Blockchain technology has revolutionized the way we think about and use money. In the past, if you wanted quick access to your capital, a simple glance into your wallet or a trip to the nearest ATM would often suffice. However, in the world of cryptocurrencies, it’s different. The blockchain not only acts as a middleman but also as a custodian, capturing every transaction in a public, immutable ledger. Money is not stored in the traditional sense in a bank account or in a physical safe. Instead, cryptocurrencies—or more precisely, the coins—are digitally documented and secured on the blockchain.
Each of these coins is associated with two types of keys: a public key and a private key. The public key serves as a sort of public address, comparable to a traditional bank account number, which everyone can see and to which anyone can send money. The private key, on the other hand, is strictly confidential and comparable to a personal password or PIN number. Only the person who possesses this key can access and use the corresponding digital assets.
However, this also means: if you lose the private key, you also lose access to your digital assets. A prominent example of this is James Howells from Wales. [1] Due to a moment of carelessness, he threw away a hard drive that stored his personal keys (Public and Private Key) — which would grant access to approximately 8,000 Bitcoins. As of the end of August 2023, this amount of Bitcoin would be worth around 190 million USD. It’s a loss that’s almost unimaginable and likely also permanent, as without the private key, there is no way to access the Bitcoins — there’s no alternative validation method, such as using an identification card, to legitimize oneself.
This story highlights an important principle in dealing with cryptocurrencies: It’s not just important to know where the digital assets are located, but it’s equally crucial to securely store the corresponding access keys. In this context, we introduce in this post the two prevailing models for storing cryptocurrencies: The Hot Wallet (Custodial Wallet) and the Cold Wallet (Non-Custodial Wallet).
Hot Wallets: CONVENIENT, BUT RISKY
Hot wallets, constantly connected to the Internet, grant users immediate and uncomplicated access to their cryptocurrencies. But this convenience comes with a significant trade-off: people often hand over their private key to platforms like Coinbase, Binance or MetaMask (custodial wallet) and thus lose direct sovereignty over their digital assets.
While such services simplify cryptocurrency trading, they are exposed to risks such as cyberattacks or internal system failures due to their constant online presences. The well-known mantra “Not your keys, not your coins” underscores the essential importance of key custody in this regard: without control over the key, there is also no real handle on the digital assets. In respect to these risk factors, every user should carefully examine whether quick access is worth the possible loss of his investment and how reputable the respective provider is.
COLD WALLETS: ANALOG SECURITY, BUT CUMBERSOME
Cold Wallets are a solution to the security challenges that come with Hot Wallets. While Hot Wallets are constantly online and generally managed by the service provider, Cold Wallets stay offline, and both keys are under the direct control of the user (Non-Custodial Wallet). The keys can be stored on various media, from specialized hardware devices to simple paper printouts.
Hardware Wallets, similar to USB sticks, store the private keys for accessing digital assets. They are often used by institutional investors and individuals who own larger amounts of cryptocurrencies. Market leaders in this area include companies like Bitbox, Ledger, and Trezor.
Paper Wallets offer another way to store private keys offline. In this method, the keys are simply printed out and securely stored. Although this method might be considered “oldschool,” it provides robust security against online attacks, as long as the paper is securely stored.
The main advantage of Cold Wallets is their reduced vulnerability to data theft. They are not connected to the Internet, which gives hackers fewer opportunities to access the stored values, as long as the physical security of the devices or paper is ensured. In times of advanced technologies like quantum computing, however, the “guessing” of private keys could become possible, allowing access to the blockchain independent of private key theft. Nonetheless, Cold Wallets remain the preferred choice for institutional investors and those who place a premium on additional security.
Seedphrases: The DIGITAL SAFETY NET
When setting up a hardware or software wallet, the seed phrase—a predetermined sequence of words—is an indispensable security feature. If the hardware wallet is lost or damaged, the seed phrase allows for the recovery of the cryptocurrencies stored on it. It serves as a safety net for accessing the digital assets on the blockchain.
CONCLUSION: IN THE DIGITAL AGE, SECURITY IS OF UTMOST IMPORTANCE
Cryptocurrencies not only represent a technological breakthrough but also reshape our concepts of property and ownership. The secure storage of Public and Private Keys, as well as Seed Phrases, is of central importance in the digital currency environment. The intriguing contrast between digital money and analog security strategies highlights the relevance of combining time-tested security approaches with the latest technology. At this juncture, our banks must offer active solutions to their customers. Why should individuals and companies entrust their digital assets to foreign apps or international crypto exchanges when they have traditionally relied on their banks for financial matters? Especially since the storage solution serves as a pivot point for many other value-added services.
