Securing bitcoin is challenging because bitcoin is not an abstract reference to value, like a balance in a bank account. Bitcoin is very much like digital cash or gold. You’ve probably heard the expression "Possession is nine tenths of the law". Well, in bitcoin, possession is ten tenths of the law. Possession of the keys to unlock the bitcoin is equivalent to possession of cash or a chunk of precious metal. You can lose it, misplace it, have it stolen or accidentally give the wrong amount to someone. In every one of those cases, the end-user would have no recourse, just as if they dropped cash on a public sidewalk.
However, bitcoin has capabilities that cash, gold and bank accounts do not. A bitcoin wallet, containing your keys, can be backed up like any file. It can be stored in multiple copies, even printed on paper for hard-copy backup. You can’t "backup" cash, gold or bank accounts. Bitcoin is different enough from anything that has come before that we need to think about bitcoin security in a novel way too.
The core principle in bitcoin is de-centralization and it has important implications for security. A centralized model, such as a traditional bank or payment network, depends on access control and vetting to keep bad actors out of the system. By comparison, a de-centralized system like bitcoin pushes the responsibility and control to the end-users. Since security of the network is based on Proof-of-Work, not access control, the network can be open and no encryption is required for bitcoin traffic.
On a traditional payment network, such a credit card system, the "payment" is really open-ended because it contains the user’s private identifier (the credit card number). After the initial charge, anyone with access to the identifier can "pull" funds and charge the owner again and again. Thus, the payment network has to be secured end-to-end with encryption and must ensure that no eavesdroppers or intermediaries can compromise the payment traffic, in transit or when it is stored (at rest). If a bad actor gains access to the system, they can compromise current transactions and payment tokens that can be used to create new transactions. Worse, when customer data is compromised, the customers are exposed to identity theft and must take action to prevent fraudulent use of the compromised accounts.
Bitcoin is dramatically different. A bitcoin transaction authorizes only a specific value to a specific recipient and cannot be forged or modified. It does not reveal any private information, such as the identities of the parties and cannot be used to authorize additional payments. Therefore, a bitcoin payment network does not need to be encrypted or protected from eavesdropping. In fact, you can broadcast bitcoin transactions over an open public channel, such as unsecured Wifi or Bluetooth, with no loss of security.
Bitcoin’s de-centralized security model puts a lot of power in the hands of the end-users. With that power comes responsibility for maintaining the secrecy of the keys. For most users that is not easy to do, especially on general purpose computing devices, such as Internet-connected smartphones or laptops. Whereas bitcoin’s de-centralized model prevents the type of mass compromise seen with credit cards, many end-users are not able to adequately secure their keys and get hacked one by one.
The most important principle for bitcoin developers is de-centralization. Most developers will be familiar with centralized security models and may be tempted to apply these models to their bitcoin applications, with disastrous results.
Bitcoin’s security relies on decentralized control over keys and on independent transaction validation by miners. If you want to leverage bitcoin’s security, you need to ensure that you remain within the bitcoin security model. In simple terms: don’t take control of keys away from users and don’t take transactions off the blockchain.
For example, many early bitcoin exchanges concentrated all user funds in a single "hot" wallet with keys stored on a single server. Such a design removes control from users and centralizes control over keys to a single system. Many such systems have been hacked with disastrous consequences for their customers.
Another common mistake is to take transactions "off blockchain" in a misguided effort to reduce transaction fees or accelerate transaction processing. An "off blockchain" system will record transactions on an internal, centralized ledger and only occasionally synchronize them to the bitcoin blockchain. This practice, again, substitutes de-centralized bitcoin security with a proprietary and centralized approach. When transactions are off blockchain, improperly secured centralized ledgers can be falsified, diverting funds and depleting reserves, unnoticed.
Unless you are prepared to invest heavily in operational security, multiple layers of access control, and audits (as the traditional banks do) you should think very carefully before taking funds outside of bitcoin’s de-centralized security context. Even if you have the funds and discipline to implement a robust security model, such a design merely replicates the fragile model of traditional financial networks, plagued by identity theft, corruption, and embezzlement. To take advantage of bitcoin’s unique decentralized security model, you have to avoid the temptation of centralized architectures which may feel familiar but ultimately subvert bitcoin’s security.
Traditional security architecture is based upon a concept called the root of trust, which is a trusted core used as the foundation for the security of the overall system or application. Security architecture is developed around the root of trust as a series of concentric circles, like layers in an onion, extending trust outwards from the root. Each layer builds upon the more-trusted inner layer using access controls, digital signatures, encryption, and other security primitives. As software systems become more complex, they are more likely to contain bugs, which make them vulnerable to security compromise. As a result the more complex a software system becomes, the harder it is to secure. The root of trust concept ensures that most of the trust is placed within the least complex part of the system, and therefore least vulnerable, parts of the system while more complex software is layered around it. This security architecture is repeated at different scales, first establishing a root of trust within the hardware of a single system, then extending that root of trust through the operating system to higher-level system services, and finally across many servers layered in concentric circles of diminishing trust.
Bitcoin security architecture is different. In bitcoin the consensus system creates a trusted public ledger which is completely de-centralized. A correctly validated blockchain uses the genesis block as the root of trust, building a chain of trust up to the current block. Bitcoin systems can and should use the blockchain as their root of trust. When designing a complex bitcoin application that consists of services on many different systems, you should carefully examine the security architecture in order to ascertain where trust is being placed. Ultimately the only thing that should be explicitly trusted is a fully validated blockchain. If your application explicitly or implicitly vests trust in anything but the blockchain, that should be a source of concern as it introduces points of vulnerability. A good method to evaluate the security architecture of your application is to consider each individual component and evaluate a hypothetical scenario where that component is completely compromised and under the control of a malicious actor. Take each component of your application, in turn, and assess the impacts on the overall security if that component is compromised. If your application is no longer secure when components are compromised that shows that you have implicitly misplaced trust in those components. A bitcoin application without vulnerabilities should be vulnerable only to a compromise of the bitcoin consensus mechanism. Meaning that its root of trust is based on the strongest part of the bitcoin security architecture.
The numerous examples of bitcoin exchange failures serve to underscore this point as their security architecture and design fails even under the most casual scrutiny. Their centralized implementations invested trust explicitly in numerous components outside the bitcoin blockchain such as hot wallets, centralized ledger databases, vulnerable encryption keys, etc. Worse yet, in most cases those trusted components lacked even the most rudimentary security controls.
Humans have used physical security controls for thousands of years. By comparison, our experience with digital security is less than fifty years old. Modern general-purpose operating systems are not very secure and not particularly suited to storing digital money. Our computers are constantly exposed to external threats via always-on Internet connections. They run thousands of software components from hundreds of authors, often with unconstrained access to the user’s files. A single piece of rogue software, among the many thousands installed on your computer, can compromise your keyboard and files, stealing any bitcoin stored on wallet applications. The level of computer maintenance required to keep a computer virus-free and trojan-free is beyond the skill level of all but a tiny minority of computer users.
Despite decades of research and advancements in information security, digital assets are still woefully vulnerable to a determined adversary. Even the most highly protected and very restricted systems, in financial services companies, intelligence agencies, and defense contractors are frequently breached. Bitcoin creates digital assets that have intrinsic value and can be stolen and diverted to new owners instantly and irrevocably. This creates a massive incentive for hackers. Until now, hackers had to convert identity information or account tokens - like credit cards, bank accounts, etc. - into value after compromising them. Despite the difficulty of fencing and laundering financial information, we have seen ever escalating thefts. Bitcoin escalates this problem because it doesn’t need to be fenced or laundered, it is intrinsic value within a digital asset.
Fortunately, bitcoin also creates the incentives to improve computer security. Whereas previously, the risk of computer compromise was vague and indirect, bitcoin makes these risks clear and obvious. Holding bitcoin on a computer serves to focus the user’s mind on the need for improved computer security. As a direct result of the proliferation and increased adoption of bitcoin and other digital currencies we have seen an escalation in both hacking techniques and security solutions. In simple terms, hackers now have a very juicy target and users have a clear incentive to defend themselves.
Over the last three years, as a direct result of bitcoin adoption, we have seen tremendous innovation in the realm of information security in the form of hardware encryption, key storage and hardware wallets, multi-signature technology, and digital escrow. In the following sections we will examine various best practices for practical user security.
Since most users are far more comfortable with physical security than information security, a very effective method for protecting bitcoin is to convert them into physical form. Bitcoin keys are nothing more than long numbers. This means that they can be stored in a physical form, such as printed on paper or etched on a metal coin. Securing the keys then becomes as simple as physically securing the printed copy of the bitcoin keys. A set of bitcoin keys that is printed on paper is called a "paper wallet" and there are many free tools that can be used to create them. I personally keep the vast majority of my bitcoins (99% or more) stored on paper wallets, encrypted with BIP0038, with multiple copies locked in safes. Keeping bitcoin offline is called cold storage and it is one of the most effective security techniques. A cold storage system is one where the keys are generated on an offline system (one never connected to the Internet) and stored offline either on paper or on digital media, such as a USB memory stick.
In the longer term, bitcoin security will increasingly be implemented with hardware tamper-proof wallets. Unlike a smartphone or desktop computer, a purpose-built bitcoin hardware wallet has only one purpose and function - holding bitcoins securely. Without general purpose software to compromise and with limited interfaces, hardware wallets can deliver an almost foolproof level of security to non-expert users. I expect to see hardware wallets becoming the predominant method of bitcoin storage. For an example of such a hardware wallet, see the Trezor (http://www.bitcointrezor.com/).
While most users are, rightly, concerned about theft, there is an even bigger risk of loss. Data files get lost all the time, but if they contain bitcoin the loss is much more painful. In the effort to secure their bitcoin wallets, users must be very careful not to go too far and end up losing the bitcoin. In the summer of 2010, a well known bitcoin awareness and education project lost almost 7,000 bitcoins. In an effort to prevent theft, the owners had implemented a complex series of encrypted backups. In the end they accidentally lost the encryption keys, making the backups worthless and losing a fortune. Like hiding money by burying it in the desert, if you do it too well you might not be able to find where you buried it.
Would you carry your entire net-worth in cash in your wallet? Most people would consider that reckless, yet bitcoin users often keep all their bitcoin in a single wallet. Instead, users should spread the risk among multiple and diverse bitcoin wallets. The prudent user will keep only a small fraction, perhaps less than 5%, of their bitcoins in an online or mobile wallet as "pocket change". The rest should be split between a few different storage mechanisms, such as a desktop wallet and offline (cold storage).
Whenever a company or individual stores large amounts of bitcoin, they should consider using a multi-signature bitcoin address. Multi-signature addresses secure funds by requiring more than one signature to make a payment. The signing keys should be stored in a number of different locations and under the control of different people. In a corporate environment, for example, the keys should be generated independently and held by several company executives, to ensure no single person can compromise the funds. Multi-signature addresses can also offer redundancy, where a single person holds several keys that are stored in different locations.
One important security consideration that is often overlooked is availability, especially in the context of incapacity or death of the key holder. Bitcoin users are told to use complex passwords and keep their keys secure and private, not sharing them with anyone. Unfortunately, that practice makes it almost impossible for the user’s family to recover any funds if the user is not available to unlock them. In most cases in fact, the families of bitcoin users may be completely unaware of the existence of bitcoin funds.
If you have a lot of bitcoin, you should consider sharing access details with a trusted relative or lawyer. A more complex survivability scheme can be set up with multi-signature access and estate planning through a lawyer specialized as a "digital asset executor".