Original article appears on Bitaroo
I am a huge advocate for people to hold their own Bitcoin private key(s). Yes, it’s hard. Yes, not everyone can or is willing to do it. I accept that, but not enough people understand why it’s important, and if they did, more would heed this advice.
I explain to people over and over again why it’s important. Here, I’ll do it again:
Imagine you buy gold from me. You send me money, and I use the money to purchase gold from the market, and I store the gold in my safe. You have an account with me, and you log in to my website with your username and password. You go to your “Balance” page and you see “Gold = 100 ounces”.
Question: How much gold do you have?
Why? Because I have the gold in MY safe. You have a promise that the gold is yours. If you want me to deliver the gold to your home so you can put it in your safe, things can go wrong. For example, I can disappear. I can set withdrawal limits to, say, 1 ounce per week. I can demand identification documents from you or “source of funds” documents from you as a condition. I can allow the government to confiscate part or all of the gold if they request it. You have no power.
“So what?”, you might ask. “It’s actually quite similar to money in the bank. Just a different level of trust.” You might trust the bank more than you trust me, but the issues I identified are the same. You might be used to this dynamic.
This is the whole point – With Bitcoin, bitcoin in YOUR possession, you are free from all this nonsense. YOU have the power and authority over your funds. No one can block you from transacting. No one can ask you for documents as a condition of you using your bitcoin. And no one can take it from you behind your back without you defending such action. You are the last stand. You are self-sovereign. This is a completely different power dynamic to the traditional financial system.
Now think of the bitcoin sitting in your exchange. It’s similar to the gold example I gave you. You have an account and password, maybe even two-factor authentication. You have an account page and a “bitcoin” balance. But that bitcoin you have in the account is not bitcoin. It’s what your exchange owes you. It’s not on the blockchain. That “bitcoin” has no address. It’s recorded in the exchange’s centralised database.
If the exchange was to fulfill its obligations to you (they usually do but sometimes they don’t), they would access their bitcoin wallet, create a transaction, sign it with the private key, broadcast it to a node, the transaction gets into the mempool (waiting list of transactions), a miner includes it in a block and wins the next round of mining, then payment from the exchange’s wallet to your wallet gets recorded on the blockchain. It’s irreversible. And the exchange will edit their database of IOUs and reduce your balance, the one you see on your account page. Your own private wallet then registers the bitcoin is in your wallet.
That wallet has a private key. It is the private key that gives you power to spend that bitcoin anytime you want. With such power, comes responsibility. You must keep that private key very secure, because if you lose it, or if someone steals it, your bitcoin is gone. That’s a post for another day.