What is a Cryptocurrency Wallet and How Does it Work?
If you want to learn about the basics of cryptocurrency and blockchain technology, one of the first things that you should become familiar with is the role of a cryptocurrency wallet.
This guide will explain everything you need to know, using really simple, real-world examples. By the end of reading it from start to finish, you will have all the information you need!
Table of Contents :
- 1. A Brief of Crypto Wallet
- 2. How Does a Cryptocurrency Wallet Work?
- 3. How Do Private and Public Keys Relate to a Wallet Address?
- 3.1. But You Said the Coins Aren’t Actually Stored in Crypto Wallets?
- 4. What Are the Different Types of Cryptocurrency Wallets?
- 4.1. Desktop Wallet
- 4.2. Mobile Wallet
- 4.3. Web or Online Wallet
- 4.4. Paper Wallet
- 4.5. Hardware Wallet
- 5. Are Cryptocurrency Wallets Secure?
- 6. Can I Store All of My Cryptocurrencies in the Same Wallet?
- 7. Is it True that Cryptocurrency Wallets are Anonymous?
- 8. Which Cryptocurrency Wallet is the Best?
- 8.1. Exodus
- 8.2. Ledger Nano S
- 8.3. Jaxx
- 9. Conclusion
A Brief of Crypto Wallet
Before I go any further, I want you to think about how you store your real-world cash. You don’t walk about holding it in your hands, do you? Instead, you most probably store it a leather wallet or purse, or maybe even a piggy bank!
Either way, it is wise to store your money where it is safe. A cryptocurrency wallet follows the same core principles.
Nevertheless, by obtaining a crypto wallet, you will have the ability to send and receive Bitcoin and other cryptocurrencies.
So, now that you have a basic understanding of what a cryptocurrency wallet is used for, let’s see more depth how it works.
How Does a Cryptocurrency Wallet Work?
In the above section, I used the example of a real-world leather wallet, insofar that the wallet physically stores your cash. However, things are slightly different in the digital world of cryptocurrencies and blockchain technology.
Coins are not actually stored in a physical wallet, as cryptocurrencies do not exist in a physical form. Instead, the blockchain consists of transactional records that details which private and the public key has control over the funds.
To make sure you have a full understanding, I will quickly explain the role of a wallet address, as well as a private and public key, as they are all related.
A wallet address is like a bank account number. There is no harm in giving somebody else your bank account number, as people will need it if they are to transfer your funds. This could be so your employer can pay you your salary, so a customer can pay your invoice or so that your friends and family can send you some birthday money!
In the world of cryptocurrency, if somebody wants to transfer your coins, you simply give them your wallet address. Just like in the real world, no two wallet addresses are ever the same, which means that there is no chance that somebody else would get your funds. Also, there is no limit to the number of wallet addresses you can create.
To give you an example of what a Bitcoin address looks like, here is the wallet address that is believed to belong to the creator of Bitcoin, Satoshi Nakamoto!
As you can see, it uses a combination of numbers and letters, using both upper case and lower case. As most blockchains are transparent, it is easy to find out how much money a certain cryptocurrency wallet has, as well as the transactions the owner has previously made.
However, a cryptocurrency wallet address does not reveal the real-world identity of its owner, which is why the blockchain is referred to as “pseudonymous”.
How Do Private and Public Keys Relate to a Wallet Address?
So, now that you know that a wallet address is very similar to a bank account number, I am now going to explain how you are given control of the funds. People often think that a public key is the same as a public wallet address, however, this is not correct.
Essentially, each individual cryptocurrency wallet address (remember, no two addresses can be the same) each have a unique private and public key. The private key allows you to access the funds that are related to the crypto wallet address.
To give you a real-world example, when you want to transfer money from your bank account to somebody else’s bank account, you will need to enter your private password. Nobody else has access to this password, not even the bank. Otherwise, if somebody knew what it was, they would be able to send money from your bank account!
A private key does the exact same job and it is linked specifically to the individual crypto wallet address. So what about a public key? A public key is mathematically linked to your wallet address! However, it is a “hashed version”, which I will explain below.
A hash function allows a sequence of letters and/or numbers (called an “input”) to be encrypted into a new set of letters and/or numbers (called an “output”). This adds an extra layer of security and ensures that your wallet cannot be hacked. Here is a quick example to make things simple.
Private Key: 03bf350d2821375158a608b51e3e898e507fe47f2d2e8c774de4a9a7edecf74eda
Public Key: 99b1ebcfc11a13df5161aba8160460fe1601d541
Now, I know what you are thinking: these two sets of keys are completely different? To the human eye, yes, however, the software technology knows that the two keys are specifically linked to each other! That proves that you are the owner of the coins and it allows you to transfer funds whenever you want!
The important thing to remember is that everything I have explained here is very technical. However, when you use a cryptocurrency wallet, the software does everything for you. It’s like using the internet to send an email!
You don’t actually need to understand the technology that runs in the background, the likes of Gmail and Hotmail do everything for you regarding emails – just like a cryptocurrency wallet does regarding crypto transactions!
Are Coins Aren’t Actually Stored in Crypto Wallets?
You should now have a good understanding of what a cryptocurrency wallet is and how public and private keys are linked to a public wallet address. However, you might remember earlier that I said the coins aren’t actually physically stored in the wallet? That’s true! Let me clear things up.
As Bitcoin and other cryptocurrencies are not physical money, they are digitally stored on the blockchain. The blockchain is like a giant accounting ledger that stores every single transaction that has ever occurred in the system, as well as the total account balances of each public address.
The software within the cryptocurrency wallet is connected directly to the blockchain, so it allows you to submit transactions to the ledger. However, the crypto wallet is the protocol that generates your public and private keys. Without it, you wouldn’t be able to access your funds in the real world.
To get a better understanding of this relationship, think about walking into a store and paying for goods using a debit or credit card. There is no physical exchange of money between you and the store. However, by entering your private pin number, you verify that you own the funds and so they can move the funds from your account to the account of the store.
This is the same as a cryptocurrency wallet. By entering your private key, you verify that you own the coins and then you can transfer them to someone else. That is the only way that the coins can move from person A to person B.
So, now that you know the function of a cryptocurrency wallet, let’s take a look at the different types available!
What Are the Different Types of Cryptocurrency Wallets?
There are lots of different wallet types available and the one you choose will depend on your personal needs. Essentially, different wallets offer different things, such as extra security, user-friendliness or convenience. I will now list the most popular types of cryptocurrency wallets.
Desktop wallets are to be downloaded to a specific laptop or computer and they can only be accessed from that particular device. Generally speaking, they offer a good combination of security and convenience. However, it is important to remember that if a hacker were able to remotely get hold of your device, they could gain access to your wallet.
A mobile wallet is very similar to a desktop wallet as the wallet is downloaded directly to your device. You normally access your cryptocurrency wallet by downloading a mobile app, which also allows you to spend your coins in a physical store by scanning a QR code.
Web or Online Wallet
A web wallet offers the greatest level of convenience when sending coins to another person, however, they are also the least secure. This is because the wallet provider usually has full control over it.
An example of this would be storing coins in a cryptocurrency exchange. The exchange will store your coins on their central server, which means that if it hacked, the criminal could have access to all of your funds. It is best advised to only keep a small number of coins in a web crypto wallets.
Paper wallets are one of the most underrated crypto wallets available. All you need to do is to print your private and public keys onto a piece of paper — and that’s it, your funds are secure!
This is because the keys are not connected to any servers, meaning the only way somebody could access them is if they had the physical paper! When you need to transfer funds, you simply enter the keys into a software or web wallet, or even easier, just scan the QR code that you printed!
In terms of security, it doesn’t get any better than a hardware wallet. This is a physical device that has the sole purpose of storing your private and public crypto keys within the hardware.
The device is never connected to the internet unless you need to transfer funds. However, you enter your private pin directly on to the device, making it virtually impossible for a hacker to access your keys.
Are Cryptocurrency Wallets Secure?
Generally speaking, no matter which wallet you use, if somebody has access to your private key, then they have access to your funds. However, the key question is what safeguards are in place to prevent it from happening?
Any cryptocurrency wallet that has a relationship with the internet (e.g. a desktop, mobile or web wallet) will always be vulnerable.
Although abusive hackers are unethical people, they can be very intelligent. They are always creating new ways to access other people’s data, which is why you need to make sure you do everything you can to protect your private key.
Here are some examples of how a hacker could access your funds that are stored alongside an internet connection.
- Key Logger
- Remote Access to your device
There are a number of things that you can do to protect yourself from the above threats. Firstly, you should always make sure your device is using the latest software. As hackers find new methods, they are able to override the inbuilt safety controls, so by updating your software, you will always have the highest level of security.
It is also a good idea to set up extra layers of security. There are many crypto wallets that allow you to set up two-factor authentication, which means that to access it you need to confirm a code that is sent to your mobile phone.
It is also a good idea to consider a wallet that allows multi-signatures. Basically, a multi-signature wallet means that to send funds, the user must authenticate the transaction using two or more separate devices. This way, if one of your devices is lost, stolen or hacked, the criminal won’t be able to access your cryptocurrency, as they would need the other device(s) too!
Finally, it is also recommended to back up your wallet on regular occasions. This allows you to write down a backup password phrase so that if anything happened to your wallet, you could still regain access.
By making sure you follow all of the above security measures, you will ensure that your cryptocurrency wallet is safe and secure against hackers!
Can I Store All of My Cryptocurrencies in the Same Wallet?
This is the golden question — with the answer being sometimes, as it depends on the specific coins you are holding! For example, if you are holding Bitcoin only, you just need to find a wallet that is compatible with Bitcoin. However, what if you are holding Bitcoin and Litecoin?
Although they each have their own blockchain, it is possible to use a multi-currency wallet. These crypto wallets allow you to store different cryptocurrencies within the same wallet, which is much easier than having to use a different wallet for each coin.
However, it all depends on what the wallet can support. Interestingly, most tokens that are available were built on top of the Ethereum blockchain – meaning that they are “ERC-20” compatible. So, if you have lots of ERC-20 tokens, then they can sometimes all be stored within the same multi-currency wallet!
Other coins are not as flexible though, so always check with the wallet provider before you attempt to transfer funds across as if the coin is not compatible you will lose them forever!
Is it True that Cryptocurrency Wallets are Anonymous?
You might remember how I mentioned that the blockchain protocol is pseudonymous, not anonymous.
This means that although your wallet address does not contain your name, people still have access to lots of other information.
This includes all of the previous transactions that the particular wallet address has made (both sent and received), including the amount and the other addresses involved in the transaction.
In reality, this isn’t really an issue, as unless you give somebody your real-world identity, it would be very difficult for someone to know who owns the address.
Just remember, governments now regulate cryptocurrency exchanges, which means that if you want to buy coins using real-world money, then you need to identify yourself by submitting documents.
This means that even once you have withdrawn your funds to your wallet, the exchange will know that your identity is linked to the wallet you sent them to.
Which Cryptocurrency Wallet is the Best?
You should by now have a very good understanding of what a cryptocurrency wallet, how the technology works and the different types available.
You should also have a good idea of how to protect your wallet from hackers, as well as what information you reveal or don’t reveal when you use it.
Exodus is a multi-currency desktop wallet that allows you to store lots of different coins, such as Bitcoin, Litecoin and Dash, as well as various ERC-20 tokens.
One of the best features of Exodus (other than it being free) is that it is really user-friendly. When you log in, you can view you entire cryptocurrency portfolio on a visual pie chart, which also lets you know the current market value of each coin.
The wallet provider never has access to your private keys, nor are they connected to the Exodus servers. For even more convenience, Exodus even has a ShapeShift API built in, which allows you to buy and sell cryptocurrencies within the wallet.
Ledger Nano S
For the ultimate layer of security, it doesn’t get any better than a hardware wallet, such as Ledger Nano S. You will receive a physical device that allows you to store a range of cryptocurrencies offline.
When you want to send coins to someone, you simply need to plug the wallet into your device (such as a laptop) and then enter your private pin number. If the wallet is lost or stolen, you can recover your coins by entering your backup passphrase on another device!
You will need to pay about 90 Euros for the Ledger Nano S, however, if you have a large number of coins, it is well worth the investment. Only ever buy it from the official Ledger Nano S website.
- Super secure
- Protection against physical damage
- Supports more than 1500 coins and tokens
Ledger Nano X
- Can be managed from mobile device
- Very secure
- Supports more than 1500 cryptocurrencies
- Top-notch security
- Touchscreen user interface
- Easy to set up
Jaxx is also one the most popular multi-currency wallets and it is available for download on most desktop and mobile devices. For extra convenience, you can also access your wallet through a Google or Firefox browser extension, making it great if you need to send funds on the go.
The Jaxx developers never hold your private keys, as these are only stored on your device. Moreover, just like Exodus, there is a built-in ShapeShift API that lets you easily trade/swap coins directly from your wallet!
If you have read the guide from start to finish, you should now have a really good understanding of what a wallet is, how the technology works and what it can be used for.
You should also have a good idea of the different types of wallets available on the market. As you now know, different wallet types suit different needs.
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