Protect Your Bitcoins Against Theft and Hacks

How Do You Protect Your Bitcoins Against Theft and Hacks?

Even though the cryptocurrency industry has only gone mainstream over the past decade, it has already produced a narrative so well known it’s almost a cliche. An individual, or perhaps even a digital currency exchange, is subjected to a malicious hack.

As result, a large sum of digital currency goes missing. The hackers seem to vanish into the void of internet anonymity, taking with them digital assets impossible to trace or recover.

Cold Wallets Are Key

Many investors buy a popular digital currency like Bitcoin or Ether on an exchange, only to keep the currency on that platform. Digital exchanges take safety precautions to prevent thefts, but they are not immune to hacks.

One of the best ways to protect your investment is to secure a wallet. There are two primary types of cryptocurrency wallets. Of the two, “cold storage” or “cold wallet” hardware devices are the safer option.

These wallets look like USB drives and act as a physical store for tokens or coins. Because they’re not connected to the internet, cold wallets cannot be hacked online. Each hardware wallet comes with a private key: a password-like bit of code that decrypts the wallet, giving access to the coins or tokens that it stores. While hardware wallets are tremendously effective against digital thieves, the carry a different risk: Lose your password key, and you’ll never recover the contents of the wallet.

Other Types of Wallets

Those a bit squeamish about relying on a device that can be taken or misplaced to store digital currency can use secure online wallets instead.

Like cold wallets, online wallets tend to have private keys that are not recoverable if missing, so it’s absolutely essential that you store your private key in a secure location that you’ll remember. Individuals have gone to extreme measures to safeguard their keys—keeping them in safe deposit boxes or as encryptions in graphic files. Some users have gotten tattoos with their key information.

Paper wallets are a particular type of online wallet. They are generated by web platforms such as BitAddress or WalletGenerator. These applications create Bitcoin addresses and private keys that can then be printed out. Once the paper wallet’s key is printed, it is removed from the online wallet and network. The CryptoHex wallet takes the process a step further by stamping the key information on a strip of metal.

Desktop wallets are another option. There is no direct interface between them and the internet. However, there are viruses that are designed to retrieve information for these wallets from a desktop computer, so such wallets may not be as secure as the options above.

Digital Currency Exchanges

Most transactions involving cryptocurrencies are done via a digital currency exchange. These platforms are typically accessible via a web browser or a mobile application and allow users to acquire tokens and digital coins using either a fiat currency or a different cryptocurrency.

Cryptocurrency security experts recommend against keeping any digital currency holdings on an exchange for two primary reasons. First, if the exchange is hacked, you may lose your holdings. Second, if the exchange were to fold for any reason, you may not have recourse to recover your holdings.

There is no cryptocurrency equivalent of the Securities Investor Protection Corporation (SIPC), which protects clients of failed brokerages against losses of up to $500,000 per account, including up to $250,000 for cash balances. Nor is any cryptocurrency wallet insured directly by the Federal Deposit Insurance Corp. (FDIC), which provides up to $250,000 of protection for deposits at qualifying banks and credit unions.

Instead, many cryptocurrency exchanges let customers hold their U.S. dollar balances in linked accounts at partner banks insured by the FDIC. But that protection doesn’t extend to client crypto balances.

To safeguard their customers’ holdings of cryptocurrency, exchanges rely on a mix of security precautions and insurance coverage. For example, FTX US says it stores most customer digital assets in cold storage at BitGo Trust, the institutional digital custody specialist that offers up to $250 million of insurance coverage against the theft or loss of private keys it holds. FTX US client crypto assets held in “warm” or “hot” digital wallets accessible online are covered by the exchange’s $7.5 million “primary crime insurance policy” from AON Plc (AON), the London-based insurance broker and risk specialist.

Although savvy cryptocurrency investors typically move their holdings off the exchange platform once they’ve completed a transaction, trading on a digital currency exchange still entails custody risk. That makes it all the more important to choose one’s exchange carefully.

Popular digital currencies like Bitcoin, Ether, Cardano, and Ripple are available on a wide variety of crypto exchanges. These providers are not all the same with regard to safety and security; a bit of due diligence is required on the part of the investor to be sure that they are not running unnecessary risks in the transaction process by operating on an unsafe exchange.

In the case of other digital currencies, particularly those that are less popular or newer to the scene, the exchange options may be more limited. Still, if an exchange seems to lack security or can’t convincingly explain how it safeguards client funds, it’s best to avoid it.

Investing in cryptocurrencies and Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns Bitcoin, Ethereum, Cardano, and Ripple.