Once bitcoins have been acquired, the next question is how you want to store them. Since bitcoin is a form of currency and wealth storage, this is a very important step because security is a huge concern. There are two major types of storage: hot and cold. The differences are as follows:
- Cold storage deals with a wallet that is either entirely offline or is at least encrypted with its password stored offline. This can be a wallet stored on a USB drive or online backup site, as well as paper wallets.
- Hot storage is considered as coins that are easily accessible for sending funds.
For people that plan to actually use their coins for purchases and trades, hot storage is just fine. For those that want to keep them secured for years, cold storage is the way to go.
How to Use Cold Storage
As stated, cold storage is considered as a wallet that is highly protected. A way to set this up on a local system is to install Bitcoin QT on an offline computer and then encrypt the wallet before ever using it. Cold storage is also part of sites like Coinbase and Blockchain.info, although this must be done be done by choosing cold storage options within these websites.
The important thing to realize with regards to cold storage is that it’s only as safe as you make it. Even if you encrypt your wallets, if the system you are accessing them from to send funds (which requires unlocking the wallet prior to making the send) has been compromised, it’s possible for attackers to still get access to your coins. As a result, it is important not only to create addresses safely when using cold storage, but also access them safely.
An excellent tutorial on how to both create and utilize cold storage is this one from the official bitcoin site. The guide helps explain everything that is needed to both create and secure the coins. Just keep in mind that security only matters if you’re doing everything you can to keep it secure. The biggest flaw most people have with their wallets and them being stolen is steps they skipped or things they ignored.
For the majority of bitcoin users, hot storage is what is used. This allows for easily accessing coins to spend them, as well as accepting them. In a sense, this is what we call the true wallet, being that the coins are accessible at any point without too much effort. This type of storage has a few different options:
- Local storage
- Online wallets
Each of these have their own pros and cons, as we’ll now look at.
Local storage is the only manner in which coins can be stored with absolute control. There is no risk with storing coins locally when it comes to sites shutting down or having rogue employees run off with coins. You are in direct control over your wallet, what is done with the wallet, and all keys associated with it.
The downside to local storage is that you need to keep constant backups in a safe and secure location every time a new address is generated or a transaction is sent. Not doing so puts all of the coins in the wallet at risk due to a system crash or other complication. Along with this, you are responsible for keeping the system the wallets are on secure from intruders: both online and offline.
There is also the off-chance you might accidentally throw them out or lose them.
Online wallets are best compared to being like an online bank account. You store your coins in the wallet and then can access them when you need them. This takes a lot of the risk out of holding coins locally, given that backups are handled by the online wallet service. At the same time though, it opens the doors to a new kind of risk: service breaches. An employee of a site could decide they want to run off with all of the coins. The site could go out of business. There are a lot of variables that should be considered.
For online wallets, a site like Coinbase is by far one of the most trusted. They are backed by venture capitalists and have proven themselves to be a reliable online wallet provider. Storing and using coins on Coinbase is also just as easy as with a bank account: simply transfer the coins in by using the deposit addresses and transfer them back out through withdrawals.
Exchanges are like online wallets, in the sense that they work in a similar manner. For people to trade coins through an exchange, they need to have a method for storing coins there. This is in effect an online wallet. The storing of coins on exchanges is great for those that want to do trading, as it makes things much faster and easier, but it also brings with it a couple of problems.
Exchanges are major targets for both attackers and scams. When it comes to being able to trade the latest and greatest coins, some scammers will set up new exchanges for the sole purpose of taking everyone’s money. And when it comes to attackers, exchanges are known to be carrying quite a big stash of loot for taking. This makes them prime targets.
Along with this, exchanges often charge large fees for withdrawing. Some, for example, will charge 0.002 BTC for a withdrawal. The client and network itself, on the other hand, would only require a fee of 0.0001, or 5% of that amount. While this isn’t a big deal for a couple of transactions, if you are someone that is dealing in bitcoins pretty often, these add up quickly.
Picking a Wallet Storage Method
Generally speaking, most people will either store their coins locally (in an encrypted wallet) or through a site like Coinbase. Coinbase allows for the transacting of coins from anywhere, at any time, while the local wallet can only be accessed when you are at the system that is hosting it. There is really no right or wrong here; it is simply a matter of convenience.