Imagine your cryptocurrency as digital money stored in a virtual wallet. Now, a cold or hardware wallet is like a super secure vault for that digital money.
Think of it as a USB stick or a small device resembling a mini computer. Instead of keeping your cryptocurrency online, where it could potentially be vulnerable to hackers, a hardware wallet stores your digital coins offline, often disconnected from the internet.
When you want to transact, connect the hardware wallet to your computer or phone, do your business, and then disconnect it again. This way, even if someone tries to hack into your computer or phone, they can’t access your cryptocurrency because the private keys needed to move the money are stored safely offline on the hardware wallet.
In simple terms, a cold or hardware wallet is like a digital safe for your cryptocurrency, keeping it protected from online threats.
KEY TAKEAWAYS:
— The expression “not your keys, not your coins” refers to needing to own the private keys associated with your funds
— The person owning private keys is the one deciding how the crypto assets associated are spent – if you don’t own this, you’re entrusting your crypto to a third party
— If you do own your keys, you have complete control over how to use your funds
— Owning your keys also means being responsible for their security.
Public and Private Keys: Explained
Like a bank account number, cryptocurrencies are sent to a receiving address. The technical term for this address is the public key. When someone sends you some Bitcoin, they will send it to your public key. It’s called public since you can send it to anyone without compromising your crypto.
There is, however, another key that is linked to your public key. That would be the private key. This key is vital. Anyone with access to the private key can access the funds on the public key linked to it. In simpler terms, a private key is similar to a password – a means of identifying you as the true owner. When speaking of “not your keys, not your coins,” it refers to your private key.
Centralized Platforms Retain Custody Of Your Keys (And Therefore Your Coins)
When logging into your favorite crypto exchange, it might seem like you own the coins on your account. After all, you need to log in to access them, right?
Wrong. Not all exchanges work in the same way. Some cryptocurrency platforms, such as centralized exchanges, use custodial wallets. Put simply, custodial wallets allow users to access them but not own them. In fact, the centralized entity governing these platforms has the power to take a cut of any cryptocurrency transaction you make. This is because you don’t own the private keys to the crypto assets on your account – the exchange or centralized platform does instead.
This phenomenon isn’t limited to exchanges: it goes for any wallet provider that doesn’t allow you to own the keys to the associated funds. If you don’t own the private keys, you are not the true owner of the funds – you’d be entrusting a third party to it. This means they can do whatever they want with the cryptocurrencies on your account.
Self-Custody of Your Private Keys: Why It Matters
There are many reasons why you’d want to own your keys rather than leave them in the custody of a third party, requiring you to trust your funds to them.
The most obvious is accidentally entrusting it to malicious actors. Should you have trusted a malicious third party with your money, you’ll likely never see it back. Thankfully, this is quite unlikely for established companies.
Even then, you will never be in total control over your own money with them. As mentioned previously, they can set certain restrictions like a maximum withdrawal limit or fees associated with using their services. They can decide what you can do with your own hard-earned money. Also, if their platform has any technical issues, you’re basically locked out of your cryptocurrencies. In short, so long as you don’t own your keys, you won’t have financial freedom, and your funds remain at someone else’s mercy.
In addition, you won’t have control over the security of the platform’s system either—you’re outsourcing your cryptocurrency’s security to them. Unfortunately, over the years, there have been major hacks that have stolen around 2 billion dollars.
The opposite is true if you own your private keys. By having the private keys, you can set your own rules. There won’t be anyone else telling you what you can or cannot do with your own cryptocurrencies. By having your keys, you fully own your coins and can enjoy financial freedom.
Having your own keys does come with an important responsibility, though: you must ensure you’ll be the only one to hold those private keys. Anyone who manages to get their hands on them can access and take your cryptocurrencies.
