Cryptocurrencies are stored either in hot wallets or cold wallets. Hot wallets are always connected to the internet and are easier to set up. Access to, and spending these coins are relatively easier in hot wallets. Cold wallets, on the other hand, are storage devices and can range from simple pieces of paper to external storage units like hard drives or pen drives, or even encrypted phones and computing devices that aren’t connected to the internet. Thus, cold wallets are considered much safer than hot wallets. They, however, support a small number of coins as compared to hot wallets.
For a more explanatory article on different types of wallets: Hot Wallet or a Cold Wallet
How are Cryptocurrencies stored?
In order to store a cryptocurrency, you will need:
- A Public Key
- A Private Key
When someone decides to send cryptocurrency to you over the blockchain, they are sending those coins to a hashed version known as a Public Key. Another key, known as a Private Key is hidden from everyone on the blockchain and only known to the user. The private key can be used to derive the public key.
How are Cryptocurrencies Stolen?
The private key is used to generate a signature for each transaction involving the transfer of cryptocurrency. This means that a user signs the transaction for the cryptocurrency that they want to send to another person on the blockchain, using a private key. If someone obtains your private keys, they would be able to transfer your cryptocurrencies to themselves, hence stealing the coins from your wallet.
Coins Stolen from Hot Wallets
By using a hot wallet, the private keys will always be stored on a cloud storage which is always connected to the internet. There is always a risk of your wallet getting compromised if hackers manage to get a hold of your private keys. If your private keys are stolen, it is guaranteed that your coins will also be stolen from your wallet. An estimated $1.1 billion worth of cryptocurrencies were stolen by the end of the second quarter of 2018.
Coins Stolen/Lost from Cold Wallets
Cold wallets are more secure than hot wallets as they don’t require an internet connection, which makes it next to impossible for anyone to try and hack into. This makes it such that you can guarantee the safety of your coins from hackers, as the private keys are stored on a physical device. These devices can range from writing your private key information on a piece of paper to storing them on external hardware devices like pen-drives, external hard drives, laptops, phones or tablets.
The only drawbacks are related to the fact that one cannot instantly transact using a cold wallet, as they require to be connected to a computing device for transactions to take place on a blockchain. Another drawback is the fact that except for one or two specialized wallets in the market, one cannot store multiple cryptocurrencies in one wallet.
How do you recover stolen/lost Cryptocurrencies?
In the case of hot wallets, users usually set them up with cryptocurrency exchanges. Chances are that it might get hacked in case of a breach. In this case, the exchange is responsible for its recovery but there is no guarantee that you will get your coins back.
When Bithumb was hacked in June 2018, it was later reported that the company managed to recover almost 50% of the hacked coins. In most cases, and this is the reality of these exchanges – retrieving stolen coins is close to impossible, in which case the coins are lost forever.
In recent times, however, people have found techniques and methods to recover stolen coins. A zero-knowledge proof is one such method where one party (the prover) can prove to another party (the verifier) that something is true, without revealing any information apart from the fact that a certain specific statement is true. In regular blockchain transactions, the details of a particular transaction are visible to every other party in the network. In contrast to this, zero-knowledge transactions only let others on the network know that a transaction has taken place but the details of the sender, recipient, asset class and quantity are unknown.
The ways in which you can recover from cold wallets are:
- Paper Wallets: Storing your key information in paper wallets is a very traditional concept which is now defunct. Misplacing or losing these papers without accurately remembering the details (Which is nigh impossible for any individual without photographic memory) will cause you to permanently lose your coins. The best way to safeguard your coins would be to store your paper wallet into a vault or safety deposit box.
- Pen drives, Hard drives: These devices are the most secure way to store your coins. One of the ways that you could lose your coins in these devices is if they get damaged or corrupted. Retrieving your data from these damaged or corrupted devices by professionals can prove to be an expensive affair. The other way to lose your coins is by losing or misplacing your device altogether.
- Encrypted Devices: Encrypted laptops and phones work like hardware wallets, where you can store and access your private key information. Like hardware wallets, you can retrieve deleted or lost information through professional help.
Read More: Is a Cold Wallet Really Safe?
In a nutshell, coins stored in hot wallets can be subject to hacks and theft resulting in the loss of your coins – unless your designated exchange takes some measures to restore them or tries to retrieve them from hackers. Using cold storage wallets is at the user’s discretion where you are completely responsible for the safety of your wallet, and subsequently your coins.
It’s situations such as these that have led to companies looking to create products, such as Cryptocurrency Theft Insurance to protect your crypto and safeguard your digital assets. Once products like these are successfully released, this will certainly boost the value and adoption of cryptocurrencies.