News is circulating the Internet right now that a serious bug has been discovered in the newly minted “encrypt wallet” functionality of the official client for Bitcoin versions 0.4 and 0.5. The private keys may be left unencrypted in the wallet.dat file and therefore become fodder for thieves or malware that might then use those keys to steal your coins.

Gavin Andresen at the Bitcointalk forums released the news Friday evening, outlining some of what we know about the nature of the bug,

A serious bug was been found in the “encrypt wallet” function of bitcoin versions 0.4 and 0.5: private keys may be left unencrypted in the wallet.dat file after encryption.

If your encrypted 0.4 wallet file is stolen, an attacker may be able to recover some or all of your private keys and steal some or all of your bitcoins.

The development team has been working on fixes for bitcoin versions 0.4 and 0.5, but it will take at least a few days to test them thoroughly. Until they are available, you should assume that your ‘encrypted’ wallets are as vulnerable as an unencrypted wallet, and follow all the best practices for keeping them safe (see here for a list).

It is embarrassing and astonishing that this critical a bug was not caught before the 0.4 release; constructive suggestions on how to improve the testing and release processes that do not assume access to hundreds of thousands of dollars of funds to hire security consultants or QA teams are welcome. Getting sufficient testing of code BEFORE it is released has been a chronic problem for this project.

As always, I thoroughly suggest that anyone who chooses to save their Bitcoin wallet.dat in the cloud (or on a backup service—and you should be backing up your wallet.dat file) should be using another layer of encryption that’s tried-and-true. Open source cryptographic volume programs such as TrueCrypt will make a good job of enveloping your file and even if its encryption fails, you will have the backup of the TC volume protecting your bitcoins.

The on-wallet encryption for the Bitcoin client is still in its infancy. Perhaps it was released too soon for what it is, but just because a function encrypts something valuable doesn’t mean that you should be complacent about how you treat your own security.

Even having working in-client encrypt is nice; but it’s no substitute for prudence.

No comment has been made by the Bitcoin developers yet on this issue.