How to Diversify Your Bitcoin Holdings

5 months, 2 weeks ago - April 11, 2022
How to Diversify Your Bitcoin Holdings
Keeping your Bitcoin in one place is a bad idea. Use a variety of storage mediums to optimize your Bitcoin security.

Diversification is an important part of a financial portfolio. But I've got 90% of my holdings in Bitcoin, so diversification means something different to me. It means not keeping all of my Bitcoin in one wallet. This practice is the same as not keeping all of your money in a single bank account, or all of your stock with one broker. There are a few organizational challenges in spreading out Bitcoin into various wallets, but a range of solutions exist for storing cryptocurrencies. I recommend making use of as many that make sense for you.

Don't lose your Bitcoin

Part of the challenge of owning Bitcoin is keeping track of it all. For every wallet with Bitcoin inside of it, you will have a corresponding recovery phrase. It doesn't make sense to keep all of the recovery phrases in one place. If that place is compromised or discovered by attackers, then you've lost all of your wallets. If that place burns to the ground, then you've lost your Bitcoin. For something as decentralized as Bitcoin, it's a bit of an issue to simultaneously have to deal with the centralization of wallet recovery phrases. Luckily there are some tips for decentralizing your wallets.

These tips are especially helpful to people storing substantial amounts of Bitcoin. If all that you have is $50 worth of Bitcoin, then you probably don't need to worry about wallet management.

Use hardware wallets

Make use of hardware wallets. That's right, wallets, plural. Hardware wallets are like a USB sticks that hold an encrypted version of your recovery phrase. They come in many shapes and sizes, and vary based on usability and security. The reason I may want more than one is that I want to protect myself and my funds against the widest range of vulnerabilities, including the failure of any one specific hardware wallet. Bitcoiners recommend using hardware wallets because they're kept offline and are encrypted with a password. Stealing the device doesn't steal the funds, as the attacker still needs a passcode that only you know. If someone does steal the wallet, you can always access your funds using your recovery phrase and transfer them to a new wallet..

Use a multi-signature wallet

Bitcoin comes with a built-in ability to create a wallet that requires more than one key to access. These wallets are called multi-signature, or multi-sig, wallets. Let's say you buy three hardware wallets. Bitcoin can be sent to each wallet individually, or a multi-signature wallet which requires the keys of each of your hardware wallets. Multi-signature wallets can even be designed such that the funds within it can be accessed using any two of the three hardware wallets you own. It is up for you to decide how you want to design your wallet. By using a multi-signature wallet, when or if you lose one wallets, you haven't necessarily lost access to your multi-sig wallet.

Multi-sig wallets are especially helpful in hiding your Bitcoin from attackers. If attackers have stolen one of your wallets, there is no real way for the attacker to know that they're only holding one of the three keys to a multi-sig wallet. Multi-sig wallets do require knowledge of how to create and configure them, but they're an especially useful tool when diversifying your Bitcoin holdings.

Memorize a recovery phrase

I recommend you memorize one of your recovery phrases. This kind of wallet is called a brain wallet. By memorizing the recovery phrase, you're ensuring that the only copy of the phrase resides within the confines of your memory. You can use a memorized phrase to access one of your hardware wallets or be one of the three keys to a multi-sig wallet. If your recovery phrase exists in the physical world, it's vulnerable to being stolen. The only way to remove this vulnerability is by memorizing the phrase. However, if you lose your memory for whatever reason, your funds are lost. So remember to keep at least one written backup phrase in a safe place.

Principles for storage

There are three principles to follow regardless of your storage schema:

  1. Decentralize your holdings: Don't keep everything in one place.
  2. Back up your backups: Copy down the recovery phrase multiple times, and put them in multiple locations.
  3. Use multiple mediums: Use some combination of hardware wallets, software wallets, multi-sig wallets, and brain wallets. The loss of any one of these mediums shouldn't mean the loss of any of your funds.

Following these three principles safeguards you against a wide variety of scenarios that could result in the loss of your funds. Keep in mind that wallet management is still not a perfect science. Attackers are getting more sophisticated with their methods and providers of custodial services are building better solutions. The best thing you can do is to continue to learn, experiment, and diversify.

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