TL;DR
A hardware wallet is a physical device designed to store your private keys offline, and therefore protect them from online threats.
Hardware wallets provide several benefits when it comes to the security and safe storage of cryptocurrencies.
While hardware wallets are one of the most secure ways to store your cryptocurrencies, they are not without a few potential risks. Familiarize yourself with safety tips on how to use a hardware wallet securely.
What Is a Hardware Wallet?
A hardware wallet is a physical device specifically designed to store the private keys of cryptocurrencies offline. Private keys are used to sign transactions, which means having access to one's private keys is the same as having access to one's crypto assets.
Hardware wallets, also referred to as cold wallets, protect private keys from digital threats, such as malware or hackers, by ensuring that the keys never leave the device when used to sign transactions internally. This makes them one of the more secure methods for storing cryptocurrency.
In contrast, software wallets, or hot wallets, are online applications installed on devices like a computer or smartphone, offering greater accessibility but being more vulnerable to internet-based attacks.
How Does a Hardware Wallet Work?
Since hardware wallets are offline at all times, they must be used alongside another machine that is connected to the Internet. Hardware wallets are typically built to be able to plug into PCs or smartphones without leaking the private key — even machines that have been infected by malware. From there, they interact with software that allows the user to view their balance and make transactions.
Once the user creates a transaction, they send it to the hardware wallet (1 in the diagram below). Note that the transaction is still incomplete: it needs to be signed by the private key in the device. Users confirm that the amount and address are correct when prompted on the hardware device. The transaction is then signed and sent back to the software (2), which broadcasts it to the cryptocurrency’s network (3).
A Step-by-Step Guide to Using a Hardware Wallet
Using a hardware wallet involves a few key steps. While the specifics can vary between different models and manufacturers, the general process is as follows:
Setup
Purchase a reputable hardware wallet
Only buy hardware wallets from reputable sources to avoid tampered devices. It’s crucial to buy them directly from your chosen brand’s official website and ensure the wallet is sealed when you receive it.
Initialize the wallet
Connect the hardware wallet to your computer or smartphone. This usually involves downloading a specific app or software to interface with the device.
Create a new wallet
The device will guide you to set up a new wallet, which includes generating a new set of private keys.
Backup
Write down the recovery phrase
During setup, the wallet will display a recovery phrase (usually 12-24 words from the BIP39 word list). Write these down and store them in a secure, offline place. This recovery phrase can restore your wallet if the device is lost, stolen, or damaged.
Read on to understand the difference between a recovery phrase and a private key.
Security
Set a PIN
Most hardware wallets will allow you to set a PIN for additional security. This PIN will be required to authorize transactions.
Receiving cryptocurrency
Find your address
Use the wallet's app or software to find your public address for the cryptocurrency you want to receive.
Share your address
Provide this address to the person or exchange sending you cryptocurrency. They will send the cryptocurrency to this address.
Sending cryptocurrency
Create a transaction
Use the wallet's app or software to create a new transaction. Input the recipient's address and the amount of cryptocurrency you want to send.
Sign the transaction
The hardware wallet will sign the transaction with your private keys. This is done within the device, so the keys never leave the wallet.
Broadcast the transaction
After you've signed the transaction, the wallet's software will broadcast it to the rest of the network.
Differences Between a Private Key and a Recovery Phrase
Private keys and recovery phrases are designed to control access to your cryptocurrencies. However, they represent two different formats and use cases.
Private key
A private key is a secret number - commonly in a hexadecimal format - that allows bitcoin or other cryptocurrencies to be spent. It’s a critical part of the cryptography systems behind cryptocurrencies. It's used to sign transactions, providing mathematical proof that they have come from the owner of the wallet.
Recovery phrase
A recovery phrase, seed phrase, or backup phrase is a list of words that store all the information needed to recover a cryptocurrency wallet. This phrase represents the private key(s) in a human-readable format.
It's used as a backup to restore access to your cryptocurrencies if you lose access to your wallet, lose your device or forget your PIN or password.
In summary, the private key is the raw, non-human-friendly format that's used internally within the wallet and for signing transactions, while the recovery phrase is a human-friendly format that's used for backup and recovery. The recovery phrase is usually easier to write down and store securely than a raw private key.
Does the Private Key Ever Leave the Hardware Wallet?
One of the fundamental security principles of a hardware wallet is that the private keys never leave the device.
Users create a transaction on their computer or smartphone, and this transaction data is sent to the hardware wallet, which signs the transaction internally with the private key. The signed transaction is then sent back to the computer or smartphone. At no point during this process is the private key exposed or transferred out of the device.
However, there have been proposals by hardware wallet manufacturers to add recovery options that would essentially allow the private keys to be reconstructed outside of the hardware wallet, which has been controversial.
Ten Tips for Using Hardware Wallets Securely
Considering the benefits and risks of hardware wallets, it’s good to keep in mind the following 10 tips when using hardware wallets to maximize security.
1. Buy a hardware wallet from a trusted source
Always purchase your hardware wallet directly from the manufacturer or a trusted retailer to avoid tampered devices.
2. Update to the latest firmware
Always keep your wallet's firmware up-to-date. Manufacturers often release updates to improve security and functionality.
3. Never share your recovery phrase
Your recovery phrase is as powerful as your private key. If someone else gets it, they can take control of your cryptocurrencies. Never share it, and be cautious of anyone asking for it.
4. Keep your recovery phrase secure and offline
Store your recovery phrase in a safe, secure, and offline location. Don't store it digitally or online where it could be susceptible to hacking.
5. Use a strong PIN
Set a strong PIN to protect your device from unauthorized use. Don't use a PIN that is easy to guess, like "1234" or "0000".
6. Double-check addresses
When sending cryptocurrency, always reconfirm the recipient's address. Malware can change addresses copied to your clipboard.
7. Verify transactions on the device
Always verify the transaction details on your hardware wallet's screen before confirming, not just on your computer or smartphone screen.
8. Keep your wallet secure
Treat your hardware wallet as you would valuable jewelry or large amounts of cash. Store it in a secure location when not in use.
9. Consider using a passphrase
For extra security, some wallets allow you to add a passphrase in addition to the PIN. This effectively creates a hidden wallet. However, if you forget the passphrase, there's no way to recover it, so use this feature with caution.
10. Use trusted computers
Try to only connect your hardware wallet to computers you trust and that have good security measures in place. You should avoid plugging your hardware wallet into devices simply out of convenience.
Benefits and Risks of Hardware Wallets
Hardware wallets provide several benefits, especially in terms of security and safe storage of cryptocurrencies. Here are some of the key benefits:
Security
Hardware wallets are designed with strong security measures. They store your private keys offline, keeping them safe from online attacks, such as phishing, malware, and hackers.
Private key isolation
The private keys never leave the device and all transactions are signed within the device, further protecting your private keys from exposure.
Backup and recovery
Hardware wallets generate a recovery phrase (also known as a seed phrase) during setup. This can be used to recover your funds on a new device if your original device is lost, stolen, or damaged.
Durability & portability
They're designed to be robust and durable, more so than a piece of paper where one might note down private keys or recovery phrases. Most hardware wallets are small devices, similar in size to a USB stick, which makes them easily portable.
Control over your funds
With a hardware wallet, you're in complete control of your cryptocurrencies, as the crypto community says, “not your keys, not your coins.” With a hardware wallet, you’ll hold your own private keys, which means you don’t have to worry about custodian risks.
While hardware wallets are one of the most secure ways to store your cryptocurrencies, they are not without potential risks. Some of the risks associated with using a hardware wallet include:
Physical theft or loss
Since a hardware wallet is a physical object, it can be stolen or lost. If someone knows your PIN or can guess it, they could potentially access your cryptocurrencies.
Supply chain attack
If you buy a wallet from an unreliable source, it could have been tampered with before it reaches you. Always buy directly from the manufacturer or a trusted retailer.
Phishing attacks
A phishing attack could trick you into entering your PIN or recovery phrase into a computer that's been compromised, potentially revealing this crucial information to hackers.
Failure to back up properly
If you lose your hardware wallet and haven't properly backed up your recovery phrase, you could lose access to your cryptocurrencies.
Forgetting PIN or recovery phrase
If you forget your PIN or lose your recovery phrase, you could be locked out of your wallet permanently.
Damage
The device can be damaged by water, fire, or just through wear and tear. If the device is damaged and you haven't kept a backup of your recovery phrase, you could lose access to your cryptocurrencies. But if you have kept a backup of your recovery phrase, you can regain access via a new device.
Firmware vulnerabilities
While rare, vulnerabilities in the wallet's firmware could potentially be exploited to gain access to your private keys. Always keep your wallet's firmware up-to-date and purchase hardware wallets that have been thoroughly audited and peer-reviewed.
Address verification
If you don't carefully verify the address on the device's screen during a transaction, malware on your computer could trick you into sending cryptocurrencies to the wrong address.
Each of these risks can be mitigated through careful practices such as proper backups, careful verification of addresses, purchasing from trusted sources, and maintaining good physical security of the device.
Closing Thoughts
Hardware wallets represent a strong balance between high security and ease of use for managing cryptocurrencies. They provide a highly secure environment to store your digital assets offline, and they allow for safe transactions even when connected to a compromised computer. However, like all security solutions, they are not entirely foolproof and require careful handling and responsible usage by the user.
One should always remember that private keys or recovery phrases should never be shared. They should be stored in a secure, offline location. Buying from reputable sources, setting strong PINs, regularly updating wallet firmware, and carefully verifying transaction information are also critical steps to ensure the security of your assets.
Hardware wallets are indeed a cornerstone of cryptocurrency security, but the ultimate responsibility lies with the user who needs to be aware of all the potential risks and losses that could occur. Understanding the technology and adhering to best practices can greatly minimize these risks.
Further Reading:
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