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Hardware Wallets

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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, for example, ‘Please
sign this transaction,’ and not, ‘Show me the private key you are storing’.
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.
The user interface software is run on an online machine. When it comes
to the critical part of the transaction (the signing), the unsigned
transaction is sent to the hardware wallet, which returns the signed
transaction without revealing the private key.
Hardware wallets are more secure than software-only wallets, but
nothing is infallible.
Cold Storage
The phrase ‘keeping coins in cold storage’ 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. As private keys are just strings of characters
like:

There are many ways of storing them. You can memorise keys if you have
a good memory, you can print them out on bits of paper, you can even
engrave them on a ring that you wear, like Charlie Shrem did according to
WIRED Magazine146. 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.
If you do keep private keys on a device or printed out, you wouldn’t want
someone else to be able to see it and use it 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 print
out, they’d need to decrypt it with your passphrase before the private key
is revealed. You can split keys or use multi-sig addresses for further
security. This means if one part is found by a thief, it is useless without
another part, and also means if one part is lost, the other two will still
work. Remember, you are trying to simultaneously guard against two
things: Loss of keys and theft of keys.
Hot Wallets
A hot wallet is a wallet that can sign and broadcast transactions without
manual intervention. Exchanges, who control many bitcoins need to
manual intervention. Exchanges, who 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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