Thursday, November 28, 2013

Got Bitcoin? How not to lose them (updated!)

UPDATE: The day after I posted this, the news broke that the well known bitcoin site coindesk was hacked and hackers stole over $1m of bitcoin. Chief executive Kris Henriksen wrote on the Bitcoin Forum: ‘Please be advised that attacks are not isolated to us and if you are storing larger amounts of coins with any third party you may want to find alternative storage solutions as soon as possible.”

A few months ago, I wrote a bit about the difficulties I had buying bitcoin.  Well, eventually, as a result of establishing a bunch of wallets and setting up accounts (some verified, some unverified) in a dozen different bitcoin exchanges and sites, I was finally able to start buying bitcoin, although in small quantities.

As a result, I ended up with small amounts of bitcoin in different wallets spread between my hard drive(s), and various online places or web wallets.

The next question I faced was: once you’ve got some bitcoin, where should you store it? 

With the expanded coverage of bitcoin due to its dramatic rise recently, this is becoming an even more important question.

There was a well publicized account recently of an IT professional in the UK who got quite a few bitcoins from mining a few years ago (until his girlfriend told him to shut down the computer at night because it was making too much noise).  Earlier this year, he inadvertently threw away the hard-drive that had the bitcoin on it.  Today the bitcoin are worth $7.5 million!

So, having all your bitcoin in one wallet on one hard drive may not be the best place to keep them.  Of course, you should backup your hard-drive, that should help, but it’s not failsafe.  What if your house burns down? What if you lose the backup?  There are some bitcoin clients let you print out your private key (or a way to re-generate your private key) – but what if you lose that piece of paper?

And both of those don’t protect you from someone stealing your hard drive (or making a copy of the piece of paper with the private key on there) and then spending those bitcoin for you.

So what’s a bitcoin owner to do?

In the real world of what’s called fiat currency – i.e. USD and the like -- we don’t store cash (or even gold or securities) at home for these very reasons – they could get stolen, burned down or otherwise destroyed.  Rather we use the banking system to keep track of our money.  Can we learn anything from the traditional banking system?

Well that would be funny, because the whole point of bitcoin is to get around the traditional banking system. 

Well, the equivalent of banks would be online wallets or exchanges where you buy and sell bitcoin, like coinbase and bitstamp and localbitcoins or mt gox.  This seems like a good idea as well since they have servers (multiple servers, I’m sure) and back up their data regularly. 

But there are non-trivial drawbacks to storing your bitcoin on these sites as well:

  1.  Security.  There have been a number of well publicized break-ins and thefts of bitcoin from servers.  There was one in Australia where a well known site literally lost millions of dollars in bitcoin through a breakin – and the best they could offer their clients as an apology.  Also, all someone needs is your password and they could break into your account, perhaps this is even easier than breaking into your house. 
  2. Web accounts vs web wallets.  Most of these sites don’t actually store your bitcoin separately from others.  Instead, they keep track of the bitcoin you have in your account, and store them in central pools.  Try it – go to one of these sites and look for the single bitcoin address that holds all of the bitcoin you have in that address.  If they are holding your currency in a pool, again the possibility exists of something going wrong.
  3. Solvency.  These sites are run by companies which may or may not be well funded, and it’s possible they could go out of business. What happens to your bitcoin then? They’re locked in some address that’s owned by the business.  Are you technically a creditor of a company that holds your bitcoin and goes bankrupt? I don’t think this is really clear.
  4. Regulation.  At one point, the US government made it difficult for people to get their money out of exchanges like Mt. Gox, so it could be a tricky situation when you use these sites to store your bitcoin, then you sell some of it.
  5. Scams. In another well known example, there was a website in China where people deposited bitcoin in web wallets, and the people who setup the site decided to just take the bitcoin and run with it. 

Unfortunately, there is no FDIC (Federal Deposit Insurance Corporation) for bitcoin. At least not yet. After all we didn’t have FDIC until so many banks went belly up in the Great Depression.

So, having bitcoin on your hard-drive is kind of like having cash under your mattress.  And storing bitcoin in online accounts is kind of like putting your money in banks before the Great Depression.

So, again I ask, where should you store your bitcoin?

The right answer, for now anyways, is nowhere.  Or rather, everywhere. 

To be more specific, don’t store it in just one place or one type of wallet/account.  

In a fault tolerant system, one part of the system can go down, but the others can keep going. An old trick used by those with lots of money when FDIC only insured up to $100K per account was to have different accounts in different banks, each with $100k in them.

I came upon this solution of spreading out my bitcoin by chance, since I ended up buying bitcoin on different sites.  My plan was to transfer all the bitcoin to my hard-drive, but then as I thought about it I realized having a significant amount of bitcoin on one hard-drive, even with a backup, is probably not the best idea, so I left small amounts on various sites and even transferred from my hard drive to some web wallets.

As more and more people see bitcoin as an asset class to store your savings, just like stocks and bonds, it’s bound to be regulated in some ways (maybe even with something along the lines of an FDIC).   But today, it’s still the wild wild west, and my advice is, don’t put all your bitcoin eggs in one basket!

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Blogger Bart Pycke said...

Did you check out Coinkite? Closest thing to a Bitcoin Bank.

3:01 AM  
Blogger adam bell said...

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11:40 AM  

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