Owning and Securing your Bitcoin
The Importance of Self Custody
By now you should have a basic understanding of where Bitcoin comes from, why it was created, and how the Blockchain operates.
The final introductory topics that we want to cover concern how Bitcoins can be sent and received, and the self-custody of Bitcoin.
Self-custody has never been more important than it is today. In recent years, a number of major cryptocurrency exchanges and lenders, such as FTX, Blockfi, and Celcius, have all gone bankrupt. The biggest losers in each of these scenarios have been the countless individuals who have stored their Bitcoins with these companies, and not in a wallet controlled by the individual.
Whilst it can be convenient to leave Bitcoins on a crypto exchange, this convenience comes at the cost of security. This is a trade-off that should not be taken lightly.
The Key to Bitcoin
When someone sets up a Bitcoin wallet (see below) for the first time, they will be given two pieces of information; a public and a private key.
Together, these keys represent ownership over the Bitcoins they are associated with. Below we provide a basic introduction to both types of keys in an attempt to demonstrate their importance.
A Public Key
Simply put, a public key is an address that allows someone to receive a Bitcoin transaction. For example, if Alice is going to send Bob 2 Bitcoins, she will first require his public key. Once she has this information, the transaction can take place.
As a result, sharing a Bitcoin public key with others is necessary so transactions can occur on the Blockchain. Sharing a public key with others does not compromise an individual’s control of their Bitcoin and therefore does not pose a security risk.
The following is an example of what a Bitcoin public key might look like:
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Private keys, on the other hand, should never be made publicly available. In fact, the Bitcoin community strongly discourages anyone from storing a private key on any kind of device that could be hacked, like a computer or a tablet. When recording a private key, it is hard to beat pen and paper.
This is because a private key is what grants someone access to, and therefore control of, any Bitcoins associated with a public address. A private key can be likened to a pin code for a bank account. If someone has knowledge of a private key, then they can send the Bitcoins associated with that key anywhere they wish.
Earlier, we mentioned that there is a security trade-off that a lot of people make when they leave their Bitcoin on a crypto exchange. This is because when a customer leaves their Bitcoin on an exchange, like FTX, they leave it in what is referred to as a custodial wallet. The most significant risk with this type of wallet is that the exchange, and not the individual, will have control of the private keys. Ultimately this ensures that the exchange, and not the individual, has control of the Bitcoin. If the exchange goes into bankruptcy, then the individual may lose control of the Bitcoin they have purchased.
Not Your Keys, Not Your Cheese
A Private Key
Self Custody
If leaving your Bitcoin on an exchange is not recommended, then the next question we need to answer is; where should people store their Bitcoin? We believe that the best way to protect someone’s Bitcoin is by investing in what is referred to as a “wallet”.
We have already covered custodian wallets, which, from a security point of view, do not come recommended.
A good alternative, especially for those new to Bitcoin, is to invest in a hardware wallet (sometimes referred to as a cold wallet).
Alternatively, some people may prefer to use what is referred to as a “hot wallet”. This is a type of software that secures the user’s private keys. Unlike a custodial wallet, a hot wallet grants the user custody of their private keys, meaning they have control of their Bitcoins. However, hot wallets are (1) always connected to the internet, and (2) store the wallet’s private keys on a host device; for example a laptop. As a result, these wallets are susceptible to being hacked.
Hardware Wallets
So, what is a hardware wallet?
A Bitcoin hardware wallet is a physical device (typically the size of a USB stick), that is designed to store the private keys necessary for accessing and managing someone’s Bitcoin. Unlike a hot wallet, the device stores a user’s private keys offline. One of the most widely used hardware wallet producers, Ledger, claims that this offline functionality is one reason why their devices are “completely impenetrable from external threats”. Of course, we cannot confirm this, and we are not recommending Ledger wallets specifically. However, we do take the view that a hardware wallet is far safer than a custodial or a hot wallet.
But, we hear you ask, if the hardware wallet stores the private keys itself, then how can I prove ownership of the Bitcoins associated with the hardware wallet’s private key?
Typically, when someone sets up their hardware wallet, they will be presented with a list of 12, 18, or 24 random words. Wallet manufacturers like Ledger and Trezor refer to these words as Recovery Phrases and Recovery Seeds respectively. These phrases are specific to one hardware wallet, and much like a private key, should be recorded on paper only. Together, this list of phrases constitutes a hardware wallet’s private key. Therefore, if someone loses or damages their physical hardware wallet, this does not mean that they cannot access their Bitcoins. All they need is a new hardware wallet and their record of what words made up their original recovery phrase. Provided they can enter the phrase correctly, they will regain access to the Bitcoin protected by their original wallet.
Why Go To All This Trouble?
Why go to all this trouble to protect something that I cannot even touch? Well, the obvious answer to this question is to avoid future fiascos like the ones suffered by those who left their Bitcoin on exchanges that have collapsed.
Equally, we believe that when someone takes steps to enhance their Bitcoin security, they take another step towards true ownership of their Bitcoin. If you are the only person who has access to your private keys, then you become the only person who has the ability to spend or send your Bitcoin.
In comparison, not even a bank can offer that level of control to its customers. A customer might be the only person who knows the pin code for their account, but a bank can still stop that individual from sending or withdrawing money if it decides to.
History is littered with examples where banks and governments have controlled how their customers can use their own money. In 1933, Executive Order 6102 made it illegal for Americans to own “gold coins, gold bullion, and gold certificates”. In 2016, the Indian government limited the amount of money civilians could withdraw from their own banks. Today, banks like Chase UK have taken steps to ensure their customers will not be able to buy Bitcoin or other cryptocurrencies with their Chase UK account.
In comparison, Bitcoin provides people with absolute freedom. Provided they maintain control of their own private keys, they are able to use their Bitcoin however they want. There are of course risks that come with this freedom, but it is difficult to argue that someone does not own something that only they can control.