censorship resistance.
Finally, leaving your Bitcoin on an exchange presents the risk of the exchange itself. Exchanges have been hacked many times throughout the years, putting user’s funds at risk. Even some of the most well-known exchanges have suffered hacks. In late 2019, Binance – one of the largest spot cryptocurrency exchanges by volume – suffered a hack in which 7,000 Bitcoin were stolen. There is also a legal risk. If a jurisdiction attempts to outlaw Bitcoin for whatever reason, any funds stored on an exchange account based in that country would likely be frozen. Since the exchange is the entity that is holding the Bitcoin private keys, they are the ones who actually control, and therefore technically ‘own’ the Bitcoin. As a result, users who store their Bitcoin on exchanges take on the risk of those exchanges.
Part of what makes Bitcoin unique is its open nature. Bitcoin doesn’t care who or what you are, where you are, or what time it is.
As long as you control the keys, which give you access to the Bitcoin, you can send it wherever you want. In this aspect lies one of Bitcoin’s most powerful attributes, ie; its censorship resistance.
But this is why it’s important to know the risks associated with who or what controls those private keys. Most exchanges are reputable and very well run, but the risk of failure, hack, or loss always exists.
So just keep in mind that when you leave your coins on an exchange, you do not technically own your Bitcoin. Bitcoin on an exchange is simply a promise – an IOU – that the exchange will give you ‘your’ Bitcoin if you ask for it.
A desktop wallet is a Bitcoin wallet that users download as a computer program. Desktop wallets are genuine Bitcoin wallets, meaning that users control their seed phrase, and provide an easy way to store and send Bitcoin. Unfortunately, in terms of security, desktop wallets leave a lot to be desired.
The reason why desktop wallets lack security compared to other storage solutions does not have to do with the wallets themselves. Certain wallets, like Electrum and Wasabi, have been around for years, are well-known, and have garnered much respect within the Bitcoin community.
The problem with desktop wallets is the computer operating systems themselves. Computers get viruses. Windows in particular is notorious for viruses since its inception and, while better, Macs can get viruses too.
It’s when your computer is infected by some form of virus or malware that your Bitcoin is at risk, because IF your keys are stored on the computer (whether in a file or in the desktop wallet), that malware can steal it, thereby giving control of your keys to the attacker
Simply put; an infected computer can result in stolen funds. Since hackers know that Bitcoin is valuable (and the keys often improperly stored), viruses are often made to specifically search for Bitcoin files on a person’s computer.
There are certain measures that a user can take to minimize the risk, such as requiring two-factor authentication before any funds are sent, but you need to be aware of the risks.
All in all, because computers themselves are difficult to secure, desktop wallets are difficult to secure as well.
Compared to desktop wallets, mobile wallets provide a reasonably more secure option for securing your Bitcoin. Think about the difference in the way that you react and download new programs on the computer compared to a mobile phone. When you download something on a computer, that program can come from anywhere on the internet. On a mobile phone, applications must be downloaded directly from either Google or Apple’s app store, which are closed environments.
Because of this walled-garden approach, both iOS and Android offer more secure operating environments than OSX and Windows. The result has been fewer hacks, with viruses and malware are much rarer on phones than on computers. Admittedly, iOS is better than Android in this regard.
However, phones are not entirely secure environments. Mobile devices are, typically speaking, constantly connected to the internet, either through WiFi or by using data. Any device that is connected to the internet faces a certain level of risk. The app stores are not perfect either. Hackers can make fake apps that look very similar to the real ones, tricking users into downloading malicious software.
Finally, people often give permissions for their applications to access a bevy of personal data, such as name, contacts, location, and more. If a malicious app is granted permission to sensitive information, your keys, and therefore your funds may be at risk.
Still, mobile wallets tend to be an upgrade over desktop wallets. They are best used for holding small amounts of Bitcoin that may be used in everyday transactions.
The best way for any Bitcoin user to secure their keys, and therefore their Bitcoin, is with a hardware wallet. A hardware wallet is a small device that usually connects to the computer via USB (although some wallets allow the use of micro SD cards).
Recall that if there is a virus or malware on either your desktop or mobile phone, your keys and thus Bitcoin may be at risk. That is because the wallets on these environments store the keys locally, and therefore, the private keys are visible within the wallets themselves. Since both desktop and mobile wallets are often connected to the internet, a compromised wallet can lead to lost funds.
Hardware wallets do not work this way. A hardware wallet is never connected to the internet, even when it’s plugged into your computer. Whenever you want to send funds while using a hardware wallet, the transaction needs to be confirmed on the hardware wallet itself, which remains offline. Even if the hardware wallet is plugged into an internet-connected device, the private keys never leave the hardware wallet itself.
The reason that hardware wallets represent an order of magnitude better security over both desktop and mobile wallets is that the private keys to your Bitcoin, which allow funds to be transferred, are stored on the device itself.
What this means is that even if your computer has been infected with a virus, it is still safe to use a hardware wallet.
This fact alone makes purchasing a hardware wallet worthwhile when storing any amount of Bitcoin greater than the value of the wallet itself.
Some hardware wallets come with their own software for sending and receiving Bitcoin, though most are compatible with the most common desktop wallets. This is another important point – using a hardware wallet with a desktop wallet removes most of the risks that come from using a desktop wallet alone, because the keys are on the hardware device and the desktop software is just an interface.
A desktop wallet itself is a usually hot wallet, with funds always active and online. Using a hardware wallet through a desktop wallet however, is a form of cold storage, the funds are only accessible when the hardware wallet is plugged in. Even then, all transactions must be confirmed on the device itself.
In closing, there are multiple ways to store your Bitcoin, all with varying degrees of security. The best approach is to hold your own keys so that you have direct control over your Bitcoin. For new holders just getting into Bitcoin however, it is okay to keep your coins on an exchange for a bit while you learn more about how Bitcoin works.
Once you are comfortable storing your mnemonic phrase, hardware wallets offer the best security compared to desktop and mobile wallets and are a worthwhile purchase for storing any meaningful amount of Bitcoin. Hardware wallets are easy to use, affordable, and provide the most secure way to store your Bitcoin safely for a long period of time.
You can start buying and accumulating Bitcoin at any time on an app like Amber. Amber allows users to get started buying Bitcoin within just a few minutes of creating an account. Once you learn about how to manage your mnemonic seed and self-custody your coins, you can simply withdraw from Amber to your own wallet.
In fact, one of Amber’s latest features (available on Amber Black) is the ability to automate withdrawals to your own wallet so you can set up automated buys, automated withdrawals and know that your Bitcoin is being securely stored.
Written by Sean Cover
Sean Cover is a finance and accounting professional with a passion for the history of money and monetary systems. Sean is the author of 808 Insights, a newsletter that analyzes topics related to Bitcoin and other financial markets. The newsletter can be found at https://insights.808digital.io/.
Follow Sean on Twitter at https://twitter.com/seancover.