Storing the intangible - How Bitcoin is locked down

 Today I’d like to talk about how the bitcoin network (and other blockchain networks) store their tokens/cryptocurrencies, and talk about some of the options that we have to keep these assets safe and accessible.

First I’m going to go over a few key Phrases that people use when referring to the storing and transacting of cryptocurrencies.

Public Address (Public Key) - an address used to receive cryptocurrency - is public like a BSB & Account number.

Private Key - A private code used to authorise the spending or withdrawal of cryptocurrency

Wallet (Crypto-wallet/Bitcoin Wallet etc) - a collection of public and private keys, or software used to manage those keys.

Public Addresses vs Private Keys

When looking at how we store and interact with cryptocurrency, it is important to understand the two main components of a crypto-wallet - a Public Address and a Private Key.

All cryptocurrency, in one form or another, exists in a Public Address (a.k.a. – Public Key). This can either controlled directly by you on a paper or hardware wallet; on your behalf in a Custodial Wallet; or on an Exchange - think of this as being your ‘bank account’. Further details on each of these wallet types are provided below.

A Public Address is a 34-character combination of random digits, and upper and lowercase letters (with a few exceptions like uppercase “O”, the number “0”, uppercase “i” and lowercase “L” and as they look similar). The Address shows the current balance of the cryptocurrency blockchain that it is a part of - So you need a unique Public Address for each cryptocurrency that you own, one for Bitcoin, one for Ethererum, one for Litecoin etc. Your Public Address balance is worked out by looking at the entire blockchain history, and calculating the difference between all inputs (Receipt of money) and all outputs (spending of money) for your Public Address. There are 1.46 x 10^48 (a massive number with 16 commas) of potential Public Addresses out there that have not yet appeared on the Bitcoin network, however they may have owners with keys, and will only become ‘live’ when they have completed their first transaction – in the form of an input, or ‘deposit’.

It is important to note that there are no ‘off-chain’ transactions. For any transaction to be valid, it MUST exist on the blockchain.

As the name suggests, a Public Address is public, and is used for receiving cryptocurrency in a similar way that a BSB and Account Number is used for bank transfers. If someone out there has your BSB and Account Number, the only thing they can really do with that information is send you money. The same holds true with your Public Address.

The more important part of the storage of cryptocurrency is the PRIVATE KEY as this is what provides security and is what enables you to withdraw your crypto. The Private Key is generated along with your Public Address by means of a ‘seed’ – this is used to cryptographically link the Private Key to your public wallet address, and this is the ONLY way that you can transfer crypto out of your wallet. Every time you want to send Currency from your wallet, a ‘Signature’ is generated using your private key to authorise the transaction. A signature is unique to every transaction and is verified by the system to ensure authenticity. When people talk about being ‘hacked’ and losing all their Crypto – it is because somehow their Private Key has become compromised.

To summarise: the Public Address is for receiving crypto and the Private Key is for sending.

Also it is worth noting that without the Private Key, the crypto stored in your wallet is completely useless. I recently  met a person who confided that they had lost their Private Key. This person had purchased about 10 Bitcoin a few years ago. He wanted to know if there was a way to withdraw the Bitcoin without the Private Key and unfortunately, the answer is No’.Without the Private Key, the only thing this person can do is  kick themselves while watching their potential gains increase exponentially as the price of Bitcoin soars. With the value of Bitcoin currently sitting at over over AUD 9,000 , this must surely hurt.

Types of Wallets

All wallets do the same thing - they provide an interface to allow you to easily (or not) send and receive cryptocurrency. The biggest difference between them is how they manage security, and how they use and protect your Private Key to ensure that it’s YOU wanting to send crypto to a certain wallet address, and not a hacker.

Paper Wallet: - These are exactly what they sound like, a piece of paper with your Public Address and Private Key on a piece of paper - usually accompanied with QR codes for both keys for convenience. These can be created ‘offline’ (as in you don’t need to be connected to the internet to create it) so that there is no ‘digital’ record of your private key anywhere online (or anywhere assuming you delete/wipe/burn all files after you’ve printed off the wallet). Ironically many consider printing out your offline wallet, laminating it and storing it in a safe deposit box to be the safest way to store your crypto.

Custodial Wallet: - This is a wallet managed by someone else, usually a service operated by a third party that controls your Private Keys ‘securely’ for a fee. In most cases these businesses will have insurance covering all client assets, and the process of transferring crypto is a lot easier for the user, albeit slightly slower - as the user will need to submit a request to transfer crypto out of their wallet, and then wait for the custodian to process the transaction, and then wait for the blockchain to process the transaction.

Exchange Wallet: - Similar to a custodial wallet, whereby the private keys are controlled by an exchange - however these are mandatory for the vast majority of exchanges in order to buy/sell crypto on their exchange. If you want to convert fiat currency into crypto or vice versa the easiest way to do it is via an exchange, and in the majority of cases you will need to have an account and wallet on that exchange. The main difference between this and custodial wallets are that they are free; however they are less trusted by the community after major hacks have affected many exchanges - such as Mt. Gox 2014 (744,408 BTC = $5.21 Billion); Bitfinex 2016 (119,756 BTC = $838 Million); Bitstamp 2015 (19,000 BTC $133 Million); Bitcoinica (2012 46,703BTC = $326 Million and 18,547 BTC = $130 Million a few months later) and many more… note - all BTC Values are at the current exchange rate of roughly $7,000USD.

Hardware Wallet: A specifically designed USB (usually) drive that has been securely hardened to store Bitcoin. It generates wallet keys, verifies and signs transactions on the drive and then uploads the transaction to the network - meaning that only signed transactions are sent to the network, and private keys never leave the drive. This significantly reduces the risk of compromising your private key, as it is always separated from any vulnerable environment (eg - your virus filled laptop, and the internet).

So there is a mix of convenience, security and backup to consider when choosing how you will store your crypto-assets. As time goes on there will be more wallet options and solutions to help solve these issues - and you will need to choose one that works for you - but remember if you lose your paper/hardware wallet or compromise your other keys, it's like losing cash from your wallet - except that you can look online to see your money still sitting there knowing that the 400 BTC you bought in 2012 for under $1000 is now worth more than your house. Taunting you.