Bitcoin gives one sovereignty, but the responsibility of safe storage is the cost of continuing to enjoy such sovereignty. The promise of permissionless money that is tamper-proof and sensor-proof is only realistic if the Bitcoin is held in self custody.
BUENOS AIRES, ARGENTINA – MARCH 17: A person holds a cold wallet at the Bitcoin cultural center on … [+]
There are risks to storing one’s Bitcoin on a centralized exchange, including counterparty risk, the risk that the exchange would be hacked and your Bitcoin would be stolen, and the risk of rehypothecation. To mitigate these risks, Bitcoin owners may choose to self-custody all or a portion of their Bitcoin holdings.
When one owns Bitcoin, they own a public key that is similar to a mailing address. To get paid in Bitcoin, they share the public key. To spend their Bitcoin, they use a private key. The private key is any 256-bit number from 0x1 to 0xFFFF FFFF FFFF FFFF FFFF FFFF FFFF FFFE. If another person has access to your private keys, they can spend the Bitcoin in your wallet. To protect your Bitcoin, you have to make sure that no other person can access your private keys, except in the case of inheritance.
Hard wallets
Hard wallets are physical storage devices used primarily to store private keys. The majority of them are flash disk drives or hard disk drives. They are the most secure way to store Bitcoin because they are stored offline. Ledger and Trezor are two companies that make hardware wallets.
After configuring your hardware wallet, you will be given a recovery phrase, which you should write down on paper or other offline medium. You will also have a four-digit PIN number to access the wallet via a desktop computer or smartphone.
Hard wallets are portable, and you can carry them around the same way you would carry cash money. Unlike cash, nobody will know that you are carrying a hardware wallet and how much is contained in it.
If you lose your cash, there is little that you can do to safely recover it. However, if you lose your hardware wallet, you can use your backed-up recovery phrase to recover your Bitcoin in another hard wallet.
Hard wallets are sometimes referred to as “cold wallets” since they do not require a computer or smartphone to be connected to the internet.
Hot wallets
Hot wallets are online software wallets that are used to store private keys. They provide the most utility, but they are less secure than hard wallets. Hardware wallets are preferable for long-term storage of Bitcoin because they do not require frequent updates.
There are two types of hot wallets. Custodial and non-custodial wallets. Custodial wallets make sure you don’t own your keys and the wallet provider exposes you to counterparty risk while non-custodial wallets allow you to own your private keys and give you the responsibility to self-custody your Bitcoin.
A hot wallet that supports the lightning network may be ideal for a checking account where you frequently transact in Bitcoin. The Bitcoin lightning layer enables faster and less expensive transactions. Blue Wallet, Wallet of Satoshi, and Muun wallet are some popular wallets that support lightning.
The Lightning layer on top of the Bitcoin blockchain is still in its early stages, and many lightning wallets are custodial. This means that certain Bitcoin hot wallets that support the Lightning network own and control the user’s private keys. This exposes the clients’ Bitcoin to the same risks that users who hold Bitcoin on an exchange face.
Bitcoin inheritance
If you store your Bitcoin securely, your beneficiaries may not be able to access your accumulated Bitcoin in case you die or become incapacitated. It is imperative to set up an inheritance plan to make it easy for your beneficiaries to benefit from your stored Bitcoin.
The best Bitcoin estate plans involve having a trusted party with whom you can share the locations of your hard wallets, lists of hot wallets, and addresses of your exchange wallets. Alternatively, one can seek the services of an attorney and develop a will or subscribe to the services of a crypto inheritance firm.
The idea is to make it simple for your beneficiaries to learn that you own Bitcoin, to check and verify the size of your Bitcoin holdings, to learn where the Bitcoin is stored, and to learn how to retrieve such Bitcoin.
It is critical to avoid exposing your private keys to a lawyer, friend, or family member when creating a crypto estate plan. In the past, a family member trusted with private keys decided to use Bitcoin for personal gain even before the planned event.
Why is self-custody important?
Owning your Bitcoin private keys allows you the power to enjoy the full Bitcoin benefits. You do not need any permission to store, send, and receive Bitcoin. With self-custody, there are no know-your-customer (KYC) requirements, and you can transact your Bitcoin pseudonymously.
If you decide to keep your Bitcoin on an exchange, you run the risk of being held hostage by the government or the exchange. In addition, the exchange could be selling you paper Bitcoin and pushing the price down.
Some exchanges can freeze your Bitcoin transactions, set limits on the amount you can transact, and even use your deposits to back up their exposures.
If you want to send a large amount of Bitcoin, my personal rule is to start with a small amount. Once you’ve confirmed that the transaction was successful, send the larger amount. It is important to note that if you send your Bitcoin to the wrong address, there is no way to recover it and there is no customer service.
