Before starting off with Hardware Wallets, we just remind ourselves of the fact that we worked on the details of software wallets in the last session. Wallets Sometimes Bitcoin wallets can have a hardware component. Private keys are stored in chips on small handheld devices. Two popular hardware wallets are called ‘Trezor’ and ‘Ledger Nano,’ but there are others.
These devices are specifically designed to store private keys securely and only respond to certain pre-programmed requests. In Hardware Wallets because the private key is stored on hardware that is not connected to the internet and can communicate with the outside world only via a limited set of pre-programmed interfaces, it is much harder for a hacker to gain access to the private keys.
Hardware Wallets – Cold Storage
The phrase ‘keeping coins in cold storage’ with respect to Hardware Wallets was popular in 2013-17 before hardware wallets became widely available. Remember, you don’t store bitcoins, you store private keys. ‘Cold storage’ is keeping a note of those private keys on offline media, such as a piece of paper or a computer not private keys on offline media, such as a piece of paper or a computer not connected to the internet. You could store them on an offline computer which, for increased security, should not have a modem or network card. You could write them down and put them in a bank’s locked deposit box. These are all methods of storing your private keys offline.
In Hardware Wallets, if you do keep private keys on a device or printed out, you wouldn’t want someone else to be able to see them and use them to steal your bitcoins. So one way of increasing security is to first encrypt the private key with a passphrase that you can remember and then store or print out the encrypted result. Passphrases are a lot easier to remember than private keys! This means that even if someone gets hold of the device or prints it out, they’d need to decrypt it with your passphrase before the private key is revealed.
Hardware Wallets – Hot Wallets
In Hardware Wallets, a hot wallet is a wallet that can sign and broadcast transactions without manual intervention. Exchanges, which control many bitcoins need to manual intervention. Exchanges, which control many bitcoins need to manage lots of Bitcoin payments, as we will see later. They often have a ‘hot wallet’ that controls a small proportion of their total bitcoins. Customers of exchanges like to withdraw bitcoins from the exchanges by clicking a button, causing an automated process to run to make and sign a Bitcoin transaction moving bitcoins from the exchange’s hot wallet to the user’s personal wallet. This means that somewhere, a private key belonging to the exchange must be stored on a ‘hot’ machine connected to the internet.
There is a trade-off between security and convenience. Online machines are easier to hack than offline machines but can automate the process of creating and broadcasting Bitcoin transactions. Due to this trade-off, exchanges keep only a small fraction of BTC in hot wallets, enough to satisfy customer demand, similar to banks that keep a small amount of cash in tellers’ tills at branches.
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