Bitcoin, the first (and according to some, the best) of many cryptocurrencies on the market, is a digital asset. This is a virtual currency that you can’t carry in your regular wallet or pocket, so where is it actually stored? Is it stored in computers? Is it stored in software applications on your mobile devices? Or is it perhaps stored in hardware devices like USB sticks and hard drives? Actually, Bitcoin is not stored anywhere but on its blockchain. That said, you can use all the digital options above to make a virtual wallet to store and manage your Bitcoin.
If you are confused by all of these options, don’t worry because we prepared a guide to explain how Bitcoin is stored and what kinds of wallets you can use to buy, sell and trade your Bitcoin safely.
How Does the Bitcoin Blockchain Store Bitcoins?
Although Bitcoin has been around for quite a while now, most people don’t really understand how it works. When we think of currencies, we usually imagine them in terms of their placeholders like paper money, coins, or checks instead of more abstract terms such as values and numbers. Even with cryptocurrencies like Bitcoin, people imagine placeholders such as virtual coins made from lines of code. But digital assets like Bitcoin and altcoins are actually even more abstract than that, because these digital currencies only exist on their own, native blockchains.
What Is a Blockchain?
Blockchain technology lies at the foundation of Bitcoin and most other altcoins. Satoshi Nakamoto, the pseudonymous creator of Bitcoin, came up with the concept in order to provide a safe and decentralized alternative to electronic payment systems managed by central authorities like banks and other companies.
When you make a purchase through a credit card, your transactions get recorded by the bank and your account is updated to reflect your new balance according to your expenditure. You can verify your purchases and how much money you have by checking your account summary: a list that shows how much money was deposited, withdrawn or transferred from your balance.
A blockchain employs a similar method to function. It is essentially a ledger full of timestamped transaction records, ordered chronologically in blocks. Each block of transactions follows the previous block, creating an unbroken chain of transactions, hence the name blockchain.
However, with a blockchain you don’t need to trust a central authority like a bank to audit the books to prevent scams and fraud. A bank allows you to see only your transaction history to verify your balance but the responsibility of monitoring all the balances rests with the bank. With a public blockchain like Bitcoin’s, the whole ledger is secured by cryptography and shared publicly on the Bitcoin network, so that anyone can verify the validity of the records. This creates a trustless system that doesn’t depend on central authorities.
What Is a Bitcoin Wallet?
The Bitcoin blockchain is a public, immutable ledger that shows each and every Bitcoin transaction. Essentially, when people make a Bitcoin transaction, they are not actually sending or receiving anything. Instead, all they do is simply create a new record on the blockchain that shows how much BTC they have in their accounts. So, all you need in order to make Bitcoin transactions and control your funds is a way of interacting with the blockchain. This is where Bitcoin wallets come in.
Bitcoin owners need a special password known as a private key to interact with the Bitcoin blockchain. A Bitcoin wallet is a piece of software (can be online or offline) that generates and stores this private key. You access your digital assets and manage your funds only through this private key so it is essential to keep it safe. Keep in mind that Bitcoin is a decentralized payment system and there is no higher authority you can appeal to if you lose your private key. You have complete responsibility over your keys, so it is important that you pick a secure digital wallet.
How Do Cryptocurrency Wallets Work?
To reiterate, a cryptocurrency wallet is a software program that helps you access the blockchain to make transactions and monitor your balances. When you set up a digital wallet, you get a private key and a public key generated through cryptography. These keys are not like usual passwords. They consist of long strings of alphanumeric characters and you can’t simply change them to your birthday or your pet’s name to make them easier to remember.
You can use the public key to generate Bitcoin addresses for sending and receiving BTC. You know how we talked about Bitcoin accounts getting recorded on the blockchain? These are actually Bitcoin wallet addresses that people generate through their public keys. It is okay to share your Bitcoin addresses with people in order to receive BTC or to confirm that you are sending them Bitcoin. You can also generate multiple addresses using a public key.
Your private key, on the other hand, should not be shared with anyone you don’t want to grant complete access to your digital assets to. A private key is your only proof that you own Bitcoin, and if you lose that, there is no way of getting your assets back.
There are five wallet types that help you store your keys and interact with the blockchain to make transactions. We will discuss these Bitcoin wallet options to help you understand what they offer in terms of security and accessibility, so you can decide what kind of wallet will suit your needs best.
What Are the Different Types of Bitcoin Wallets?
The first thing you need to know about Bitcoin wallets is that they are either hot wallets or cold wallets. Hot wallets are online, i.e. need an internet connection to work, whereas cold wallets keep your keys offline. Let us walk you through each type of Bitcoin wallet to see how they work.
Hot wallets are web wallets, mobile wallets, and desktop wallets that store your security keys on devices connected to the internet. Hot wallets are a convenient option for frequent traders who make daily transactions, but since they are connected to the internet, they are more vulnerable to cyberattacks and hacking.
Some cryptocurrency exchanges offer online Bitcoin wallets. You can easily access these wallets through your browser without the hassle of downloading and maintaining software. You can use these wallets to trade easily on the cryptocurrency exchange.
Most cryptocurrency exchanges, such as Coinbase or Gemini, offer custodial wallets that support multiple digital currencies alongside Bitcoin. With custodial wallets, your security keys are stored by the exchange company on their private servers. On the positive side, this means that you only have to remember your exchange passphrase to log into your account. However, entrusting a third party with your keys also means you are completely dependent on them to keep your Bitcoin secure. Unfortunately, cryptocurrency exchanges often field cyber attacks and if their security is breached, you might lose your digital assets forever.
Another problem with exchange service wallets is that they are not well regulated. Some well-known cryptocurrency exchanges such as Africrypt, Thodex, or QuadrigaCX turned out to be scams that led investors to lose billions of dollars.
If you don’t feel comfortable entrusting your keys to a third-party, you can go with a non-custodial online wallet. You get to keep your private key with non-custodial wallets, they are not stored on company servers. While this is a good solution for those who don’t want to sacrifice security for convenience, it also means that you have the sole responsibility of keeping your keys secure.
Another way of keeping your keys secure is downloading digital wallet software to your computer. A desktop wallet means you don’t have to entrust your private key to a third-party provider.
However, using a desktop wallet means you need to have top-notch security to defend your computer against malware and phishing attacks. While online wallet services use professional security to defend their servers, you probably have limited options to secure your computer. Also, your computer’s hard drive can be stolen or corrupted, so if you have a desktop wallet, it is important to keep a separate backup somewhere else.
If you want to use a desktop wallet, it is a good idea to pick one with a multi-signature (multisig) feature. You need at least two confirmations from separate sources to make transactions with a multisig wallet. Electrum is a Bitcoin software wallet for Linux, iOS, and Android operating systems that also has a multi-signature (multisig) feature.
Mobile wallets are another convenient hot wallet option. You can easily trade on-the-go after downloading a wallet app to your mobile device.
Mobile wallets are not usually recommended because keeping your phone secure can be harder than keeping your computer safe. You can lose your phone or damage it in a way that makes the app useless. However, most mobile wallet apps offer a backup option in case of such events. If you get a mobile wallet, you should keep a backup in a secure place.
The trouble with mobile wallets is that it is sometimes hard to differentiate scams from legit applications. There have been cases of fake apps finding their way into Apple’s App Store, which is often marketed as a safe place to download applications. These apps showcase high ratings and good reviews on the market place, but they are actually scams. They often use names and logos of well-known wallet companies to fraud people into giving up their private keys.
If you want a mobile wallet, make sure it is a legit application by checking with the company’s official website.
Cold wallets provide offline storage for your keys so they are highly secure against cyberattacks. Paper wallets and hardware wallets are both cold wallets. Cold storage is a good option especially if you are holding a significant amount of Bitcoin. However, if you misplace or lose your cold wallet, you permanently lose access to the digital assets.
These are hardware devices that resemble USB sticks that you can plug into a computer when you want to make Bitcoin transactions. Hardware wallets are often praised as the most secure option to store your keys because they are not connected to the internet and they can be protected against theft with additional measures such as PIN codes and passwords.
The upside of owning a hardware wallet is that you can put it into your pocket and travel anywhere. The downside is that you can also forget or lose it anywhere if you are not particularly careful. Another problem is that you might forget your PIN code or password, and end up losing your keys anyways. Unfortunately, these problems are more common than you might imagine.
That said, hardware wallets like Trezor or Ledger offer recovery services that allow you to create backup wallets in case you lose or damage your hardware wallet. Seed recovery services generate a list of 12 to 20 random words that you can use to recover your private key. These words are called seed phrases and they are the last – and sometimes the only – barrier standing between your digital assets and the inaccessible blockchain void. Make sure you print or write down the words carefully and keep them in a safe place, like a safety deposit box. Your daughter’s pillow or a cluttered drawer are not great places to store your recovery phrases.
If you lose your hardware cryptocurrency wallet’s PIN code and your recovery seeds, your only option is to wait until technology improves to a degree that it becomes possible to break the security measures of the wallet.
As you might have taken note, almost every wallet option above requires either keeping a backup or keeping a paper copy of something: a passphrase, PIN code, seed recovery list etc. So we are back to where it all begins: paper.
You can use a wallet generator site to create your own keys and corresponding QR codes to create a paper wallet. First, perform a malware check on your computer. Unplugging the WiFi while generating keys and cleaning your cache after printing them is also advisable.
Paper wallets are almost uniquely safe against technological failure. They can’t be hacked because they are offline, and it is hard to put a PIN code on paper. However, a piece of paper is easy to burn, lose, or destroy. It is best to laminate a paper wallet so that it can remain unharmed for a long time. You can place it in a safe or a safety deposit box to make sure it remains accessible only to you and your family.
A Few Words Before You Go…
Hopefully, you have a better understanding of where Bitcoins are stored and how you can access and manage your BTC through a cryptocurrency wallet application. Bitcoin wallets generate and store your private key, the one piece of information you absolutely must have in order to interact with the Bitcoin blockchain. We explored different types of cryptocurrency wallets you can use to store your keys, and discussed their pros and cons so that you can pick the right wallet for you. It is common practice to use an online wallet for moving small amounts of BTC, and a cold wallet for keeping large amounts of Bitcoin, so don’t feel like you have to settle on one type only.
Remember that hot wallets provide convenience and cold wallets offer increased security. Usually, each wallet type comes with extra security and backup options such as multisig features, two step authentication, or recovery seeds. Research these features well before picking a wallet. If you are good with computers, perhaps a desktop wallet could be the best option for you, or if you are completely disorganized, you should take additional measures to secure your keys. Go with what works for your habits best, but make sure you pick a reputable wallet service.