Cryptocurrencies have grown in popularity and prominence over the past few years. Users can make significant gains on their assets, and investors also see a lot of activity concerning how they can improve their profits using cryptocurrencies.
As expected, the primary reason for holding crypto is for investments. Everyone believes that they can make more money using cryptocurrencies, and they simply hold their assets on exchanges and other custodians. From a functionality standpoint, it makes sense. Most exchanges provide convenience and ensure that you can always access your funds for trading and any other operation.
However, like every other financial innovation, there are risks to putting your cryptocurrencies on exchanges. One of the most fundamental risks concerns your private keys and their safety. So, it’s worth understanding what these keys are and how they matter to your funds’ safety.
Understanding Private and Public Keys
Anyone with a working knowledge of Bitcoin and other cryptocurrencies will know what private keys are. They are essentially the infrastructure that makes Bitcoin one of the most secure cryptocurrencies available.
To understand private and public keys well, consider a good old mailbox. Your mailbox takes in your mail, and it has a specific number - or an address. If anyone wants to send you a letter from around the country, they will need to know this number to be able to send it over.
As the receiver, you have a private address - or a key - to open the mailbox. So, when you get back from work every day, you use your private key to open the mailbox to see if you have a new piece of mail.
To protect your mail and mailbox, you don’t give anyone the keys. Also, you want to ensure that you know where the key is every time, so you can preserve the mailbox and its contents.
The exact analogy applies to cryptocurrencies as well.
When you want to receive Bitcoin, you open an account with a wallet provider, and you get an address. You can send that address to anyone who wants to send you Bitcoins, and they can use it to facilitate the transfer. That address is known as your public address. When the assets come into your wallet, and you would like to spend them, you use your private address (or key) to access them.
The explanation is a tad rudimentary, but you should be able to understand it better from there.
What is the Private Key?
The private key is an alphanumeric combination that you use to spend and send your cryptocurrencies. It is a 256-bit long number that you get once you create an account with a wallet provider. For security purposes, cryptographic functions help to increase the degree of randomness.
An example of a Bitcoin private key is: 5Kb8kLf9zgWQnogidDA76MzPL6TsZZY36hWXMssSzNydYXYB9KF
The Public Key
The crypto public key is another alphanumeric combination obtained through the use of cryptographic functions. They are the addresses with which you get your cryptocurrencies, and they can be given to anyone.
Private keys can’t be reverse-engineered, and it is almost impossible for them to be gotten without your authorization.
The Ideal Application of Private Keys
Private keys are critical to the utility of your cryptocurrencies. They are used to facilitate immutable and irreversible transactions, and they help you spend your assets anywhere. The irreversible nature of your private key-generated transactions is guaranteed via the use of mathematical signatures that are linked to each facilitated transaction.
Interestingly, the digital signatures for each transaction you make with a private key are unique. So, it is impossible to copy your transactions. You can use the same private key as many times as you want without fear.
The Ill-Equipped Nature of Crypto Exchanges
When you get into the crypto space, exchanges are usually your default choice when making purchases. It’s easy to see why - these are established companies, and there is a degree of trust that you have in them. So, you commit your funds and leave them be.
Most users who don’t understand how to get their crypto keys simply rely on exchanges to hold their assets. In truth, this step isn’t all bad. Exchanges make for quicker transactions, and they are more convenient to use and work with. The companies are also more trustworthy, so you get to keep your mind at ease. Over time, exchanges have improved their security infrastructure, and they are now better equipped to help you with security and more.
Still, you should know that centralized exchanges are still not the safest option. Exchanges falter all the time, and there are different ways by which you can find yourself stranded when they do.
Take the case of QuadrigaCX - a Canadian crypto exchange. The company’s chief executive, Gerald Cotten, died in December 2018 due to complications from Crohn's disease while on vacation in India. At the time of his death, the exchange held about $150 million in customers’ funds. However, Cotten was the only person with access to the exchange’s cold wallet private keys. To this day, efforts to crack the cold wallet have proved abortive.
Interestingly, other details about Cotten’s life have come out since his death. For instance, reports confirmed that he had been using customer funds to engage in risky trading and other criminal activities without revealing them to anyone.
Many exchanges are run by structured companies that restrict this sort of fraud or suspicious activity to be fair. However, as a crypto investor, you can’t take the chance. You need to protect your funds at all costs, and exchanges might not be the best bet for you.