From multi-sig and HD to cold, hot, and paper — here’s the rundown
So, you’ve bought bitcoin and it is snugly tucked away inside your safe and secure BTC.com wallet. Great news! Now that you’re in the wonderful world of bitcoin, however, you might have noticed that you’ve entered quite the rabbit hole (in a good way, of course)! Bitcoin is funny like that — the more you know, the more there is to know. So let’s head down, focusing on a topic that is relevant to anyone who owns bitcoin: types of BTCwallets.
Multi-signature wallets
If you have opened the BTC.com wallet, you are the proud owner of a multi-signature (multi-sig) wallet. A wallet is known as multi-sig if it requires more than one private key to spend bitcoin. Many multi-sig wallets, including the BTC.com wallet, are known as 2-of-3 multisig wallets. This means that, in order to spend bitcoin, two of the three private keys are necessary.
When you create a BTC.com wallet, for example, one of your private keys is encrypted in the wallet itself. Another is given to you, unencrypted, on your backup PDF. The final private key is securely stored with BTC.com. Should you forget your password, you can use your backup PDF to regain access to your bitcoin, as it will couple with the private key stored with BTC.com to create the two keys necessary to spend bitcoin. In the unlikely event that you forget your password AND lose your backup PDF, your bitcoin will be gone forever, as only one of three private keys will be available. Requiring two private keys is a safety precaution, and assures you of your funds’ safety.
Want to learn more about private keys? Check out our guide.
Hierarchical Deterministic wallets
In addition to being a multi-sig wallet, the BTC.com wallet is also an example of a Hierarchical Deterministic (HD) wallet. An HD wallet generates a new bitcoin address for each transaction made, greatly improving security and safety. These wallets create these addresses sequentially, using a master, or primary, seed, meaning that even though a new address is used each time you send or receive bitcoin, your wallet can be recovered using the original primary seed, which, in the case of a BTC.com wallet can be found on your backup PDF.
If you haven’t already, be sure to look over our step-by-step recovery process, which we posted on the blog a while back.
Hot wallets
If a bitcoin wallet is hot, it is online, connected to the internet in some way. A hot wallet might be a good idea if you plan on frequently using your bitcoin, whether you will be sending or receiving. It should be noted that hot wallets are best suited for storing smaller amounts of bitcoin for relatively shorter amounts of time. Transactions made using hot wallets can be near-instantaneous, and are very convenient. A typical bitcoin user will probably want some sort of hot wallet, just like a typical civilian will want to keep money in a checking account. If you have a large amount of bitcoin, however, you might also want to look into creating a cold storage wallet.
Cold storage wallets
A cold wallet is a bitcoin wallet that is not connected to the internet. If hot wallets are the checking accounts of bitcoin, cold wallets are more closely aligned with savings accounts, as they are best used for long-term storage, meaning that the bitcoin inside it will not often need to be accessed.
One example of a cold wallet is a hardware wallet, which is a physical device that is kept in your home or office, and can be connected to a computer when you need access to your bitcoin. Transactions are accomplished by pressing a button on the wallet itself, making hardware wallets essentially impossible to hack.
Some wallets, when created, will generate a mnemonic phrase (or seed), and instruct the user to write it down and store it in a secure location. A mnemonic phrase is a list of words that, together, contain all the information you need for the wallet’s recovery. In the unlikely event that you somehow lose access to your hard drive or computer — or simply lose your password — a mnemonic phrase will allow you to regain control of your bitcoin. Like hardware wallets, mnemonic phrases are very, very secure.
The above XKCD comic shows why a mnemonic phrase is so safe. Now, you won’t have to remember the entire list of words, as you might a password for Facebook or your email, but the point regarding security remains the same.
Another type of cold wallet is a paper wallet. This type of wallet is rather strange, as it consists solely of a document or printed-out piece of paper containing all the information to access bitcoin stored at one specific address. A paper wallet is different from a hardware wallet, in that hardware wallets can generate more than one address, while the paper wallet is bound to one private key.
If, for whatever reason, you don’t trust the technology of a hot or hardware wallet, a paper wallet might be an option for you. A downside of a paper wallet is that you can’t immediately confirm that it is working, without using the keys and essentially defeating the purpose of a paper wallet altogether. That said, they do have their place, depending on how you use (or do not use) bitcoin.