Don’t Risk It! The Alarming Reasons You Must Store Your Private Key Offline
Before diving into the details, let’s begin with the conclusion. The phrase that best captures the essence of digital assets is “Not your keys, not your crypto.”
We are aware that many cryptocurrency users have lost their assets due to security incidents across various blockchain services. According to Cointelegraph, during the first three quarters of 2024, approximately $2.1 billion (USD) was lost, primarily from centralized finance platforms (CiFi). Among other central exchange incidents, the Japanese exchange DMM was hacked, resulting in a $305 million (USD) loss, the Turkish exchange BtcTurk lost $55 million (USD), and the Indian exchange WazirX faced one of the largest hacks of the year, with hackers stealing $230 million (USD). Last but not least, one of the world’s largest exchanges, FTX, went bankrupt in 2022, with estimated losses amounting to around $8 billion (USD).
Secondly, all cryptocurrency assets operate anonymously, meaning that the ownership of cryptocurrency is authenticated solely by your private key, not by your name or any other personal information. Therefore, if your private key (or seed phrase) is lost or hacked, you lose ownership of your assets. The private key, which is the only proof of ownership for digital assets on the blockchain network, is represented as a hash value; a combination of numbers and letters. Since this hash value is impossible for humans to remember, an industry standard called BIP39 was created, which converts the hash into a set of human-readable words. Nearly all blockchain wallets display 12 or 24 seed phrases (recovery words), which are randomly selected from a list of 2,054 words that can be easily found online.
While all blockchain wallets use seed phrases (recovery words) to represent the private key, the main difference lies in where the private key is stored. A hardware wallet (cold wallet) stores the private key on a separate device that is not connected to the internet, while a software wallet (hot wallet) stores the private key on an internet-connected device. Of course, each type of wallet has its advantages and disadvantages (e.g., hot wallets are free, while hardware wallets are paid), but from a security perspective, hardware wallets that are not connected to the internet are much safer from hacking. In this article, we will explore how hardware wallets securely protect your private key.
🔐 How Hardware Wallets Work
A hardware wallet operates in conjunction with a separate device that is connected to the internet, as illustrated in the diagram below. This device could be a PC, laptop, or mobile device, which allows the hardware wallet to interact with the blockchain network. The internet-connected device plays a crucial role in managing transaction data, while the hardware wallet remains isolated from direct internet exposure to maintain security.
The primary objective of a transaction is to transmit transaction data to the blockchain network in order to move digital assets, such as cryptocurrency. However, for this process to be securely executed, an electronic signature, generated using the private key stored in the hardware wallet, is required. To initiate a transaction, the internet-connected device first retrieves relevant data from the blockchain network, such as the recipient’s address, transaction amount, and other necessary information. As shown in the diagram, once the transaction data is prepared, it is sent to the hardware wallet for signing.
When the transaction data reaches the hardware wallet, which is not connected to the internet, the wallet uses the private key to generate an electronic signature. This signature is a critical element that ensures the authenticity and validity of the transaction, guaranteeing that only the owner of the private key can approve the movement of assets.
Once the electronic signature is created, the signed transaction data is returned to the internet-connected device. At this stage, the transaction is ready to be transmitted to the blockchain network. The internet-connected device sends the signed transaction to the blockchain, where it is verified and added to the ledger. This ensures that the transaction is confirmed, and the assets are successfully transferred to the intended destination. Importantly, the signed transaction sent to the blockchain contains no information about the user's private key—only the electronically signed data is transmitted to the blockchain. This means that even if someone gains access to this data, they will not be able to extract any private key information, as it is designed to be secure in such situations.
Throughout the entire process, the hardware wallet ensures that the private key never leaves the device, maintaining a high level of security. By keeping it offline and protected from potential cyber threats, users can safely interact with blockchain networks by combining the use of a hardware wallet and an internet-connected device, minimizing the risks associated with online transactions.
🛡️ Safe Private Key Storage
Imagine storing your private key on a smartphone or PC that is connected to the internet. If a hacker gains access to your smartphone or PC, it could pose a serious security risk. For instance, if the hacker figures out your phone’s lock pattern or PIN, they essentially gain control of your private key. This is because the private key is stored on the smartphone, meaning the security of your digital assets depends solely on the lock screen security of your phone.
On the other hand, if you use a cold wallet (where the private key is stored on a separate hardware device), you don’t need to worry about losing your assets, even if your smartphone is lost or stolen. Since the hardware wallet is a standalone device, no private key-related information remains on your smartphone. Even if a hacker steals both your smartphone and hardware wallet and tries to access your assets, hardware wallets come with built-in security features. One of these features is that if a password is entered incorrectly more than a certain number of times (usually 10), the wallet resets itself, preventing the hacker from accessing your assets even if they have both devices.
Additionally, most hardware wallets (with a few exceptions) use a special semiconductor chip called a Secure Chip. This technology has been used for decades in various applications such as payment cards and passports. The Secure Chip stores private keys in an encrypted format and automatically deletes all data if it detects unauthorized access. Therefore, even if a hacker physically possesses the hardware wallet, it is nearly impossible for them to extract the private key. However, hardware wallets that do not use Secure Chips may be vulnerable to private key extraction using development tools, and related videos can be easily found on Google.
In the rare case that you lose or damage your hardware wallet, you can restore your private key on a new device by entering the 12 or 24 recovery words you recorded when you first set up the wallet. After verification, your private key will be restored on the new device. However, if the recovery words are entered incorrectly or in the wrong order, a different private key could be generated instead of the original one. This makes it crucial to ensure that the recovery words (seed phrases) are accurately recorded and securely stored. In fact, managing and safeguarding your recovery words is even more important than managing the hardware wallet itself.
Sometimes, people store their recovery words on a smartphone or PC connected to the internet, which poses a security risk. If that device is hacked, the hacker could input those recovery words into another wallet, clone the private key, and then steal your assets without your consent. Therefore, it is essential to always store and manage your recovery words offline to ensure their safety.
🚨 Defense Against Man-in-the-Middle Attacks
Even if a hacker doesn't physically steal your hardware wallet, they can still access your assets through other methods. One common technique is a man-in-the-middle attack, such as address swapping, which occurs between the hardware wallet and the internet-connected device. For example, when transferring assets from your hardware wallet to an exchange, you must verify that the recipient address on the exchange is correct. However, since address strings are made up of letters and numbers, they are often unfamiliar and difficult for most people to recognize. Malware that has infiltrated your internet-connected device could change the recipient's address to the hacker’s address. If you do not carefully verify the transaction details, you might send your assets to the wrong address, resulting in a loss of funds.
This is why it's crucial to ensure that your hardware wallet can verify all transaction details directly on the device itself, without relying on the internet-connected device. You should only approve and sign the transaction after confirming important information, such as the recipient’s address, directly on the hardware wallet. For added security and convenience, hardware wallets like D'CENT provide additional authentication methods, such as fingerprint recognition, and display transaction details directly on the device, further enhancing security.
Today, hackers are constantly evolving and finding new ways to steal private keys and assets. Additionally, unexpected security incidents or shutdowns of exchanges highlight the need for users to protect and manage their digital assets. Hardware wallets can be the ultimate solution for this. Of course, there’s no need to reiterate the famous phrase, "Not your keys, not your crypto."
This blog is for educational purposes only. Information presented here, including projects or brands mentioned, is informative and not financial, legal, or tax advice. While we strive for accuracy, we cannot be held liable for any inaccuracies. Cryptocurrencies are inherently risky. Do your own thorough research and consider consulting a financial advisor for investment decisions aligned with your goals and risk tolerance. External links may be present and we are not responsible for their content or practices. Review their terms of service and privacy policies.