What is cold storage?
/If you’ve been in the crypto industry for any length of time, then you have most certainly heard of cold storage. But despite the popularity of the term, relatively few have actually utilized this technology personally. The reason for this is that many people trust their counterparties, and in a perfect world that would be enough. However, as we all know - this is not a perfect world and counterparties do fail. Therefore, it’s important to understand how cold storage works because without this critical piece of technology - crypto would not really be secure at all.
Cold storage may bring to mind images of small devices that resemble a USB thumb drive, but in fact these devices are not necessary to use cold storage. While a hardware wallet, such as a Trezor or Ledger Nano do make use of cold storage capabilities, it’s entirely possible to store your private keys offline without using one. From a high level, that’s what cold storage really is - simply the ability to keep your crypto off of the internet so that it can’t be stolen.
Source: https://bitcoin.org/en/download
The popular software referred to as “Bitcoin” can be run from most normal computers by simply downloading the software and installing it like any other program. The software then syncs with a network of peers and has a wallet to send, receive, backup and recover your crypto. The way the backup and recovery process works is that your private key can be encoded into a series of words that are commonly used in the English language. These words, which come in sets of 12 or 24 most of the time, can be written down on a piece of paper or any other way you prefer such as being engraved in metal.
For example, if I download the Bitcoin Core software bitcoin.org and install it. It will then allow me to receive Bitcoin to a Bitcoin address. If I then want to back up and move my coins into cold storage - I would simply write down my backup words and store them somewhere and remove the software and the wallet from my computer. Now, a would-be hacker has no chance of obtaining my private keys because they simply aren’t on my computer.
So where do hardware wallets come in? A hardware wallet is a handy device that can store the private keys for you in such a way that you can send or receive your crypto using any computer or phone and then sign the transaction with your hardware wallet. Without your signature, the transaction would not be valid. These devices also come with a little notebook to write down your recovery information so that in the event of an unfortunate boating accident your crypto is not lost permanently.
Hardware devices have enhanced security features such as PIN lockout while maintaining compatibility with online services such as Metamask. When signing a transaction, for example, a user must enter their PIN to unlock the device and then press a physical button to approve the transaction before transmitting. The PIN code must be entered correctly or the device will eventually “Brick” itself meaning that it can become permanently locked. This ensures that if someone did manage to steal your device, they would have to guess your PIN with very few attempts or the funds would simply remain inaccessible.
The level of security that an individual or an institution requires generally scales with the size of the stack. While some individuals may be comfortable simply writing down their recovery phrase themselves, exchanges have various security protocols which can be quite complex. Coinbase, for example, is reportedly using Faraday cages and offline printers to ensure that no electronic signals can be sent or received during any critical operation, such as a move into or out of cold storage.
If you’re not actively trading your crypto on an exchange, there’s a strong case to be made to use some kind of a custodial solution, whether it’s self custody or delegating custody to another institution that specializes in that sort of thing. But at the very least, it’s important to understand that cold storage is one of the reasons that crypto, when used properly, does have a high level of security. However, as with anything related to security it’s incumbent upon the user to take all necessary precautions such as creating a backup of your recovery phrase and storing it in a remote location and not using a PIN on your hardware wallet such as “1234.” Doing so would be the equivalent of purchasing a very large and expensive bank vault to store your valuables but then leaving it unlocked with the door wide open overnight.
Cheers,
