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Are Online Wallets Safe?

Introduction

All too often, we hear arguments about whether or not you should be storing your crypto coins in online wallets. There have been quite a few scams revolving around them (usually dealing with those that offer high interest, although this is not always the case). There have also been sites that have been hacked and have had all of their coins stolen, in which they usually are not able to pay back many, if any, of the coins because of the high cost and the lack of having available insurance.

Through this article I want to look at online wallets, what makes them good and bad, what you need to be aware of them, and why they are very useful. We will also be looking at some security things and “smart things” to do if you are using an online wallet.

What is an Online Wallet?

When you are dealing in crypto currencies you essentially have two choices as to how you want to store your coins: locally or online. Locally includes things like the “brain wallet,” paper wallet or one of the many wallet clients. Each of these has their own benefits, although they all rely on one thing: you keeping everything secure on your own. Now, on the other hand we have the online wallets, where you send in your coins, they store them and then you can pay out using their service. In a real sense, this is just like a bank, only without the interest being accrued. A good way to look at this is being more like a checking account, of which most banks do not give interest in. The purpose of the online wallet is usually to make it easier to spend the funds, since you can access them from anywhere, even if you are not at home or at your home computer.

No Downloading the Block Chain

To many people, this is enough to make using online wallets well worth it. The block chain for different currencies is growing, especially Bitcoin, which appears as if it is going to hit the ten gigabyte mark before the end of the year. This is a pretty hefty file to keep up with, and it also often slows down the Bitcoin client since it parses it. On older computers, or even sometimes newer ones, the time it takes to deal with all of this updating and such is pretty large. To avoid this, online wallets are a great solution.

The worst part about computer crashes is that you lose the data, and most people do not back up the block chains because they can be downloaded again. When you are talking about an eight gigabyte file or even larger, this is a big issue. It gets even worse if you are attempting to get something sent off, as you have to wait until your client syncs before you can make the transactions!

Access Your Funds From Anywhere

With online wallets, you can access your money no matter where you are or what device you are on. As long as you are able to get on the Internet, you can log in to your wallet and handle transactions. It does not matter if you are on a laptop, at a friend's house or even on your cell phone. This makes them very feasible for transactions, as you are no longer limited to only being able to use a device that has the crypto wallet installed, running and updated.

This also saves time in that you do not have to worry about when a new client is released, as it is all irrelevant to you. This makes the process of keeping up with your finances easy and painless!

Send Less Fees

This really depends on the online wallet but some of them offer up less fees than you would normally pay. Some of them, like Coinbase, even pay the fees on your behalf as long as you are not sending a micro transaction. This means that you get the funds sent quick, without even decreasing your available balance to account for it! I do question the viability of sites that offer to pay fees on your behalf when it comes to staying alive long term, although they seem to be making it work for now. In any case, I would definitely be wary of storing too many funds in these wallets just to be safe.

It is also worth mentioning that while I definitely support Coinbase, they do have their problems from time to time. For example, a few weeks ago I was trying to send out a couple of BTC to my wallet. The system kept putting them in limbo and reversing the transaction after a day or so. What I eventually had to do was break it up in to smaller transactions, and then they went through without a hitch. This is likely due to fragmentation in the Coinbase wallet, so if you are having issues getting funds sent out this is a trick you can give a try.

Anonymity is Increased

This again depends on the online wallet you are using, but some of them use what are considered as mixed wallets, where your deposits are credited to an address that is specific to you, but your withdrawals and payments are sent from the entire pool. This helps increase anonymity because the funds you are transferring can no longer be tracked this way; all anyone will know is that you received a certain amount, and past that there are no real traces (if funds are sent off from someone else and they pull from your address this will show that you made a transfer, but since it is not yours it is still considered as increased anonymity).

There are other sites that offer similar services, called “coin mixing,” although they almost always come with their own fees and they require a lot more work than the wallets that simply do it by default.

Notice: Be Careful When Gambling

This is a notice for online wallets. As we stated, some online wallets will use random addresses for their outgoing payments. This means that if you are using one of these services for a gambling site that automatically pays you your winnings to the address your payment was sent from, you will end up not getting them, as the address you “sent” from is not necessarily the same one you own.

It is very important to realize this because all too often people are getting caught up in this situation without realizing it until it is too late. If you really want to test whether or not the online wallet you are using will allow you to receive your winnings, the best plan is to send the smallest amount possible to the game you want to play and see what happens. As an alternative, you can also send a support request to the online wallet host and see what they say about it. Never, however, jump in without knowing for sure whether or not you are going to get your winnings, as getting the situation straightened out is almost never going to happen.

Pay Via Other Methods Than Crypto Addresses

Whereas with a local wallet you have to send off payments to someone's crypto address, such as their BTC address, with a lot of online wallets there are other ways: via someone's user name or email address. This makes things even easier to keep up with, as the crypto addresses are long and nearly impossible to remember, but someone's email address is pretty simple!

In some cases, this also allows you to send funds to someone that does not have a wallet yet. In these cases, the system will send them an email allowing them to create their own wallet, and then when it is created the funds you sent will be instantly available to them. This is an awesome way to get new people involved in the crypto scene, and makes things a lot easier for the end users to understand as well!

Security: The Good and Bad

Security of the wallets is another pretty large part of what makes online wallets good, although it can also be problematic at times. Let us take a look at a couple scenarios to help better understand what this means.

Your Own Security

A lot of computer users really do not know that much about security. They understand how to turn on a computer and do some basic tasks, but past that they do not really understand how to avoid things like viruses, spy ware and phishing. This is seen by how many people each day are taken down by each of these things. In most cases this is bad enough as it is, because people can get in to things like bank accounts and other types of accounts (such as email), but with the crypto scene it is even worse. When a coin is stolen by a hacker of some sort, it is gone. There is no way to reverse the transaction to that person, and because of the anonymous nature of the crypto currencies it is extremely difficult to figure out who someone is. With a bank or other account, on the other hand, there are many traces left behind and any damage that is done can almost always be reversed.

When we are talking about money, sometimes a lot of it, this is important to realize. If your computer is not safe from intrusion, you risk losing everything.

This is where the online wallets start coming in to play for the average computer user.

Online Wallet Security

With online wallets, the end user is not as concerned with their own security, and instead relies on the wallet provider to do all of the protecting for them. While this does have its benefits, for sure, it also has some other big issues that come as a result of it.

  • Sites can be hacked

Regardless as to how protected a site may think it is, there are people around that can break in to it. This happens with fortune 500 companies all the time, so to think otherwise is being a little bit naive. In most cases, though, when someone attacks a site all they can get access to is some personal information and, in some cases, hashed passwords (that as long as you use a decent password for are unlikely to ever be broken).

When it comes to the online wallets, however, things are a bit different. Most of the sites store both your private and public keys on the server, so if someone hacks in to it they can get access to all of your funds. Much like discussed a little earlier, there is no reversing this if someone does it, and the damage caused can be substantial.

Even if they are not storing your own keys, they may have all the funds stored in their account, which could then be taken over, causing the same situation to occur. In any case, if someone takes the funds there is little to nothing you can do about it, due to how it all works.

Some sites (hopefully most) combat this a little by having two separate wallets set up, considered as a “hot wallet” and “cold storage.” The hot wallet is used for storing funds that are going to be sent back and forth between people. You would use this, for example, if you are paying off certain amounts every so often. The cold storage, on the other hand, is for storing coins long term, or at least keeping them inaccessible. This means that even if the server is compromised, there is no way the people can take the bulk of the funds, since they are stored in an area that is (usually) off site and not even connected to the Internet. While this does not get rid of all the problems related to storing coins, it does help cut down on a lot of them and help minimize the amount of risk that is being taken. When a site is handling someone else's money, that is an important thing to do!

  • Employees can go rogue

While this is not something most people really want to think about, it does happen. It could be as simple as someone getting upset about something that happened at work, or even someone that just decides that they want the money and there is too much to pass up. In cases like this, if they have enough power to do so they can wipe the wallets clean and make their way out. As far as I am aware no online wallets have gone through this problem, but it is definitely something to take in to consideration as a possibility.

Balancing the Two

For users that do not know that much about their computer's security, using online wallets is probably the best idea, however research in to them before putting any funds in one is important; especially with something as easy to lose as crypto currencies, making sure that you make the right choice is a necessity or everything can be lost.

On the other hand, it is also important to keep in mind that you are only as safe as the online wallet is. If you do this, you need to do the following:

  • Use two factor authentication
  • Use a tough password. Your online wallet password is arguably more important than any other, because the damage that can be done is irreparable
  • Keep up with anti virus and anti malware to block as many attacks as possible
  • Always, always check the web address you are visiting! All too often people are hit by tricks, such as the infamous “mtqox” when trying to visit mtgox. Be extra careful of these small mistakes. The best plan of action for this is to type in the address every time, not allowing auto complete to do anything
  • Realize that even when you are on the proper website, there can be a man in the middle attack, intercepting passwords between the time you send them and the time the website receives them. This was recently seen with Bitcointalk, as they got hit by one just a few days ago
  • (Optional) it is a good idea to change your password on a regular basis. While I would not necessarily recommend this with absolutely every site that you visit, when you are dealing with your finances this is pretty important. All it takes is one slip and all your funds are gone. Banks and other sites like that could work with you to resolve the problem, but with crypto currencies there is no way

Preparing for the Worst

It is important to keep in mind that every cent you have in an online wallet is subject to loss. This has been said over and over again on various forums and websites, yet so many people still do not understand that there is always going to be a risk. Then again, if you are not keeping your own system safe you are also facing a risk. So really, what you have to do is determine how much risk is too much for you.

As an example of some recent sites that shut down, leaving users either with nothing at all or very little to continue on with, we will take a look at some now.

LTCWallet and FTCWallet

These sites were both started up as normal online wallets. They had no benefit other than allowing you to access your funds with any web browser, so that you could send out your funds at any time. There was also the benefit of not having to download the block chain, as the website handled that as well. More or less, it was the easiest way to store coins without having to keep up with your own clients and everything.

Sadly, after a month or two they decided to enact interest for deposits. Many people were already depositors prior to this, and a lot more jumped in after. After all, free money, right? Who does not like that? This led to the site growing in popularity, although there were still a lot of people warning that the entire thing could be an elaborate scam. It hit the same point it always does; some people claim the site is a scam, others claim it is not. Only time tells who is right, and with these two wallets it did not take too long.

Both sites were taken offline without any warning. Right after, their Twitter accounts were deleted and any other tracks were removed as well. While we would normally assume that the sites were hacked, and that this is why they went offline, in this case it was pretty obvious that the owners were just flat out scamming.

Inputs.io

Inputs.io was a site much like the two mentioned previously, but with a couple added benefits. First of all, the site had a lot of security measures to ensure that your coins were not lost. They were not operating on a fractional reserve, either, so every Bitcoin or fraction of one that was in someone's account was also held in the site's cold wallet. This ensured that regardless of the amount of Bitcoin being withdrawn, there were going to be no problems.

Probably the best benefit of the site, though, was that it allowed micro transactions between people free of charge, so long as both had accounts on the Inputs.io website. Furthermore, it made the process even easier by letting you use their Bitcoin address, email address or user name. And if you wanted to share a link to pay you from, you could do so from a website link that goes straight to your payment page. Really, everything was easy to use and work with, and it led to many sites using them for transactions. After all, if money is easy to move back and forth (and it also allowed transactions that went to the block chain, although there was a small fee for this), it is a great solution for websites that take and send out a lot of payments. To help make it even more viable for these sites, Inputs.io even created its own API that made autonomous transfers easy to do; a few website owners said that to get an account set up and get the API integrated with their website was only a matter of minutes.

The problem did not come until a while after the site was out, when all of a sudden the API was exploited and a lot of people's accounts were wiped empty of all their funds. There was little to no communication during the process of figuring out what happened, and the situation apparently was much worse than initially thought of. In fact, the entire wallet was cleared out, leaving the site way below where it was in funds. While the site had a guarantee that if it were hacked the users funds would not be lost, this had changed to the point where many were losing everything they had, and a few were able to gain back a fraction of what they originally had.

Coinlenders

Coinlenders is another site owned by Tradefortress, the same person who ran Inputs.io. It was also tied to Inputs.io, although the two sites were vastly different in how they work and what they offer. While Inputs.io offered up a free micro transaction system that allowed easily transferring funds between people, Coinlenders was designed to be more like a bank. Essentially with Coinlenders you were able to make a deposit and earn fee rebates (a type of interest) on those deposits, withdrawing when you felt like it. By teaming up the two sites together, you could use Coinlenders to increase your Bitcoin holdings, while using Inputs.io to send and receive funds. The down side to this system is that you could not have a Coinlenders account without also utilizing Inputs.io; in the beginning this was possible, but then the direct depositing mechanism was removed from the site. So when Inputs.io was hacked, Coinlenders, which was stated as being “insured,” was taken over as well.

In the end, both sites were taken advantage of and all users of either site lost.

Why These Are Important

All of these are important to know about because they help better understand what has happened in the past. Each of these sites were gaining popularity and were increasing in deposits. Then one by one they were each taken offline (whether by being hacked or flat out scamming is anyone's guess, but people lost out either way). The important thing here is to always do your due diligence, and understand that even if the consensus is that a site is safe, it might not be. If you are handing your finances over to anyone at all, you are already taking a risk and you need to keep that in mind. You could make it out just fine, you could lose part of your holdings, or you could lose absolutely everything you had.

We are bound to find other sites that offer free online wallets or interest bearing bank accounts in the future. In fact, we are really hoping that more of these will pop up, because they are a way to avoid the extremely low interest we currently get in bank accounts. The issue here is that the sites really need to build up a lot of trust before some of us will send over any money, based on what we have experienced in the past. It is pretty sad, but the decisions of a couple people have had a much bigger impact on the entire crypto currency scene, and breaking past this defensive wall is not going to be easy. While it is going to take a long time for this to happen, I think the community will completely welcome any official competitors. The only issue is that they are going to have to give enough proof that they are legitimate, and part of this is going to involve not running anonymously. We have been burned way too many times from anonymous website creators, and that causes its own complications in that we can not go after the owners through the legal system. Instead, we have to take everything they throw at us and accept it as it is. When we lose everything, that is just part of the risk. And for Bitcoin, and its online wallets to be successful for the long term, we need to push the bar and prove that legitimate businesses can run on it; even banks.

Centralization Problems

Probably the most argued point against even having online wallets or crypto banks is that they are centralized. This is really the only way to run them, being that coins need to be hosted on their server; without this, it would just be a normal wallet and would have no real benefits. The issue here is that centralization goes against everything Bitcoin represents. The entire network is based on the theory of peer to peer storing and transfer of wealth, where a third party is not needed. We could argue, of course, that these online wallets are not really needed (in that everyone is more than welcome to make their own decision as to whether or not they want to use the services), but having more coins in a central spot gives that person or company much more control over the market. With enough coins, someone can cause a big disruption, dropping the price significantly. Opening up this possibility is the wrong course of action to take when the goal is to stop it from happening. Not to mention the more reliant we become on these online wallets and banks, the worse things are going to get when it comes to the centralization.

For Bitcoin to continue running and working, we need to find a way to make some sort of hybrid online wallets; something where you can use it as a cloud system but still have the coins in your own possession instead of giving them over to a third party, entrusting them with everything you have.

Example of Trustworthy Online Wallet – Coinbase

The only online wallet I am aware of that is completely trustworthy right now is Coinbase. Even it has its problems with the service it provides, but it is backed by a lot of investors and it is hard to believe that the site would just run off with everyone's coins. On top of this, my assumption, or at least hope is that they are bringing in enough money and investments that if they experienced some major issue that caused coin loss, they would be able to make up for it. Luckily they have not gotten to any point where this has been tested, but when it comes to businesses and the way they are run, despite their problems I believe Coinbase is a great example of what we should be looking forward to in the future. This is probably largely because they are financed by actual investors, rather than people that just decided to throw up a website in the hopes of making some profit off of it. They have some of the top skilled developers and security professionals there are. I think that this alone helps show how serious they are about making their business model work, and that if they were to let some major issue crash their business, I can not imagine that the investors would take that too lightly. As a result, they have a lot on the line and have to ensure that they are always running a high quality and legitimate business.

Ease of Use - Drawing in Users

I have found that online wallets, for people that are not that familiar with the Bitcoin protocol (or other crypto currencies, for that matter, being that multiple now have online wallets), allow for transactions without having to really understand what is going on. In a way, they are just like having a hosted wallet for cash: all a user has to do is understand how to use a deposit and withdrawal address, and they are able to quickly and easily send funds to one another, without having to worry about things like syncing up to the block chain, deal with the fees, etc. Along with this, the online nature of them allows for not having to even run anything on a local computer system. Instead, a browser works just fine.

I think this is what has been drawing people in. For all intents and purposes, the crypto currencies are still a pretty confusing thing for people that are not deeply involved with them. Even for people that are technology buffs and love seeing the latest and greatest things, it can still lead to confusion. When we start looking at people that do not keep up with technology (we consider these the “grandmas”), it gets even worse. Making things easier for them to understand is important in order to keep adoption rising and money flowing in and out of the Bitcoin economy. Sadly, due to the way the block chains work, the online wallets are the perfect compliment to this.

Of course, we have to keep in mind that they are traditionally not as secure as hosting things on your own, but for the people who otherwise would not even be able to get involved, they work as a good median point. Along with this, most people that are not capable of running the software on their own would not be able to secure it regardless, so just pushing people away from the online wallets is really not a solution to the problem: working on better clients is. At the end of the day, for a lot of people both online wallets and personal ones are going to offer up a similar level of security, simply because the vast majority of people ignore all of the security protocols as it is and therefore both are going to be about equal.

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