This post is structured as a question-&-answer. That’s because it was originally an answer at Quora, a Q&A site at which I am a Bitcoin columnist.
What is a ‘Paper Wallet’
A paper wallet is the ultimate offline wallet. It simply means that the private address to your crypto wallet is printed on paper — either as a string of characters, a QR code, or a series of seed recovery words.
If you destroy any electronic copy of your original wallet (e.g. the private keys that give you access to your wealth), then hiding this piece of paper is very similar to hiding a bar of gold. The only way that someone can steal it or know the amount it represents is to get their eyes and hands on something physical. They would need to know that you tucked it into your mattress or behind a secret panel of your cellar wall.
In my opinion, a paper wallet, though secure, presents a big risk to the owner—even bigger than the potential for a hardware wallet to be hacked. We’ll get to this later.
Example of a Paper Wallet
The image above is a paper wallet printed onto a card [click to enlarge]. There are web sites that will help you print one with a new or existing wallet address. One popular site is BitAddress. [Warning!]† After printing and storing the paper wallet in a place that you believe is secure, that you will not forget—and that your family can get to some day in the future)—delete all electronic copies of your original address (i.e. if you did not create a completely new wallet in the process).
More about Paper Wallets
Like other wallets (a software app, or a dedicated hardware device), your wallet contains private keys that access your wealth on the blockchain. But in the case of a paper wallet, it is made private and secure by hiding this slip of paper where no one can ever see it or peek at it online. Think of it as if you are hiding a valuable diamond.
A paper wallet cannot be hacked, unless it is within range of a camera. But the diamond analogy breaks down, because a paper wallet has other risks than hacking…
It can be lost, damaged in a flood or fire or chewed by termites or your dog. More likely, it can be forgotten for years. When your heirs finally discover it under the mattress or taped to the back of a painting, they are unlikely to recognize its purpose and simply throw it out.
Hosted Wallet: Complete Opposite of Paper Wallet
You didn’t ask for the other extreme wallet scenario. But this seems like a good time to discuss it.
When it comes to security –vs- convenience & recovery, an exchange-hosted wallet is at the other end of the spectrum. With this type of wallet, you do not control your private keys. In fact, your crypto isn’t even in a wallet dedicated to you. Instead, it is aggregated with assets of all other clients. You are trusting the exchange to track your stake via a traditional account relationship. When you spend or receive Bitcoin (or other cryptocurrency), the transaction occurs withing the exchange. It is not transmitted directly to a blockchain or Lightning Network.
Advantages of an exchange hosted wallet:
- A reputable, hosted exchange (there are very few)‡ implements and follows rigorous backup, security and disaster practices. These safety practices are probably more diligent, standardized and adhered to than whatever you would do with a software, hardware or paper wallet.
- A reputable, hosted exchange maintains your account information and instructions in their records and acts on these instructions. As with a traditional bank or broker, they pass wealth to your heirs or executor, if you provide the beneficiaries and instructions in your account profile.
With a personal wallet under your control, it is more likely that your relatives will not know about your wallet, lose it, or fail to distribute assets as you intended. This will change in the future, as multisig becomes standardized and easier for end-users to understand and use. But for now, a traditional custodian has an edge in transmitting wealth from one generation to the next.
Disadvantages of an exchange hosted wallet:
- Your money could be completely lost if the exchange does not practice very good security practices, is dishonest or becomes insolvent. (It happened with more than half of the exchanges during the first 5 years after Bitcoin was unveiled!). It is less likely today, but only if you choose your exchange carefully.‡
- With Bitcoin and most cryptocurrencies, transactions are never anonymous, nor even very private. That’s a myth. But with an exchange hosted wallet, your wealth and activities are even more exposed to outside scrutiny. That’s because reputable hosts are quick to comply with subpoenas, court orders, tax authorities and even local police investigations. They want to be seen as safe. To project this image, they are proactively compliant with oversight and proposed regulations.
- Your money can be frozen or seized by the exchange (for whatever policies they deem appropriate) or from authorities outside the exchange. Often, the reasons make no sense to individual clients affected. This happened to me very recently!
- Large computer based servers experience technical glitches—which often coincide with your most urgent need to access funds.
† Extreme Caution Recommended
BitAddress has an excellent reputation and has never been the focus of suspicion. Their source code is written in a popular script and is short enough to enable scrutiny by many developers and analysts. Additionally, the creation of your wallet and printout can be performed completely offline (no internet connection). You can further enhance safety by performing the wallet creation and printout from a PC that will never be connected to the internet. (Yes! It is that important to use paranoid practices to avoid exposure of your private keys).
Despite the quality reputation and transparency, I do not currently recommend using BitAddress to create a paper wallet.
- At the time of publishing, BitAddress has a problem with their web security certificate. This makes it possible for your web traffic to be hijacked by a DNS spoof. (This Blog does not have a security certificate at all, but you are not using it to store or create confidential information).
- Unnecessary risk is introduced by merging the process of creating a new wallet with conversion into a physical printout. Look for a tool that is completely off-line and that enables you to create a QR code or seed words for a wallet address that you already own.
Once BitAddress fixes the problem with security, the following process will protect your private keys from interlopers:
- Go to bitaddress.org
- Switch the internet off
- Save the HTML file in a USD device
- Restart the computer with a bootable Linux Live CD
- Make sure that you are offline and open the HTML file
- Follow the rest on bitaddress.org to create a paper wallet
If you download another tool to create a paper wallet, search for one that is open source and vetted by thousands of developers, users and armchair detectives. Choose one that is hosted by SourceForge or GitHub and carefully read user forums and reviews.
‡ Why are their few reputable cryptocurrency exchanges?
Regulations pertaining to cryptocurrency exchanges are not yet uniform, nor even widely understood. Additionally, there is no Federal account insurance for your hosted wallet. (Currently, the market is too volatile and risky for traditional underwriters to step up).
But, a well-capitalized exchange with high-profile investors is likely to adhere to rigorous security practices and unscheduled audits with public transparency. These reputable exchanges also work hard to comply with federal and regional regulators, and they comply with money transmitter practices, such as KYC, AML and RICO.
In my opinion, very few exchanges meet these rigorous standards, especially in this early era—which is often compared to the Wild West. Two very reputable exchanges are Coinbase (San Francisco) and Bitstamp (Founded in Slovenia and incorporated in the UK; Now, they are based in Luxembourg).
These big, reputable services mitigate the risk of hacking and theft by keeping most client assets in a ‘cold storage vault’ (off line and powered down). Your wealth is only attached to the internet when requested and in the quantity that you need. The rest is never exposed. Your online purchase or transaction is made after you have received email and text messages about the status of your coins.
Philip Raymond co-chairs CRYPSA, hosts the Bitcoin Event and is keynote speaker at Cryptocurrency Conferences. He is a top writer at Quora.
