Cold storage and hot wallets are two popular security measures that bitcoin users apply to keep their funds safe.
Cold storage is any storage of bitcoins that keeps the coins online. Hardware wallets and paper wallets are examples of cold storage. Cold storage is similar to what happens when a bank moves the funds to a dedicated vault instead of keeping them at a desk of a teller.
Many of the bitcoin wallets are connected to the Internet 24/7. While it is very convenient, it is also risky because it makes such wallets targets of attacks. Cold storage keeps coins offline, which means that hackers can’t access them. In addition to keeping coins offline when not in use, most hardware wallets have a screen and two physical buttons that the owner of the wallet has to press to approve or cancel transactions. A transaction shows up not only on the screen of a computer or mobile device but also on the screen of the wallet. Because of this, it is possible to use hardware wallets even with computers infected with viruses and malware. Finally, having to physically press a button on a hardware wallet means that even if hackers try and send the funds out, they will not be able to do so.
While cold storage can work well for individual users, it doesn’t work for exchanges and other institutions and businesses that may have to deal with a sudden influx of withdrawal requests. This is similar to what a large bank has to deal with in order to provide a large number of customers with an opportunity to access their funds at any point in time. Hot bitcoin wallets provide this kind of liquidity for bitcoins at all times. Unlike cold storage wallets, a hot wallet is online 24/7.
It is a good practice for any business to make sure not to store too many funds in any one hot wallet because if hackers were to attack the business and get access to the funds, the results would be catastrophic.
In addition to this, just like large banks may need some time to approve a large transaction, most bitcoin exchanges do not offer instant processing of large amounts of bitcoins. At the same time, every platform and business has its own definitions of what amount of bitcoins it considers to be large.
Most regular banks in the United States consider cash amounts above $10,000 to be large because $10,000 is the mark at which IRS requires businesses and organizations to file a special tax form. With bitcoin, there are no such forms and regulations, which is why there is no single definition of a large number of bitcoins.
Securing user funds
Protection of user funds is one of the most important concerns of bitcoin exchanges because if even one report of a user losing funds with an exchange appears on the Internet, the reputation of the exchange will suffer immensely. Just like in the offline world, in the online world, bad news tends to spread faster than good news.
Cold storage and hot storage are two most popular methods that bitcoin exchanges use to protect themselves. Many of the exchanges are also working on the proprietary methods and are regularly implementing additional security features.
In 2015, a group of bitcoin software developers started to collaborate with the goal of the creation of Bitcoin Exchange Security Standard and Cryptocurrency Security Standard that all wallet providers and exchanges could use.
Cryptocurrency Certification Consortium (C4) created a proposal and announced it during the DevCore bitcoin development conference in Boston, Massachusetts, in February of 2015. The goal of C4 is to establish standards to help ensure that cryptocurrency networks remain transparent, open, secure, trustworthy, safe and decentralized. C4 offers a number of professional certifications, including certified bitcoin expert (CBX) and certified bitcoin professional (CBP).
Currently, there are over ten approaches to how bitcoin software and exchanges generate private keys and master seeds. Many cryptocurrency software developers also pay a lot of attention to security audits, proof-of-reserve and other cryptocurrency-related concepts that are being developed to this day.
Many of the influential experts in the cryptocurrency world believe that the bitcoin network and other cryptocurrencies should develop and adhere to one unified security standard rather than have various exchanges coming up with their own protection methods that are hard to verify. This approach has led to some great successes in the recent years and is a part of the evolution of the cryptocurrency world.