Definition of Cold Storage
Cold storage is an offline wallet used to store bitcoins. With cold storage, digital wallets are stored on platforms that are not connected to the internet, thereby protecting the wallet from unauthorized access, cyber hacking and other vulnerabilities that systems connected to the internet are vulnerable to.
- Most cryptocurrency wallets are digital. But hackers can sometimes gain access to these storage tools despite security measures designed to prevent theft.
- Cold storage is a way of storing cryptocurrency tokens offline.
- By using cold storage, cryptocurrency investors aim to prevent hackers from being able to access their holdings through traditional means.
Understanding Cold Storage
When a checking, savings or credit card account with a traditional bank has been compromised, the bank can return the lost or stolen money back to the account holder. However, if your cryptocurrency account or wallet has been compromised and your bitcoins have been stolen, the owner will not be able to recover the coins. The reason for this is that most digital currencies are decentralized and do not have the backing of a central bank or government. Therefore, there is a need for a secure storage medium for bitcoin and altcoins.
A bitcoin wallet is associated with the public and private keys of the bitcoin owner. The private key assigned to a bitcoin user is a unique set of alphanumeric characters required to access the user’s bitcoin holdings for issuing purposes.
The public key is similar to the account name and helps identify the destination for the coins sent to the wallet. Two people who make a transaction with bitcoin, where one is the seller and the other the buyer, must share their public key with each other to complete the transaction.
The buyer of the commodity or service sends the required amount of bitcoin to the address the seller provides as payment, and the blockchain verifies the validity of the transaction and confirms that the buyer or sender actually has the funds to send.
Once the payment is sent to the address, the seller or recipient can only access the funds via the private key. Therefore, it is very important for the public key to remain safe because if it is stolen, the user’s bitcoin or altcoin can be opened and accessed from the address without permission.
Safe From Theft
Private keys stored in internet-connected wallets are vulnerable to network-based theft. This wallet is known as hot wallet. With a hot wallet, all the functions needed to complete a transaction are done from a single online device. The wallet generates and stores private keys; digitally sign transactions using private keys and broadcast signed transactions to the network. The problem is that once a signed transaction is broadcast online, an attacker crawling the network can find out the secret of the private key used to sign the transaction.
Cold storage solves this problem by signing transactions with private keys in an offline environment. Any transactions initiated online are temporarily transferred to an offline wallet stored on a device such as a USB, CD, hard drive, paper, or offline computer. It is then digitally signed before being transmitted to the online network.
Because the private keys are not in contact with the online connected server during the signing process. Even if an online hacker finds a transaction, he will not be able to access the private keys used for it. In exchange for this added security, the process of transferring to and from cold storage devices is somewhat more burdensome than the process for hot wallets.
The most basic form of cold storage is a paper wallet. A paper wallet is simply a document that has public and private keys written on it. This document is printed from an online bitcoin paper wallet tool with an offline printer. Paper wallets or documents usually have a QR code embedded in them so they can be easily scanned and signed to make transactions. The downside of this medium is that if the paper wallet is lost. Deemed unreadable or destroyed, the user will never be able to access his address where the funds are located.
Choose the Right Wallet
Another form of cold storage is a hardware wallet that uses an offline device or smart card to generate private keys offline. The USB Ledger wallet is an example of a hardware wallet that uses smart cards to secure private keys. The device looks and functions like a USB, and a computer and Chrome-based app are required to store private keys offline.
Like Paper wallets, it is important to store these USB devices and smart cards in a safe place, as any damage or loss can stop access to a user’s bitcoins. Two other popular hardware wallets include TREZOR and KeepKey.
Finally, users looking for cold storage options can also opt for offline software wallets, which are very similar to hardware wallets but are a more complex process for less technical users. Offline software wallets divide wallets into two accessible platforms – offline wallets that contain private keys and online wallets that store public keys.
An online wallet generates a new unsigned transaction and sends the user’s address to the recipient or sender at the other end of the transaction. Unsigned transactions are moved to an offline wallet and signed with private keys. The signed transaction is then transferred back to the online wallet which broadcasts it to the network. Since offline wallets are never connected to the internet, the stored private keys are kept safe. Electrum and Armory are often cited as the best offline software wallets in the cryptoeconomy.
Cryptocurrency users should ensure that their wallet of choice is compatible with the coins they are trading or trading, as not all wallets support all cryptocurrencies.