Bitcoin cold storage is a complex topic. There is a lot of information one needs to have even understand most of the topics we are going to talk about. The first concept you really have to understand to grasp what is really happening with cold storage is the concept of split key cryptography. Basically what it amounts to is that older systems used one secret to sign messages and secure information, and the participants of the transactions would have to know the key ahead of time. In fact, this is how a credit card works where the bank already knows your card details and simply has to match the characters you provide to authenticate your identity. Although there is an upside to having a central authority that can roll back transactions when necessary, sharing one’s credit card details online makes it very vulnerable to hacks.
Bitcoin takes a different approach – rather than making the transactions reversible which causes a huge number of technical and economic problems, it simply makes the transactions harder to fake. It uses better secret codes in better ways. Bitcoin uses a methodology called public key message signing, specifically the ECDSA or the elliptic curve discrete secret algorithm. Now the way ECDSA works is that you start off with a secret just as you do with your credit card number, and you derive from that code another secret code. The public key, therefore, is derived from the private key, mathematically in a way that is impossible to reverse.
Now, what makes these systems work is the mathematical relationship between the keys, and we can use one key to mathematically prove that we hold the other. The important part is that in the mathematical process, you do not have to reveal the details of your private key. It can be safely stored in its own device, and you can prove you hold it simply by signing messages with that device. This simplifies the complex issue of the security of bitcoin private keys to securing a physical object.
Cold storage, also known as cold wallets, is, therefore, the act of generating and storing the private keys in an offline environment.
Some of the popular cold storage options are:
1. Paper Wallets
It is the most inexpensive form of cold wallets available, and literally contains a pair of private/public keys printed on a piece of paper.
2. Cryptocurrency Hardware Wallets
Although hardware wallets are the safest cold storage option for cryptocurrencies, it comes with a price tag. It is an electronic device that signs transactions and, in the occasion of loss or damage of the device, it allows you to recover your funds using a backup seed key.
3. Storing Cryptocurrency in USB Drive
A USB drive can serve as a cold wallet as well and can be used to export and save private keys on it. However, it is not the safest option since anyone who gets access to your USB will be able to access your crypto coins as well.
Additionally, hardware failures are common with USB.
4. Desktop Wallets
Desktop wallets exist only on your computer and can be used to export files of encrypted private keys in an offline environment. Although this software allows a user to store their private keys offline on their machine, it goes online while receiving or sending funds through them.