Before you buy Bitcoin, you need a secure place to store it. In the world of cryptocurrencies, this place is called a "wallet," and they come in various forms. Different wallet types offer owners different options for security, storage, and access.
It's important to understand that your wallet doesn't technically store your Bitcoins. Instead, it holds private keys, which are essential for accessing a Bitcoin address and spending the funds. These digital keys are required to sign a transaction. If a user loses them, they effectively lose access to their Bitcoin.
The five main types of Bitcoin wallets are desktop, mobile, online, hardware, and paper.
Understanding Bitcoin Wallet Types
Desktop Wallets
A desktop wallet is installed on a user's computer, providing full control over funds and reasonable security. There are "thick" desktop wallets, which allow users to download network blocks and verify their authenticity, offering independent security management of funds. "Thin" wallets, on the other hand, don't require users to download blocks and can be easily installed on portable devices.
Mobile Wallets
The primary advantage of a mobile wallet is that a user's funds are always at hand. It's a very convenient way to pay for goods by scanning QR codes. Some users can even leverage their smartphone's proximity communication feature (like NFC), allowing them to tap their phone on a reader without entering any information. A common trait of all mobile wallets is that they are not full Bitcoin clients, as a full client needs to download the entire Blockchain, which is constantly growing and requires several gigabytes of storage.
Online Wallets
When using a web-based wallet, users' private keys are stored online on a server controlled by another entity. While this allows easy access to funds from any device anywhere in the world, there is always the risk of the server being hacked or the organization managing the service gaining control over your Bitcoins. This risk can be significantly reduced by implementing various security measures.
Hardware Wallets
Hardware wallets are dedicated portable devices that can hold private keys and facilitate payments. Several different types exist, but all allow users to carry essentially any amount of value in their pocket securely.
Paper Wallets
Perhaps one of the most secure options for storing Bitcoin, a paper wallet consists of two QR codes generated using a designated service. One is a public key—an address used to receive BTC. The other is a private key, which you use to spend Bitcoins stored at that address.
Where to Buy Bitcoin
Buying Bitcoin isn't as straightforward as a newcomer might expect, but the number of options is constantly growing. Everyone can choose a cryptocurrency purchase method that suits their needs; some don't even require internet access or a BTC wallet.
Bitcoin ATMs
Despite being a relatively new concept, Bitcoin ATMs are appearing in cities worldwide, and their numbers are growing steadily. These machines typically charge a commission of three to eight percent on top of the standard transaction price but provide users with a more private Bitcoin buying experience.
You simply insert cash into the ATM and scan the QR code from your mobile wallet or receive a paper receipt with codes and instructions on how to transfer the funds to your wallet. As Bitcoin gains popularity, such ATMs have the potential to become one of the most common ways to purchase the cryptocurrency.
Naturally, Bitcoin ATMs are unlikely to appear in countries where Bitcoin is banned or prohibited. You can find your nearest Bitcoin ATM using a designated mapping service.
Gift Cards
Bitcoin is often used to buy gift cards due to its anonymity and sometimes lower cost than using cash. But the gift cards themselves can be used to acquire BTC. All you need to do is purchase a gift card from a retailer, log in to a Bitcoin exchange where some vendors accept gift cards, and complete the purchase.
Depending on the particular vendor, they might want to see a real picture of the gift card's code on the back and a receipt from the store where it was purchased, while others only need an electronic or online code. Once you open a trade, the amount of BTC you want to buy is automatically held in escrow by the site, making it safe to provide the vendor with your gift card information.
Many online retailers sell gift cards for up to 60% of their value, so buying Bitcoin this way can actually save you a significant amount of money. Gift cards are also a great way to store value, given how Bitcoin's price fluctuates. However, as with any form of buying Bitcoin, you must always be cautious of scammers. Ensure you only trade with reputable vendors.
Cryptocurrency Exchanges
Every potential new Bitcoin buyer will encounter numerous exchanges competing for their business. Choosing the right one depends on many factors, with location often being the most important. An exchange should be government-regulated and comply with "Know Your Customer" (KYC) and anti-money laundering (AML) requirements.
This is why setting up an account and starting to trade on any existing exchange involves lengthy bureaucratic procedures. For example, most exchanges will require you to link an existing bank account before you start trading, which usually involves providing detailed personal identification information, negating the anonymity of Bitcoin buyers.
However, exchanges offer an unparalleled range of trading options. Whether you're looking for a full-featured platform for institutional traders or a simpler solution for a one-off trade, you'll find an exchange to fit your needs. Furthermore, most platforms can be accessed via desktop and mobile devices, allowing users to trade from anywhere. Exchanges vary in the payment options they accept, security levels, purchase limits, fees, verification requirements, and more.
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While most exchanges offer Bitcoin wallet services, this is likely the least reliable way to store your funds. Despite operating as regulated financial institutions, BTC exchanges do not offer the same level of protection as traditional banks. Trading platforms are prone to hacker attacks or can simply go out of business, often locking up users' funds. So, while it's the most obvious option for those looking to engage in regular cryptocurrency operations, the bureaucracy, potential risks, and lack of anonymity associated with Bitcoin exchanges make them unsuitable for some traders.
Peer-to-Peer (P2P) Transactions
If you prefer to keep your Bitcoin transactions anonymous, don't want to deal with banking complications, and live in a city, an in-person trade with a local seller might be the easiest way to buy Bitcoins. Among numerous sites and forums, LocalBitcoins is the most popular platform for facilitating such transactions and also offers an escrow service to further protect the parties and their funds.
In the early days of Bitcoin, these transactions often happened at sellers' homes. Nowadays, as BTC becomes more popular, people are more wary of scammers and take safety precautions. Most such transactions now occur in public places, and both parties should exercise all the caution they normally would when carrying and exchanging large amounts of cash. Additionally, the buyer needs to access their wallet to confirm the transaction, so having a smartphone or laptop with an active internet connection is another consideration.
Those not open to an in-person meeting can always look for a Bitcoin meetup, where they can buy the cryptocurrency in a group setting and enrich their knowledge about BTC in the process. Information about these meetings can be found on meetup.com and other similar sites.
Of course, you don't necessarily need to meet a seller in person to complete a transaction. Some sellers are open to trading over the internet, but you must be extremely careful, as you risk losing your money. There is always the option of using payment services like PayPal, which guarantee receipt of funds, but most sellers currently prefer non-reversible cash due to Bitcoin's constant price fluctuations.
Depending on the seller, you may need to pay a fee of five to 10 percent for the privacy and convenience, calculated on the original trade price. Some sellers will negotiate the overall price before meeting, while others will only sell Bitcoins at the exact BTC rate set during the transaction to account for any dramatic price changes.
Investment Trusts
An investment trust is a form of collective investment where investors' money is pooled from the sale of a fixed number of shares issued when the trust is launched. With Bitcoin appearing in the spotlight of the financial world, the emergence of a Bitcoin-focused investment trust was only a matter of time.
The Bitcoin Investment Trust (BIT), the first publicly traded investment vehicle related to Bitcoin, allows people to gain exposure to the cryptocurrency without having to buy or store it directly. The BIT invests exclusively in Bitcoin, and its value is derived solely from the price of BTC.
The Bitcoin Investment Trust is the first of its kind, which contributes significantly to its inflated valuation. There has been speculation about other similarly structured funds entering the market, but the BIT remains the only major player. However, as the cryptocurrency market evolves, other funds will undoubtedly enter the market, which will not only put significant pressure on the BIT but also solidify Bitcoin's status as a globally recognized currency.
Challenges of Buying Bitcoin
Using Credit Cards or PayPal
It may come as a surprise, but regardless of the exact trading method you're using, it's still not easy to buy Bitcoin with your credit card or via PayPal, depending on where you are in the world. Exchanges often avoid these payment methods, requiring users to link their bank accounts instead. Most private vendors also tend to be wary of such transactions, preferring cash.
This is due to "chargebacks." Most transactions made using credit cards or PayPal can be easily reversed by simply calling the card-issuing company. Bitcoin transactions are irreversible, and since it can be extremely difficult to prove that any goods changed hands in a Bitcoin transfer, this payment method is generally avoided.
Important Considerations When Buying Bitcoin
Legal Status in Your Country
Bitcoin certainly attracts the interest of law enforcement agencies, tax authorities, and legal regulators. What they are trying to understand is how the cryptocurrency fits into existing frameworks. How legal your Bitcoin activities are depends on who you are, where you live, and what you are doing with that BTC.
Essentially, the answer for most countries is simple: if you are not spending your Bitcoin on anything illegal, you are not breaking any law. Bitcoin has been around for some time, so most governments have had enough time to decide on its legality. While the legal landscape is always changing, it's crucial to research your local regulations before acquiring Bitcoin.
Risk Protection
It's worth remembering that, despite the identity proof requirements most exchanges and wallets impose on their users, these services do not offer the same level of protection as banks. For example, if an exchange goes out of business or is robbed by hackers, its insurance for user funds is usually very limited or non-existent.
This was the case with the infamous Chinese exchange Mt. Gox, which officially filed for bankruptcy and admitted to the irreparable loss of 750,000 of its clients' Bitcoins. Since Bitcoins do not have legal status as money in most of the world, authorities are often unsure how to handle such thefts. There have been cases of larger exchanges reimbursing their clients' funds after a theft, but at this stage of BTC's development, they are not legally obligated to do so.
Furthermore, if a cryptocurrency theft occurs due to a security lapse or password error on the user's part, there is no guaranteed way to recover the funds. Some banks even refuse to work with funds obtained through digital currency transactions due to regulatory uncertainty.
Final Tips for Buying Bitcoin Securely
When trading in Bitcoins, it is essential to treat your private key (comparable to a bank card PIN) as a protected secret and only use it to authorize BTC transactions. The private key is held in your wallet, so protecting it is a smart idea.
You can encrypt the wallet with a strong password, back up your wallet, or choose cold storage options, which basically means keeping it offline. Some exchanges even offer a "multisig vault" option for storing your keys. Multi-signature addresses allow several people to partially control an address with a public key. Then, when someone wants to spend some of the Bitcoins stored at that address, they would need some of those people to sign their transaction in addition to doing so themselves.
Finally, while most exchanges offer wallet capabilities for their users, it is very important to remember that this is not their primary business. Furthermore, cryptocurrency history is filled with instances of exchanges closing down and disappearing with their users' funds. For these reasons, if you decide to buy your Bitcoins from an exchange, it is highly recommended that you move your funds to your own private wallet and ensure they are safe and secure.
Frequently Asked Questions
What is the safest way to store my Bitcoin?
The safest way to store Bitcoin is generally considered to be a hardware wallet or a paper wallet, as they keep your private keys offline (cold storage), making them immune to online hacking attempts. For larger amounts, a multisignature wallet setup can add an extra layer of security.
Do I need to verify my identity to buy Bitcoin?
This depends on the method you use. Regulated cryptocurrency exchanges typically require identity verification (KYC procedures) to comply with financial regulations. However, methods like peer-to-peer (P2P) trading or Bitcoin ATMs often allow for more anonymous purchases, though they may have lower limits or higher fees.
Can I buy a fraction of a Bitcoin?
Yes, absolutely. Bitcoin is divisible up to eight decimal places. The smallest unit, known as a Satoshi, is one hundred millionth of a single Bitcoin (0.00000001 BTC). This allows anyone to invest any amount of money, no matter how small.
What is the difference between a Bitcoin wallet and an exchange account?
An exchange account is used for buying, selling, and trading cryptocurrencies on a platform, which holds your funds on your behalf. A wallet gives you direct control over your private keys and, therefore, your funds. The mantra "not your keys, not your coins" emphasizes that funds held on an exchange are not as secure as those in a personal wallet you control.
Why are transaction fees sometimes high?
Bitcoin transaction fees fluctuate based on network congestion. When many people are trying to make transactions at once, users bid higher fees to have their transactions included in the next block by miners. Using wallets that allow you to set custom fees can help you save money during less busy periods.
What happens if I send Bitcoin to the wrong address?
Bitcoin transactions are irreversible. If you send BTC to an incorrect address, those funds are likely lost forever, unless the address belongs to someone who voluntarily returns them. It is critically important to double-check the address before confirming any transaction.