Letter #99: What’s In Your (Bitcoin) Wallet?
Read now to learn how choosing the correct wallet type can make all the difference when it comes to the security of your Bitcoin
If you’ve decided that entrusting your Bitcoin holdings to a third-party custodian isn’t worth all the risk of loss, censorship, and confiscation, then your path of discovery may lead you to wonder which self-custody setup is best to protect your Bitcoin. After all, self-custody is rather nuanced and there are many different ways to secure the keys to your Bitcoin kingdom.
My goal with today’s Letter is to ensure each of you understands the basics of different Bitcoin wallet types. It’s important to have a good jumping off point to determine the setup that will work best for your situation. Each wallet type has unique pros and cons, and I’m hopeful we can better understand each of them along the way.
A Refresher On Private Keys
Before we can truly appreciate how different wallets work, it’s helpful to remember what your Bitcoin wallet actually protects.
One of the most fundamental building blocks of the Bitcoin blockchain is public-key cryptography. Public-key cryptography helps to facilitate the transparent nature of Bitcoin transactions by associating holdings with specific public keys, often referred to as Bitcoin addresses, that are easily viewable on the blockchain. But it ensures the security of the same holdings through use of the private key indelibly linked to each public key. Anyone can view a public key, but only the person or entity who controls the linked private key can move or even claim to own the Bitcoin associated with a particular public key.
Simply put, a Bitcoin wallet protects the private key required to move your Bitcoin. So in a very real sense, the security of your Bitcoin holdings is extremely reliant on the security and functionality of your Bitcoin wallet. If your wallet malfunctions or gets lost, and you haven’t maintained some sort of backup like a seed phrase, you could very well never have access to your Bitcoin again.
The ABCs of Wallet Types
Perhaps you’re beginning to understand why securing your wallet and the private key it protects can have such a big impact on the safety of self-custodied Bitcoin. This is definitely not an area where you want to skimp on research and preparation.
To get you started, let’s look at several of the most common wallet types:
A paper wallet is exactly what it sounds like. With this setup, your private key is written out on a piece of paper, usually as a series of words known as a seed phrase or as a scannable barcode. As you can imagine, a piece of paper is impossible to hack and may also be innocuous enough to evade detection in cases of physical theft. They are also relatively easy to create since you need nothing more than a piece of paper and a writing utensil.
That simplicity is often a double-edged sword though. Pieces of paper are easy to lose and are susceptible to accidental destruction by fire, water, age, or a host of other elements. Many people have tried to mitigate those risks by printing their “paper” wallet on a more durable material, like wood or metal. But those bulkier materials are naturally more noticeable by someone who might be interested in running off with your private keys. So if you go the route of a paper wallet to secure your Bitcoin, you’ll need to decide what tradeoffs you’re willing to accept.
By the way, don’t save a copy in the cloud, your email inbox, or the notes of your internet-connected phone or computer. Doing so defeats the purpose of having a paper wallet by making the digitized version hackable through the internet.
Software wallets are probably the most commonly used setup, if for no other reason than that there are so many options to choose from and people can set them up in just a few minutes on their computer or phone. In a nutshell, a software wallet is simply any software program that holds your private key. But they also typically come with a polished user interface to make viewing and moving your Bitcoin as simple as possible.
Software wallets suffer from some pretty severe drawbacks though, in my opinion:
They’re usually connected to the internet, meaning that your private key is accessible to any hacker smart enough to bypass the security of the app, program, or cloud where your private key is sitting.
Your private key is at the mercy of the developers in charge of programming and maintaining the wallet’s software. What if there’s a glitch? What if there’s an insider attack? What if the software company goes out of business or is shut down?
Software wallets are certainly different from setups with third-party custodians, but they do both seem to suffer from a similar amount of counterparty risk.
Hardware wallets are often considered to be the most secure setup for self-custody. They are typically made from durable materials that are resistant to destruction or deterioration. They’re also built for one purpose, storing Bitcoin private keys, so there’s less risk of unrelated software causing a glitch or system failure, like can sometimes happen with a phone or computer.
Hardware wallets are not without risks however. Many of them are designed to resemble USB sticks and drives, making them noticeable targets for thieves. Similarly, their reliance on physical hardware makes them susceptible to degradation over time, as well as interception and compromise during shipping from the manufacturer to your location.
No Bitcoin wallet is 100% secure, but that doesn’t mean that they can’t be a vast improvement over custodial solutions offered by crypto companies around the world. After all, whose fingers would you rather have in your wallet, your own or someone else’s?
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This is not financial advice. This newsletter and related content are for informational purposes only. Cryptocurrencies and digital assets can be risky. Always do your own research before making any sort of investment.