A cryptocurrency wallet is a piece of software that stores the private and public keys of cryptocurrencies and connects to the blockchain to send and receive transactions. In other words, it’s used to check ownership of cryptocurrencies in the blockchain and updates each time a transaction is performed to show the balance.
To understand how Bitcoin and cryptocurrency wallets work and how they are secured in the blockchain it is important to know what public keys and private keys are. An easy way to understand this concept is to compare Bitcoin and cryptocurrencies to email.
As we all know if we want to send or receive emails we need to have an email account. When we sign up to services such as Gmail or Yahoo we choose an email address and a password.
If you want to receive emails, you give your email address to others and that way anyone that has your address can send you emails. You would only give to others your email address but not the password and the reason is obvious. If people knew your private password anyone could go into your email account read your emails and even worst, send emails to your contacts impersonating you.
On the other hand, if you want to send emails, first you would have to connect to your email service provider by entering your username which is your email address and your private password. Once you are in your account you can check for received emails and send emails.
When it comes to Bitcoin and cryptocurrencies, the email software or service provider such as outlook, yahoo, or Gmail represent your Bitcoin or crypto wallet. The internet represents the blockchain which serves as a worldwide ledger that stores the available balance in each public address. Your email address represents your public key, and your password represents the private key.
For you to receive Bitcoin or any cryptocurrency you have to give your public address to whoever is sending the funds, just as you would give your email address to a person that wants to send you email. Your private key which is what gives you ownership over your coins must be kept private just as you keep private your email password.
When you decide to send funds, your wallet, which could be an app installed in your phone, or a software installed in your computer connects to the blockchain, checks the available balance using the public address, then validates ownership of the funds using your private key.
Once the transaction is validated, this information is updated in the worldwide ledger called blockchain and the funds are accredited to the receiving address.
The wallet doesn’t store the actual cryptocurrency. The only things stored in the wallet are the public and private keys which enables the owner of the coin to send and receive funds. Bitcoins and other cryptocurrency coins are stored in the blockchain through these cryptocurrency keys.
Since cryptocurrency doesn’t physically exist aside from bits of storage in the blockchain, the keys that identify the currency must be protected. This is what a cryptocurrency wallet does.
Due to the sensitivity of the data involved, cryptocurrency wallets are designed with security in mind. But there are some good practices that help secure Bitcoin or any other cryptocurrency beyond just relying on the built-in security features of your wallet.
Some wallets only support one kind of cryptocurrency like Bitcoin, others support a variety of cryptocurrencies like Ethereum, Litecoin, Ripple, Dash, etc. It is vitally important not to attempt to send funds to a wallet that doesn’t support that cryptocurrency.
For example, don’t send Bitcoin to a wallet that is only designed to store altcoins, or vice versa. Doing so results in losing those funds forever, because just as email is a one-way transaction, in cryptocurrencies and Bitcoin transactions are only one way meaning that once the funds are sent there is no going back to reverse the transaction.
Bitcoin and Cryptocurrency wallets are divided in two main categories: hot wallets and cold wallets, both types are explained next.
What is a hot wallet?
A hot wallet is simply a Cryptocurrency wallet that runs in a computer or electronic device that is connected to the internet. In other words, it’s an online wallet. This type of wallet can also run on a live website that hold your private keys.
The connected nature of this type of wallet to the internet makes it not ideal to store cryptos long-term. This is because hot wallets are easier targets for hacking attempts.
The only time a wallet should be hot is when you are sending or checking for received funds, and even then, it is very important that the wallet is online for as short as possible.
It should also be secured by multiple layers of security like 2FA (2-factor authentication) and a complex password. As might be expected a wallet that is not online is referred to as a cold wallet, which will be discussed next.
What is a cold wallet?
A cold wallet is a wallet that is offline, in other words the computer or device that runs the wallet’s software is not connected to the internet.
Since the wallet is offline, it cannot be accessed remotely and thus is much less susceptible to hacking. Storing your coins in a cold wallet is sometimes referred to as cold storage. Cold storage is the preferred method of storing cryptocurrency for a long period of time.
If you would like to learn more about hot and cold wallets and learn about the different types of each one, please read the post Types of Hot and Cold Wallets by clicking here.
Cryptocurrency wallets are a vital piece of the cryptocurrency landscape, as they allow us to store our cryptocurrency coin and keep it away from remote hackers as well as the individuals who are physically present around us.
Indeed, if the cryptographic keys that represent our funds are lost, so too are our funds themselves. The strengths of software-based cryptocurrency wallets include ease of use and the ability to quickly and easily make transactions. This is ideal for those who have a large influx and outflow of funds.
However, a hardware wallet provides the versatility needed to accommodate both the short-term holder of cryptocurrency and the long-term investor.
Software wallets are great for those who are casual users just get starting in cryptocurrency, but anyone who is serious about getting into cryptocurrency and securing their coins for the long haul, a hardware wallet would be the best way to go.
Alberto is the originator and primary contributor for this blog. He is an electrical engineer, tech and crypto enthusiast. Likes to learn and help others understand the amazing world of Bitcoin and cryptocurrencies.