diff --git a/CHANGELOG.md b/CHANGELOG.md
index 99b55bf..d760e36 100644
--- a/CHANGELOG.md
+++ b/CHANGELOG.md
@@ -116,3 +116,35 @@
 - Initial MVP release, all core features functional
 - Encrypted storage planned for future release
 - Interactive shell in Go SSH direct mode not yet available
+
+## Phase 2 — Security Enhancement
+
+### AES-256-GCM Encryption
+- New `pkg/crypto/crypto.go`: AES-256-GCM encrypt/decrypt with PBKDF2 key derivation
+- 100,000 iterations, 16-byte salt, SHA-256 key derivation
+- `Encrypt(plaintext, password)` → base64(salt + nonce + ciphertext)
+- `Decrypt(encoded, password)` → plaintext
+- `IsEncrypted(data)` checks if data looks like encrypted content
+
+### Storage Layer Encryption
+- `JSONStorage` now has `password` field for master encryption key
+- `SetPassword()`, `GetPassword()`, `IsEncrypted()` methods
+- `readJSON()` auto-decrypts if password is set and data is encrypted
+- `replaceHosts/KeyPairs/Snippets()` auto-encrypt before writing
+- All existing CRUD operations transparently encrypt/decrypt
+
+### Known Hosts Verification
+- New `pkg/knownhosts/knownhosts.go`: TOFU (Trust-On-First-Use) model
+- `KnownHosts` manages `known_hosts` file (JSON format)
+- `Verify()` checks if host key matches stored key
+- `HostKeyCallback()` returns `cryptossh.HostKeyCallback` for SSH config
+- Warns on key mismatch (potential MITM attack)
+
+### SSH Client Security
+- `Client` now supports `hostKeyCallback` and `passphraseCallback`
+- `SetHostKeyCallback()` — replaces `InsecureIgnoreHostKey()`
+- `SetPassphraseCallback()` — prompts for passphrase on encrypted keys
+- `getKeySigner()` tries passphrase callback if key is encrypted
+
+### Models Updated
+- `AppConfig`: added `EncryptionEnabled`, `PasswordHash`, `KnownHostsFile`
diff --git a/internal/models/models.go b/internal/models/models.go
index e6ba29e..a9c3b6d 100644
--- a/internal/models/models.go
+++ b/internal/models/models.go
@@ -59,6 +59,20 @@ type AppConfig struct {
 	Editor            string `json:"editor"`
 	AutoSync          bool   `json:"auto_sync"`
 	SyncProvider      string `json:"sync_provider,omitempty"`
+
+	// Security
+	EncryptionEnabled bool   `json:"encryption_enabled"`
+	PasswordHash      string `json:"password_hash,omitempty"` // SHA-256 hash for verification
+	KnownHostsFile    string `json:"known_hosts_file,omitempty"`
+}
+
+// KnownHost represents a verified host key
+type KnownHost struct {
+	Hostname string `json:"hostname"`
+	Port     int    `json:"port"`
+	KeyType  string `json:"key_type"`  // "ssh-rsa", "ssh-ed25519", etc.
+	KeyHash  string `json:"key_hash"`  // Base64-encoded host key
+	AddedAt  time.Time `json:"added_at"`
 }
 
 // DefaultConfig returns the default application configuration
@@ -70,5 +84,6 @@ func DefaultConfig() *AppConfig {
 		Theme:             "dark",
 		Editor:            "vim",
 		AutoSync:          false,
+		EncryptionEnabled: false,
 	}
 }
\ No newline at end of file
diff --git a/pkg/crypto/crypto.go b/pkg/crypto/crypto.go
new file mode 100644
index 0000000..64132d1
--- /dev/null
+++ b/pkg/crypto/crypto.go
@@ -0,0 +1,122 @@
+package crypto
+
+import (
+	"crypto/aes"
+	"crypto/cipher"
+	"crypto/rand"
+	"crypto/sha256"
+	"encoding/base64"
+	"errors"
+	"io"
+
+	"golang.org/x/crypto/pbkdf2"
+)
+
+const (
+	KeyLength   = 32 // AES-256
+	SaltLength  = 16
+	Iterations  = 100000
+)
+
+var (
+	ErrInvalidPassword = errors.New("invalid password")
+	ErrDecryptionFailed = errors.New("decryption failed — wrong password or corrupted data")
+)
+
+// DeriveKey derives an AES-256 key from a password using PBKDF2
+func DeriveKey(password string, salt []byte) []byte {
+	return pbkdf2.Key([]byte(password), salt, Iterations, KeyLength, sha256.New)
+}
+
+// Encrypt encrypts plaintext using AES-256-GCM with a password
+func Encrypt(plaintext []byte, password string) (string, error) {
+	salt := make([]byte, SaltLength)
+	if _, err := io.ReadFull(rand.Reader, salt); err != nil {
+		return "", err
+	}
+
+	key := DeriveKey(password, salt)
+
+	block, err := aes.NewCipher(key)
+	if err != nil {
+		return "", err
+	}
+
+	aesGCM, err := cipher.NewGCM(block)
+	if err != nil {
+		return "", err
+	}
+
+	nonce := make([]byte, aesGCM.NonceSize())
+	if _, err := io.ReadFull(rand.Reader, nonce); err != nil {
+		return "", err
+	}
+
+	ciphertext := aesGCM.Seal(nil, nonce, plaintext, nil)
+
+	// Format: base64(salt + nonce + ciphertext)
+	result := make([]byte, 0, len(salt)+len(nonce)+len(ciphertext))
+	result = append(result, salt...)
+	result = append(result, nonce...)
+	result = append(result, ciphertext...)
+
+	return base64.StdEncoding.EncodeToString(result), nil
+}
+
+// Decrypt decrypts ciphertext using AES-256-GCM with a password
+func Decrypt(encoded string, password string) ([]byte, error) {
+	data, err := base64.StdEncoding.DecodeString(encoded)
+	if err != nil {
+		return nil, ErrDecryptionFailed
+	}
+
+	if len(data) < SaltLength+12 { // 12 = minimum nonce size for GCM
+		return nil, ErrDecryptionFailed
+	}
+
+	salt := data[:SaltLength]
+	data = data[SaltLength:]
+
+	key := DeriveKey(password, salt)
+
+	block, err := aes.NewCipher(key)
+	if err != nil {
+		return nil, ErrDecryptionFailed
+	}
+
+	aesGCM, err := cipher.NewGCM(block)
+	if err != nil {
+		return nil, ErrDecryptionFailed
+	}
+
+	nonceSize := aesGCM.NonceSize()
+	if len(data) < nonceSize {
+		return nil, ErrDecryptionFailed
+	}
+
+	nonce := data[:nonceSize]
+	ciphertext := data[nonceSize:]
+
+	plaintext, err := aesGCM.Open(nil, nonce, ciphertext, nil)
+	if err != nil {
+		return nil, ErrInvalidPassword
+	}
+
+	return plaintext, nil
+}
+
+// IsEncrypted checks if a string looks like base64-encoded encrypted data
+func IsEncrypted(data string) bool {
+	decoded, err := base64.StdEncoding.DecodeString(data)
+	if err != nil {
+		return false
+	}
+	// Minimum: 16 (salt) + 12 (nonce) + 16 (min ciphertext) = 44 bytes
+	return len(decoded) >= 44
+}
+
+// HashPassword creates a SHA-256 hash of a password for verification
+func HashPassword(password string) string {
+	h := sha256.Sum256([]byte(password))
+	return base64.StdEncoding.EncodeToString(h[:])
+}
diff --git a/pkg/knownhosts/knownhosts.go b/pkg/knownhosts/knownhosts.go
new file mode 100644
index 0000000..4240873
--- /dev/null
+++ b/pkg/knownhosts/knownhosts.go
@@ -0,0 +1,187 @@
+package knownhosts
+
+import (
+	"encoding/base64"
+	"encoding/json"
+	"fmt"
+	"net"
+	"os"
+	"path/filepath"
+	"sync"
+	"time"
+
+	cryptossh "golang.org/x/crypto/ssh"
+)
+
+// KnownHosts manages the known_hosts file
+type KnownHosts struct {
+	path  string
+	hosts map[string]*HostKey // key = "hostname:port"
+	mu    sync.RWMutex
+}
+
+// HostKey represents a stored host key
+type HostKey struct {
+	Hostname string    `json:"hostname"`
+	Port     int       `json:"port"`
+	KeyType  string    `json:"key_type"`
+	KeyData  string    `json:"key_data"` // Base64-encoded raw key
+	AddedAt  time.Time `json:"added_at"`
+}
+
+// New creates a new KnownHosts manager
+func New(dataDir string) (*KnownHosts, error) {
+	path := filepath.Join(dataDir, "known_hosts")
+	kh := &KnownHosts{
+		path:  path,
+		hosts: make(map[string]*HostKey),
+	}
+
+	if err := kh.load(); err != nil {
+		// File doesn't exist yet, that's OK
+		if !os.IsNotExist(err) {
+			return nil, err
+		}
+	}
+
+	return kh, nil
+}
+
+// Load reads the known_hosts file
+func (kh *KnownHosts) load() error {
+	kh.mu.Lock()
+	defer kh.mu.Unlock()
+
+	data, err := os.ReadFile(kh.path)
+	if err != nil {
+		return err
+	}
+
+	var hosts []*HostKey
+	if err := json.Unmarshal(data, &hosts); err != nil {
+		return err
+	}
+
+	for _, h := range hosts {
+		key := fmt.Sprintf("%s:%d", h.Hostname, h.Port)
+		kh.hosts[key] = h
+	}
+
+	return nil
+}
+
+// Save writes the known_hosts file
+func (kh *KnownHosts) Save() error {
+	kh.mu.RLock()
+	defer kh.mu.RUnlock()
+
+	var hosts []*HostKey
+	for _, h := range kh.hosts {
+		hosts = append(hosts, h)
+	}
+
+	data, err := json.MarshalIndent(hosts, "", "  ")
+	if err != nil {
+		return err
+	}
+
+	return os.WriteFile(kh.path, data, 0600)
+}
+
+// Verify checks if a host key is known and matches
+func (kh *KnownHosts) Verify(hostname string, port int, remoteKey cryptossh.PublicKey) (bool, *HostKey) {
+	kh.mu.RLock()
+	defer kh.mu.RUnlock()
+
+	key := fmt.Sprintf("%s:%d", hostname, port)
+	stored, ok := kh.hosts[key]
+	if !ok {
+		return false, nil // Unknown host
+	}
+
+	// Compare key type and data
+	remoteType := remoteKey.Type()
+	remoteData := base64.StdEncoding.EncodeToString(remoteKey.Marshal())
+
+	if stored.KeyType != remoteType || stored.KeyData != remoteData {
+		return false, stored // Key mismatch — potential MITM
+	}
+
+	return true, stored // Key matches
+}
+
+// Add stores a new host key
+func (kh *KnownHosts) Add(hostname string, port int, remoteKey cryptossh.PublicKey) error {
+	kh.mu.Lock()
+	defer kh.mu.Unlock()
+
+	key := fmt.Sprintf("%s:%d", hostname, port)
+	kh.hosts[key] = &HostKey{
+		Hostname: hostname,
+		Port:     port,
+		KeyType:  remoteKey.Type(),
+		KeyData:  base64.StdEncoding.EncodeToString(remoteKey.Marshal()),
+		AddedAt:  time.Now(),
+	}
+
+	return kh.Save()
+}
+
+// Remove removes a host key
+func (kh *KnownHosts) Remove(hostname string, port int) error {
+	kh.mu.Lock()
+	defer kh.mu.Unlock()
+
+	key := fmt.Sprintf("%s:%d", hostname, port)
+	delete(kh.hosts, key)
+
+	return kh.Save()
+}
+
+// Get returns the stored host key for a given host
+func (kh *KnownHosts) Get(hostname string, port int) *HostKey {
+	kh.mu.RLock()
+	defer kh.mu.RUnlock()
+
+	key := fmt.Sprintf("%s:%d", hostname, port)
+	return kh.hosts[key]
+}
+
+// HostKeyCallback returns a crypto/ssh HostKeyCallback for use in SSH config
+func (kh *KnownHosts) HostKeyCallback(autoAdd bool) cryptossh.HostKeyCallback {
+	return func(hostname string, remote net.Addr, remoteKey cryptossh.PublicKey) error {
+		// Extract port from address
+		_, portStr, err := net.SplitHostPort(remote.String())
+		if err != nil {
+			return fmt.Errorf("failed to parse address: %w", err)
+		}
+
+		port := 22
+		fmt.Sscanf(portStr, "%d", &port)
+
+		// Check if host is known
+		matches, stored := kh.Verify(hostname, port, remoteKey)
+		if matches {
+			return nil // Key matches, connection OK
+		}
+
+		if stored == nil {
+			// Unknown host — auto-add if enabled
+			if autoAdd {
+				if err := kh.Add(hostname, port, remoteKey); err != nil {
+					return fmt.Errorf("failed to add host key: %w", err)
+				}
+				return nil
+			}
+			return fmt.Errorf("host key not found for %s:%d — run 'hostkeeper trust %s' to add", hostname, port, hostname)
+		}
+
+		// Key mismatch — potential MITM attack
+		return fmt.Errorf("WARNING: host key mismatch for %s:%d!\n"+
+			"Stored key type: %s\n"+
+			"Remote key type: %s\n"+
+			"This could indicate a MITM attack.\n"+
+			"Run 'hostkeeper trust --remove %s' and try again.",
+			hostname, port, stored.KeyType, remoteKey.Type(), hostname)
+	}
+}
diff --git a/pkg/ssh/auth.go b/pkg/ssh/auth.go
index 10873df..c2f6716 100644
--- a/pkg/ssh/auth.go
+++ b/pkg/ssh/auth.go
@@ -79,10 +79,20 @@ func (c *Client) getKeySigner() (cryptossh.Signer, error) {
 		return nil, fmt.Errorf("failed to read key file %s: %w", keyPath, err)
 	}
 
-	// Parse the key (support passphrase-protected keys in Phase 2)
+	// Parse the key (support passphrase-protected keys)
 	var signer cryptossh.Signer
 	if c.host.Auth.Password != "" {
 		signer, err = cryptossh.ParsePrivateKeyWithPassphrase(keyData, []byte(c.host.Auth.Password))
+	} else if c.passphraseCallback != nil {
+		// Try without passphrase first
+		signer, err = cryptossh.ParsePrivateKey(keyData)
+		if err != nil && strings.Contains(err.Error(), "encrypted") {
+			// Key is encrypted, prompt for passphrase
+			passphrase := c.passphraseCallback()
+			if passphrase != "" {
+				signer, err = cryptossh.ParsePrivateKeyWithPassphrase(keyData, []byte(passphrase))
+			}
+		}
 	} else {
 		signer, err = cryptossh.ParsePrivateKey(keyData)
 	}
diff --git a/pkg/ssh/client.go b/pkg/ssh/client.go
index 4b0a75f..67abe1d 100644
--- a/pkg/ssh/client.go
+++ b/pkg/ssh/client.go
@@ -18,10 +18,12 @@ import (
 
 // Client represents an SSH client
 type Client struct {
-	host    *models.Host
-	timeout time.Duration
-	client  *cryptossh.Client
-	config  *cryptossh.ClientConfig
+	host            *models.Host
+	timeout         time.Duration
+	client          *cryptossh.Client
+	config          *cryptossh.ClientConfig
+	hostKeyCallback cryptossh.HostKeyCallback
+	passphraseCallback func() string // called to get passphrase for encrypted keys
 }
 
 // NewClient creates a new SSH client
@@ -32,6 +34,16 @@ func NewClient(host *models.Host, timeout time.Duration) *Client {
 	}
 }
 
+// SetHostKeyCallback sets the host key verification callback
+func (c *Client) SetHostKeyCallback(cb cryptossh.HostKeyCallback) {
+	c.hostKeyCallback = cb
+}
+
+// SetPassphraseCallback sets the callback for getting key passphrases
+func (c *Client) SetPassphraseCallback(cb func() string) {
+	c.passphraseCallback = cb
+}
+
 // Connect establishes an SSH connection
 func (c *Client) Connect(ctx context.Context) error {
 	// Create SSH configuration
@@ -69,9 +81,14 @@ func (c *Client) dialTCP(ctx context.Context, address string) (net.Conn, error)
 
 // setupConfig creates SSH client configuration
 func (c *Client) setupConfig() error {
+	hostKeyCallback := cryptossh.InsecureIgnoreHostKey()
+	if c.hostKeyCallback != nil {
+		hostKeyCallback = c.hostKeyCallback
+	}
+
 	config := &cryptossh.ClientConfig{
 		User:            c.host.Username,
-		HostKeyCallback: cryptossh.InsecureIgnoreHostKey(), //nolint:gosec // Phase 1 - will be improved in Phase 2
+		HostKeyCallback: hostKeyCallback,
 		Timeout:         c.timeout,
 	}
 
diff --git a/pkg/storage/json_storage.go b/pkg/storage/json_storage.go
index 10ec56b..609abcb 100644
--- a/pkg/storage/json_storage.go
+++ b/pkg/storage/json_storage.go
@@ -12,12 +12,14 @@ import (
 	"github.com/google/uuid"
 
 	"git.tukangketik.id/swanadiva/hostkeeper/internal/models"
+	"git.tukangketik.id/swanadiva/hostkeeper/pkg/crypto"
 )
 
 // JSONStorage implements Storage interface using JSON files
 type JSONStorage struct {
-	dataDir string
-	mu      sync.RWMutex
+	dataDir  string
+	password string // master password for encryption (empty = no encryption)
+	mu       sync.RWMutex
 }
 
 // NewJSONStorage creates a new JSON storage instance
@@ -35,6 +37,21 @@ func NewJSONStorage(dataDir string) (*JSONStorage, error) {
 	return s, nil
 }
 
+// SetPassword sets the master password for encryption/decryption
+func (s *JSONStorage) SetPassword(password string) {
+	s.password = password
+}
+
+// GetPassword returns the current master password
+func (s *JSONStorage) GetPassword() string {
+	return s.password
+}
+
+// IsEncrypted returns whether encryption is enabled
+func (s *JSONStorage) IsEncrypted() bool {
+	return s.password != ""
+}
+
 func (s *JSONStorage) ensureDataFiles() error {
 	files := map[string]string{
 		"hosts.json":    "hosts",
@@ -162,6 +179,15 @@ func (s *JSONStorage) replaceHosts(hosts []*models.Host) error {
 		return fmt.Errorf("failed to marshal hosts: %w", err)
 	}
 
+	// Encrypt if password is set
+	if s.password != "" {
+		encrypted, err := crypto.Encrypt(bytes, s.password)
+		if err != nil {
+			return fmt.Errorf("failed to encrypt hosts: %w", err)
+		}
+		bytes = []byte(encrypted)
+	}
+
 	return os.WriteFile(s.getHostsPath(), bytes, 0600)
 }
 
@@ -272,6 +298,15 @@ func (s *JSONStorage) replaceKeyPairs(keys []*models.KeyPair) error {
 		return fmt.Errorf("failed to marshal key pairs: %w", err)
 	}
 
+	// Encrypt if password is set
+	if s.password != "" {
+		encrypted, err := crypto.Encrypt(bytes, s.password)
+		if err != nil {
+			return fmt.Errorf("failed to encrypt key pairs: %w", err)
+		}
+		bytes = []byte(encrypted)
+	}
+
 	return os.WriteFile(s.getKeysPath(), bytes, 0600)
 }
 
@@ -382,6 +417,15 @@ func (s *JSONStorage) replaceSnippets(snippets []*models.Snippet) error {
 		return fmt.Errorf("failed to marshal snippets: %w", err)
 	}
 
+	// Encrypt if password is set
+	if s.password != "" {
+		encrypted, err := crypto.Encrypt(bytes, s.password)
+		if err != nil {
+			return fmt.Errorf("failed to encrypt snippets: %w", err)
+		}
+		bytes = []byte(encrypted)
+	}
+
 	return os.WriteFile(s.getSnippetsPath(), bytes, 0600)
 }
 
@@ -508,5 +552,15 @@ func (s *JSONStorage) readJSON(path string, v interface{}) error {
 	if err != nil {
 		return err
 	}
+
+	// Decrypt if password is set and data looks encrypted
+	if s.password != "" && crypto.IsEncrypted(string(data)) {
+		decrypted, err := crypto.Decrypt(string(data), s.password)
+		if err != nil {
+			return fmt.Errorf("decryption failed: %w", err)
+		}
+		data = decrypted
+	}
+
 	return json.Unmarshal(data, v)
 }
\ No newline at end of file