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Crypto Terminology// 5 min read

Explained: What is Cold Storage?

Explained: What is Cold Storage?

Ever since cryptocurrencies started amassing value, token holders have been obsessed with how to store them securely. On the typical spectrum of value storage – where the gold in Fort Knox is one side, while the other is the cash in your wallet – the standard for cryptocurrency falls somewhere in between.

Just like with the traditional spectrum, increasing levels of security are available to match almost every need. For newcomers and cryptocurrency veterans alike, these can be confusing. Many of us really only understand the risk when it’s too late, and our tokens have been stolen or lost forever.

The final point is worth illustrating in more detail, because a new study from blockchain research company Chainalysis, suggests that more than 3.7 million (!!) bitcoins have been lost permanently. The thought of losing our crypto, due to a something as trivial as a forgotten password or a deleted private key file is nightmare inducing.

With so many coins lost and so many accounts hacked, it is finally time to learn how to store our tokens securely.

What does Cold Storage mean?

When reading about cryptocurrencies a heuristic is commonly used:

  1. “Hot” means the wallet is connected to the internet
  2. “Cold” means the wallet is disconnected from the internet

You’ve obviously heard of cold storage before, and you may well have read about a hot wallet. In this context, a hot wallet refers to storage from which tokens can be spent directly. Íf you store your tokens on an exchange, for example, you are storing them in a hot wallet – because anyone with access to the servers (or your password/email combo) can spend your balance.

With this in mind, cold storage simply refers to a cryptocurrency wallet which cannot be accessed via the internet. Importantly, you are not storing your tokens on the device, but instead your private keys. The most popular forms of cold storage are:

  1. A hardware wallet (like Trezor or Ledger).
  2. A paper wallet.
  3. A USB drive.

The primary advantage of keeping your private keys in cold storage is that nobody can spend your tokens without access to the device. This gives you a significantly higher level of security than on an exchange or on a mobile wallet.

That being said, you’ve likely already pictured yourself losing a hardware wallet or USB drive, sending your tokens into oblivion. Fear not, because sometimes there is a plan B.

Using a Hardware Wallet

Hardware wallets are a great way of storing your tokens because they find a balanced approach to safety and convenience.

Looking at a standard hardware wallet you might be forgiven for thinking it’s just a USB drive with better marketing. This isn’t true. In fact, most wallets contain sophisticated technology which provides a much higher level of security and utility.

In the case of TREZOR, for example, the wallet not only holds your private keys but can even sign a transaction without connecting to the internet. This allows you to spend your tokens as well as store them securely.

Additionally, hardware wallets allow you to create a backup, meaning you can recover your tokens on another device using a unique seed (This is the plan B mentioned above). Even if you lose or damage your wallet, you may be able to recover your tokens.

That being said, they also have disadvantages. Hardware wallets are by far the most expensive option listed above, with some models costing hundreds of dollars. Nevertheless, you get what you pay for, and depending on the value of your portfolio, the cost may be justified.

A final positive note is that hardware wallets have more sophisticated security than most alternatives. One example of this may be a pin code that is required to use the device. Another may be the inclusion of a passphrase, as well as a pin, to ensure you are the only one who can access and spend your tokens.

In combination, these features make hardware wallets the best option for those wishing to put their tokens in cold storage. Let’s now have a look at common alternatives.

Using a Paper Wallet

A paper wallet is a rather grandiose term for: “private key written on piece of paper”. This description is tongue-in-cheek of course, but that really is the essence of it.

That being said, a paper wallet does have some advantages. Obviously, your private key is stored offline, meaning no-one can spend your crypto without access to that piece of paper. This makes Paper Wallets impervious to most forms of attack. Even if a server is breached or hackers gain access to your personal device, your tokens remain safe.

I’m afraid that is where the advantages end, however, as Paper Wallets harbor risks that most alternatives do not. The obvious one here is that paper is not a durable material. Even short exposure to the elements could rub out your private keys, with no way of returning them. Laminating the paper, or treating it other ways, does little to mitigate the risks of normal wear and tear.

Even more worryingly, Paper Wallets are often touted as a good option for beginners, because they seem more traditional – relying on printers and ink to function. As a result, scammers have even started selling paper wallets to the uninitiated. To buy a paper wallet like this is a big mistake because the sellers can simply retain your private key, giving him permanent access to your tokens

Although the concept of buying a paper wallet might seem funny, using a paper wallet generator like BitAddress harbors the same risk and defeats the purpose of cold storage. Indeed, if BitAddress’s servers are breached, the hacker may have access to all the generated private keys.

Creating a secure paper wallet is not an easy task. This walkthrough details five steps, including downloading Ubuntu, and running it from your flash drive.

As you can tell, I do not think Paper Wallets are worth the risk.

Using a USB drive

USB drives have become increasingly popular as a way of storing bitcoin. There a number of reasons for this, such as the low cost of a USB drive, the high level of security and the relative ease of setting it up.

What separates a typical USB drive from a hardware wallet is the lack of cryptocurrency related technology, which allows you to generate public and private keys. Luckily, this significant hurdle can be (somewhat) overcome by using the Electrum Bitcoin Wallet in combination with the USB.

To get started, simply download Electrum and disconnect your device from the internet once completed. This ensures that your private keys remain in cold storage. Next, plug in your USB device and run the wallet installer. Your private keys are now in cold storage on your USB drive.

To make a transaction, you would again disconnect from the internet, plug in your USB and generate a transaction from the private key file. Then eject your USB and reconnect to the internet, transmitting your transaction to the network.

This short guide shows how easy it is to set up cold storage using a USB drive. One of the obvious disadvantages is that Electrum currently only supports bitcoin. This makes USB drives unable to store a portfolio of tokens, which is what most users are looking for.

Nevertheless, if you don’t want to spend money on a dedicated hardware wallet, definitely give the USB drive + Electrum a shot!

Conclusion

Cryptocurrency has always stood for the freedom of the individual. The ability to do what we want with our money, without the need for middlemen or fear of censorship. One of the hardest lessons we have to learn is that freedom always comes with responsibility. Crypto might give us the freedom to choose what we do with our money, but it also gives us all the responsibility of looking after it.

As a result, we need to think long and hard about how we store the private keys to our tokens. Cold storage is an excellent choice for all portfolio sizes and hardware wallets, in particular, are always worth the money.

The few disadvantages inherent in this approach have been detailed above, but one final thing to consider is the availability of a multi-signature (multi-sig) function. Multi-sig creates two distinct private keys for one account, meaning that both are required to access the funds. This effectively minimizes the chance of malicious actors gaining access to your tokens because they would have to obtain two private keys rather than one.

For those who are looking for a multi-sig cold storage option, Electrum installed on a USB drive is worth looking into.

Written by:

Chris Grundy is an avid tech enthusiast and the Head of Marketing at SelfKey. He's been writing about the Bitcoin space since 2015 and has enjoyed every minute of it.

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