Crypto Wallet Basics
Welcome to the Bitcoin and cryptocurrency wallets series. This is the first of a three part series which explains and demystifies the primary connection to the crypto world : wallets.
What crypto wallets are, how to choose one, and how to use them. These topics go very deep and are under active development, innovation and research. As such, the information may be over-simplified for the purpose of being a useful introduction.
A cryptocurrency wallet is an application which interacts with blockchains. Wallet applications always allow for
sending cryptocurrency; And they often differentiate themselves with advanced features; e.g. staking, lending, trading, game integrations, privacy enhancements, and many, many more.
Cryptocurrency wallets come in many forms, but at a minimum they are apps which manage a
private key and one or more associated
public keys. More on keys later.
Unlike fiat currencies which are stored in physical wallets and bank accounts, cryptocurrency exists exclusively on blockchains. All of the information about how many bitcoins each address (account) has, is stored on the blockchain, but only the person with the
private key is able to interact with them (sign transactions).
Wallets remove the complexity by managing the keys and blockchain interactions automatically, allowing anyone to send and receive and interact in general with blockchains. Wallets are the primary way users interact with crypto applications.
Bear 🐻 with me as we go through some core concepts.
Bitcoin (BTC), Bitcoin Cash (BCH), Ethereum (ETH), and other cryptocurrency exists on their respective blockchains. Wallets are the user applications which allow
receiving and other network interactions.
Every wallet has it's own set of advanced features.
Private keys are used to access the accounts of cryptocurrency. They enable wallet to do two key actions - Generating
public keys to receive transactions, and signing transaction with the
private key to send assets and interact with the blockchain.
Private keys are the only information to required to access an account and send funds from it. As such, the private key should be protected very privately. If you are not in control of a wallets private key, then it can be taken away (exchange accounts), if someone else has access to a wallets' private key, they can move and potentially steal the assets in that wallet.
Most wallets allow for multiple accounts, which is most often done by managing multiple private keys.
During wallet setup, you will usually be asked to back-up a set of 12 or 24 words - often called a mnemonic, or seed-phrase. This seed-phrase encodes the private key, and should be protected to the same degree. Every wallet has a unique private key, and a unique seed phrase.
Wallets allow the user to backup and store their private keys; most will guide you through the process. Take your time with this step and backup your wallets properly.
Some wallets - typically web and exchange wallets - control your private keys for you. Having an exchange control your keys is simple and often required trading, but it's not as secure as controlling your own private keys. Every so often exchanges "lose" their holdings, and if they control your keys, they can also lose your holdings. So if you are going to hold coins it's best to hold them on your own private keys.
In the event your want to use a different wallet, then there's an
import wallet flow in which you enter the backed-up seed-phrase, and then that account is usable from the new location. The information lives on the blockchain, wallets just access and interact with them.
Since the only things needed to send your coins is the private key, as such, a common saying is "Not your keys, not your money".
The only information required to access your assets is the private key. If the private key is lost, the assets are lost. It's very important to back-up your private key in a secure place and to never expose or share your private key with anyone.
Not your keys, not your coins. Not your keys, not your coins. Not your keys, not your coins.
Public keys / public address, are where you receive funds. Friends, family, strangers, computer programs, etc, can send money to public keys. All these addresses allow is to receive money/transactions, so they can be shared freely and openly. Public keys are often displayed as QR codes and they are extremely easy to use and setup for payments and purchasing goods.
Public keys are generated from private keys, and wallets will generate between one, to millions of public addresses for each private key. Wallets with advanced privacy features often generate new public keys every time they do an action, if done well, this can lead to greater privacy and safety. Public key management has many variations with tradeoffs.
Some blockchains are addressed based, such as Ethereum (ETH. These generally have 1 constant public address for each account.
Other blockchains are UTXO based, such as Bitcoin (BTC), Bitcoin Cash (BCH) and Dogecoin (DOGE) . These can have many public keys for each account, depending on the wallet used.
🔑 Key Ideas
Crypto wallets come in many forms, each with their trade-offs around security, convenience, and ease-of-use. It's common to use different types of wallets for different purposes. Some types are great for spending money daily, some are great for distributing money, and others are perfect for long term storage/security/privacy. Let's go over them briefly.
The most common type of wallet. Mobile wallets are phone applications perfect for sending and receiving crypto assets in everyday life. Everyone should have a wallet on their phones loaded with enough funds for coffee and to split bills with roommates and friends.
These wallets however are not the most secure - in the same way money in your wallet is less secure than a bank - so it's only recommend to keep enough in mobile wallets for daily/weekly use. Their security is usually equivalent to the phone they are on. If someone gains access to the phone, they can likely also get access to the funds on the phone.
Similar to phone wallets, except usually with more advanced features. The functionality of these can extend to a better UI, long term asset tracking, trading capabilities, full-node verification of the blockchain, chain analysis, privacy enhancements, mining, and more; the only limit being developers 🌈 imagination 🌈.
Desktop wallets are a great candidate for storing cryptocurrency, and for using cryptocurrency on the ever-increasing amount of websites that accept cryptocurrency as a payment option.
Wallets that are accessed via extensions within a web browser. These turn your web-browser into a wallet and allow for many exciting interactions with the crypto web (often referred to as web3). Web wallets are probably the easiest ones to use while interactive with crypto web-apps. Getting familiar with one is recommended.
In terms of security, these should be treated like mobile wallets. Secure as your computer, but if you are hacked these may be vulnerable. Stick to reputable ones, and don't store much in them.
Web wallets are wallets that are accessible through websites and web-apps. They usually secure your private keys behind a password and 2-factor authentication. These can be simple to use, but are generally not recommended for storing assets for long periods of time.
If the company managing the keys disappears, you may be left with no way of accessing your assets.
These are commonly found as part of applications that use crypto for micro transactions, such as memo.cash.
Be very wary of putting large amounts in them and avoid websites which requires you to give them your existing private keys.
These are a subset of web wallets connected to a crypto exchange. With these wallets the exchange manages the private keys for you, and hopefully protects them with a password / 2-factor Authentication combination. Exchange wallets are required for trading assets, and will be where your assets are held while buying and selling through an exchange.
Since the exchange controls your private key, if they get hacked or shut down your assets may be lost. Therefore, it's recommended to only store actively traded assets on exchange wallets and to move the rest into wallets which you control the private keys.
Paper wallets are frequently used during event giveaways and tipping. Paper wallets are both the private and public keys printed on a piece of paper. These are great for distributing small amounts of an asset at events, like weddings, birthdays, store openings, meetups, promotions, etc.
The security on these entirely depends on where/how the private key is displayed, and who has access to them. If you receive a paper wallet it's recommend to scan the code with a mobile wallet to "sweep"/transfer the funds off of the paper wallet, then dispose of the paper wallet once emptied.
Hardware wallets are a secure way of storing crypto assets for the long-term. Hardware wallets are designed such that the private keys on them are never exposed to other devices. The only way for funds to be stolen from a hardware wallet is if someone steals your private key recovery phrase.
These wallets are recommended for secure long-term storage. Everyone serious about crypto should consider getting one of these
That's all for part 1.
In part 2 we will cover some of the features to look for in a cryptocurrency wallet.
Crypto Wallet Basics