What should I use to keep my bitcoins safe: a physical/hardware wallet (like the Ledger) or a software wallet? Or a paper wallet? Or maybe it’s better to leave my bitcoins on my trusted exchange?
What is a wallet?
Bitcoins exist only in the blockchain. This means that a wallet does not “contain” any bitcoins. So what is a wallet?
When bitcoin users makes a transaction, they write something like this on the blockchain: Mary gives Paul 1 bitcoin, signed Mary. A wallet is a software that prepares this writing and sends it to a node, which will replicate it to the other nodes, until a miner inserts it in a block, making it effective.
So a wallet must be able to communicate with the nodes, and must know how to prepare the writing with the source address (Mary), the destination address (Paul), the amount (1 bitcoin), and the signature (signed Mary).
Of this information, one piece is much more important than the others, and it is obviously the signature. Imagine that the wallet prepares the transaction by writing it on a sheet of paper inserted in an envelope. The signature is the sealing wax stamp that seals the envelope with your credentials, making it impossible to forge. The envelope is then taken by the miner and inserted into the blocks of the blockchain.
What is a private key, and how secure can a wallet be?
The stamp that imprints your seal on the sealing wax is called private key, and is a very long number kept inside the wallet. If someone gets this number, they can sign a transaction for you.
The security of a wallet depends on how well the private key is protected (the seal). Three possible types of security can be distinguished:
Type 1: extremely insecure. Any wallet managed by a website. So all the exchanges, or all the wallets for which you have to log into a site to see your cryptocurrencies. Why are these wallets insecure? Because your private key resides on the computer of whoever manages the website, and you are not the owner of it. If someone has your private key, they can sign for you and take everything.
Type 2: moderately insecure. Any wallet that resides on your device (computer or smartphone) that you regularly connect to the Internet, also called “hot wallet”. This solution is better than Type 1, but still liable to failure. How? Well, you have to consider that your coins could be worth a lot in the future, and many people will be interested in them, so special viruses will inevitably be created that will infect computers and smartphones in search of wallets to steal passwords from, probably with a keylogger.
Type 3: pretty safe. A wallet whose private key resides somewhere offline, disconnected from the Internet and which will never go online. This system (cold wallet) is the best way to ensure a valid level of security. Some people print the private key (on paper, wood, aluminum) and don’t even keep it on a digital device, while others use a dedicated, offline computer, just to keep the wallet’s private key. For example, the various hardware wallets that you can buy online (such as the Ledger) are nothing more than small computers that manage a private key to be kept offline. You’ll use a wallet connected to the Internet (without a private key of course) which generates the addresses to receive the cryptocurrencies, and creates the related transactions, when you want to send a bitcoin. In the latter case, however, the wallet will require you to sign the transaction offline, so you’ll have to move it in some way (via QR code, USB key or other) from the online computer to the offline computer, to sign it and then return the signed transaction online to be sent at the nodes.
Cryptocurrencies type of use
All wallets are fine, depending on the case: for example, if you do daily trading, using a wallet with the key offline can be tedious and slow, and in this case it is better to leave the coins on an exchange site. If, on the other hand, you want to buy a cappuccino in the morning, a wallet on your mobile is great for managing money for everyday expenses (commissions permitting). If, on the other hand, you plan to keep bitcoins for the long term, an offline wallet is the best choice.
In any case, the suggestion is always the same: first of all ask yourself in which category the wallet you want to use fits (type 1, 2 or 3), giving you a clear answer on how you want to use your cryptocurrencies.