What are Wallet Seed Phrases? — And Why Are They Important?
Before taking self-custody of your cryptocurrency you need to fully understand Seed Phrases
Diving into the world of cryptocurrency you will soon come across something very important called Seed Phrases, which also can be referred to as Seed Recovery Phrase, or Seed Backup Phrase. Wallet providers will tell you to note down these random words and keep them in a safe place, but what does this random selection of words do, and more importantly why is it so important to safeguard them?
When you will receive a seed phrase?
The important thing to know is that you will only receive a seed phase when you take self custody of your coins. By taking self custody of your cryptocurrency it means moving them off exchanges and taking ownership of the private key. Whoever has the private key of the wallet has complete control of the coins in the wallet.
For example, if you were to keep your cryptocurrency on Coinbase, Coinbase has custody of your coins by holding the private key. Holding the private key gives Coinbase full control of your coins, meaning they would be able to send the coins to any wallet of their choosing. It would not be in Coinbase’s interest to act in this way, but by holding custody of your cryptocurrency they are technically able to do so.
Custodian Vs Non-Custodian Wallets
As Bitcoin as other cryptocurrencies were developed to create a decentralized financial system, not practicing self-custody of your coins can be seen as defeating the purpose by adding a centralized element. The notion of “Not your keys, not your Bitcoin’’ is a very popular notion with the Bitcoin community, meaning unless you have self custody of your Bitcoin you don’t own the Bitcoin.
For a certain proportion of Bitcoin users, not taking custody of their Bitcoin and your cryptocurrency will come down to the following reasons
- Trust and Easy of Use of Exchange- As the cryptocurrency space grows there has been an increase in regulation and measures to protect consumers. Established exchanges and custodian providers can therefore be seen as a relatively safe way to store crypto, this might be why $233 Bn of assets are held on Coinbase by users.
- Low Account Value — If you hold a fairly modest amount of cryptocurrency, many users won’t see the need to understand how to take full custody of their coins.
- Lack of technical understanding — If the user does not feel fully comfortable with the cryptocurrency ecosystem and is only purchasing coins as speculation, many will hold on to major exchanges which gives them a degree of safety and a simple user interface to buy/sell coins.
Taking Self-Custody Of Your Coins
When you take self-custody of your coins, you are responsible for the safety and security of your wallet. Self-custody means selecting the correct medium of storage for the purpose that you have for the coins and also ensuring that you have a key management system in place.
As a society, we are very comfortable with others having custody over our assets. Banks in the large part have been around for hundreds of years and have been in the business of providing custody and security for our assets. Banks take the responsibility for the security of our assets in exchange for being able to hold and leverage the assets held. Banks remove a large amount of stress that comes with safeguarding our assets. Your funds will be federally insured up to a certain limit and if you forget your login credentials that can easily be reset.
Taking self-custody of your cryptocurrency makes you responsible for the safeguarding of your assets, not someone else.
Day to Day Usage
The majority of wallets have built a user interface to mirror with a username/password solution that we have become accustomed to with WEB 2.0. The username and password solution allows for quick access to your funds with a layer of protection to reduce the potential for funds to be compromised or hacked.
The main difference with having custody of your coins is that if you forget your password to your wallet, the wallet provider will not be able to simply reset your password and grant you access. The wallet company is not able to unlock your account even if they wanted to as this would introduce a centralized element to the system and therefore a point of failure. The only way to recover a wallet after a password is lost or the wallet is lost/stolen is through the Seed Phrase.
So what exactly is a Seed Phrase?
When you create any new wallet, the wallet provider will provide you with the Seed Phrase, which is a random selection of 12–24 words chosen from a selection of 2048 words from BIP 39. The user needs to write down the words in the order that they are given and securely store them. Remember, if anyone is able to find out your seed phrase, it would allow them to access your wallet and take control of all of your funds.
How is it secure?
The seed phrase is extremely secure through the power of mathematics. The only way to “hack” your seed phrase is through brute force of guessing the correct words in the correct order.
Even with a 12-word seed phrase out of a possible 2048 words, there are a possible 777,788,267,247,859,345,059,141,959,844,041,626,185 combinations that would have to be processed to access your funds.
Even with today’s computing power, it would take hundreds of thousands of years to brute force open your wallet by guessing your seed phrase.
How do you keep Seed Phrases Safe?
There are many different methods of storing your seed phase which is split into online and offline solutions. Storing your seed phrase needs to be secure enough that someone is not able to find it, but not so complex of a system that you lock yourself out. Out of all the solutions it is recommended to follow an offline solution as these have much lower risks of being compromised.
One report suggests that approximately 1500 Bitcoin are lost every day from poor key management, so you key management of your wallet seed phrase is definitely something to take seriously.
Offline Solutions
Paper Wallets — Paper wallets consist of putting the key phase simply on a piece of paper and securing the paper. The main issue with paper wallets is that in the case of fire or water damage your paper wallet would become destroyed and with it, you could lose your funds. Paper wallets are a temporary solution but are by no means suitable for the long-term storage of Seed Phrases.
Metal Seed Wallets — A quick search on Amazon provides a wide range of solutions for a more durable solution to store your seed phrase. The metal seed wallets are fire and waterproof so are a much better option for long-term storage than paper wallets. Obviously, the issue remains that if someone is able to find your metal seed wallet then they are able to gain access to your account. Taking into consideration the durability with relative ease of setup, Metal Seed Wallets can be a great solution for holding seed phrases.
Safe Deposit Box — Users can store their seed phrase in a safety deposit box, or split the seed phrase across multiple deposit boxes. The safe deposit box in its own way introduces a centralized element into the process. There is a risk of the bank being robbed and the seed phrase taken or the bank confiscating the items inside.
If you are thinking about taking self-custody of your cryptocurrency you need to understand that you are making yourself responsible for the security and safety of your funds. You need to think about key management and how you will be able to access your funds in the event of a worst-case scenario such as a hardware failure of your laptop before it happens.
In late 2020, for the first time in 9 years, my trusty 2011 Macbook Pro couldn’t boot up, and with it, some of my crypto wallet credentials were lost.
With my crypto journey starting in 2017, I had always been disciplined about storing seed phrases for my wallets, however, I always just stored them in my notebook at the time. There was a large amount of unease about going through old notebooks to find a certain set of words that I need to unlock my funds. I had to place a lot of trust in a less wise 2017 Jordan but was luckily was able to restore all of my wallets. Like many life situations, we never think bad things can happen to us until they do. Losing my wallet credentials was a good wake-up call that I needed to take my key management much more seriously as it could have easily not have had a happy ending.
When designing Nested, our goal was to make it as easy as possible for anyone to save Bitcoin for their child’s future. The last scenario we ever wanted was for a user to save money for their child, only to be unable to access the funds due to poor key/wallet management. For that reason, when saving Bitcoin for your child with Nested the default option is for the Bitcoin to be held with our licensed and registered custodian provider. By partnering up with our custodian provider, it allows our users to access industry-leading secure cold storage practices without having to deal with both key and wallet management for the beneficiary over such a long period of time
Users are also able to take full custody of the beneficiary's coins by withdrawing the funds to a wallet of their choosing if they desire.
Nested is scheduled to launch in the Fall of 2021 and will initially serve the US market only. If you are interested in being kept up to date with our launch you can sign up for our mailing list.
Have any comments or questions? We would love to hear from you! Reach out to me at jordan@getnested.co
Jordan Johnson — Founder of Nested
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