In order to send and receive Bitcoin you will need a Bitcoin wallet. Bitcoin does not have accounts as such, but uses addresses, which look like long strings of random numbers and letters, E.g. 1Don44Hs9b4zxGH6xnrDbjHLmaZq8Ja3EM. Anybody can send bitcoins to any address, but you can only spend the bitcoins at an address if you have the private key. Think of the private key as the password, which is an even longer string of letters and numbers, e.g 5J9p9kaTgvfzDmMDhWnqXR9D3MDib28siJnBtwCLfcCHmpfRAmY.
We use ‘wallets’ to manage these addresses and private keys. Bitcoin wallets generally fall into one of three categories, standard wallets, online wallets and paper wallets.
The main advantage of standard wallets are that you are the only person that controls your private keys so, unless someone else gets access to your computer, it is impossible for anyone to steal your bitcoins.
The downside is that you are responsible for making backups of your wallet in case of hardware failure or accidental deletion. This may be as simple as writing down a mnemonic phrase when you first install the software, or making regular backups of the particular file which stores the important data. Computer viruses are also a problem, especially on Windows OS, although most wallets use encryption, poor passwords and password stealing keyloggers are always a concern!
Online wallets are websites which effectively manage your Bitcoin addresses and private keys for you. Often compared to online banks or Paypal, online wallets offer convenience and ease of use, but it is important to recognise that you are trusting a 3rd party with your bitcoins. It is very easy to set up an online wallet and advertise it to consumers, but this ease has led to many dishonest people disappearing when greed takes over. Additionally, such websites become huge targets for hackers and rarely can afford to reimburse their customers in the event of lost coins.
The last year has seen significant investment in companies providing online wallets, leading to increased confidence due to increased capital, bank level security procedures and better qualified personnel. For example, it is unlikely that Coinbase, with $75 million in venture capital funding, is about to take everybody’s bitcoins and run.
However, as businesses dealing with large sums of other peoples’ money, online wallets have to abide by the Anti Money Laundering laws in the countries in which they operate, which could possibly lead to your bitcoins being frozen until you have answered, what can often appear rather arbitrary, questions about yourself and your finances. It is also unlikely you would be refunded if someone accessed your account fraudulently, so password security is still a concern. You should always use a good unique password for each online wallet, as well as two-factor authentication, which should always be an option.
Paper wallets, when created properly, are the most secure way to store your bitcoins although, arguably, not very convenient for day to day spending. As said earlier, Bitcoin addresses and private keys are nothing more than, what look like random, strings of letters and numbers. Therefore, in its simplest form, a paper wallet is created by printing (or writing down) this information.
Best practice would be to save the website to your computer and then disconnect the internet before loading it up and creating your paper wallets; print your new wallets and delete the computer file before reconnecting the internet. This will prevent any malicious software on your computer from transmitting the data to a bad person over the internet. However, it will not protect against keyloggers that are taking screenshots as you generate your paper wallets! It is often advised to copy the Bitaddress.org website to a computer that has never been connected to the internet, perhaps on a live CD, before making your paper wallets. This may well depend on your level of paranoia, technical expertise and the number of bitcoins you need to keep safe.
The downside to paper wallets are like that of keeping physical cash, if someone steals the actual bit of paper then they have your bitcoins. It is possible to create encrypted paper wallets (wallets whose private key requires a password before it can be used) to protect against this. You will also need to consider making copies to protect against fire damage etc, but remember, with unencrypted wallets or those with weak passwords. every copy you make is another one you need to keep safe.
In order to spend bitcoins stored in a paper wallet you will need to import the private key into another wallet, either an online service or a standard wallet. Most wallets offer this facility. Normally when creating a paper wallet you will also create two QR Codes, which stores the address and private key. This is for easy importing and also to make it easy for you to give others your Bitcoin address so they can send you funds.
A great way to improve the usability of paper wallets is to use another type of wallet as a “watch only” wallet. That means you store the Bitcoin address (but not the private key) within the wallet and have the wallet monitor the Bitcoin network for related transactions. This allows you to view your balance, including any incoming transactions, whilst knowing your private keys are safely stored elsewhere.