Welcome to Part 2 of our Beginners Series! In Part 1, we answered the question: What is Bitcoin? Well, if you’re reading this then you already know the answer to that question and are interested in learning what a wallet is and why people use them. We’ll also talk about the different kinds of wallet available such as hardware wallets, mobile wallets, paper wallets, web wallets, brain wallets, hot wallets and cold wallets. That’s a lot of wallets…but don’t worry, we’ll keep things simple and stick to plain English. Let’s go!
In its most basic form, a wallet allows you to store, send and receive Bitcoins (and actually many other cryptocurrencies too), a bit like a bank account. Wallets connect to the blockchain, check their balance and also send and receive transactions. They also have a lock on them too, called a private key. Hold on…a what? Listen up because this bit is important. You private key is a long string of letters and numbers that grant you (or anyone else who has them) access to your wallet and its contents. Leaving your private key somewhere that someone can find it would be like leaving your wallet on the bus with all your money in it – so you’ll want to keep your private key very safe.
The private key also has a second function. It is randomised and combined with other numbers and letters to create your wallet address. Using the bank analogy, this is the equivalent to your bank account number; where a unique identifier is given to each customer. The big difference here though, is that this account number (or wallet address) isn’t actually registered to anyone, thus making it private. It’s also not possible to reverse engineer the private key from a wallet address either, thanks to a cryptography feature called hashing (unrelated to anything you may have done in college). So, all you have is a wallet and a private key to access that wallet.
Seed Phrases – Wallet Simplification
Now, given that the private key to your wallet looks a bit like the picture above, you can see that it’s not the most memorable thing in the world right? Enter the HD wallet (HD standing for ‘hierarchical deterministic’ but you don’t need to remember that). Instead of having to remember every letter and number (oh and it’s case sensitive too), an HD wallet simplifies things by creating what’s known as a seed phrase – a series of more common dictionary words that you can actually remember. This way, if you lose access to your wallet, you can recover it by setting up a new one using the wallet seed phrase. Again, just like the private keys, if you lose these; access to your wallet and its contents are gone for good.
There was a story run by a UK newspaper telling of a man who inadvertently disposed of an old hard drive from his computer in 2013, forgetting that it had about $130 worth of bitcoin stored on it. Once he saw the price of bitcoin skyrocket (in 2017), he realised that it had become worth more than $80,000,000. Those 7500 bitcoin he discarded would be worth a cool $202,000,000 today. He actually considered investing in digging up the landfill site where he believed it had been buried to see if he could recover the drive which had the keys to the wallet stored on it.
Needless to say, it’s a good idea to keep a copy of your seed phrase somewhere very safe.
Types of Wallets
The majority of software wallets are known as lite wallets because they don’t hold a full copy of the blockchain (which would take up significant space). Instead, these lite or SVP (Simple Payment Verification) wallets are a lot quicker in operation and don’t take up the full 350GB of space required for a copy of the blockchain (as of December of 2020).
The vast majority of users have what is known as a hot wallet which essentially means that it is connected to the Internet in some way – be that on your computer or smartphone for example. Unfortunately, these are probably the least secure as they do offer a potential way in for a hacker.
Within hot wallets, we can think of a number of varieties, each with their own pros and cons. The worst option (in our view) is what is called a ‘web wallet’, which is simply a wallet used by a website to store your coins; perhaps for betting or trading with. Usually you have to deposit your funds into a web wallet before using their services. In this example, you don’t have any access to it beyond the website itself because you don’t have a copy of the private key. This means that if the website gets hacked or goes away, then your cryptocurrency probably goes away with it. If you are forced to use a web wallet for something, such as trading bitcoin, then you want to move it out of there into a safer wallet as soon as you reasonably can. Not only do you not control the wallet, but also hackers have been known to breach a website and empty out its customers web wallets. Ouch. Make sure the website you’re using supports multi-factor authentication such as by sending a text message with a code enabling you to login, or some other security – at least a password or FaceID!
If you remember that you don’t actually hold any bitcoin yourself, but rather just have the keys to a wallet that does, then here’s how to think of a mobile wallet. A mobile wallet is simply an app that has your private keys and can show you the balance of your account as well letting you send and receive bitcoin from others. There are many examples such as Zengo, Aqua and Mycelium but all of them have two serious flaws in common. Security and Privacy.
Although they may seem convenient, mobile phones are both registered to you (either the number or the handset), thus limiting the privacy of your bitcoin. The other issue is that 70 million phones are lost each year, with only about 7% being ever recovered. And if it’s not on your phone but on your laptop computer, then remember that one laptop is stolen every 53 seconds. So there’s the security problem right there. Again, we strongly advise you to enable multi-factor authentication and password protect your wallet – plus of course make yourself a copy of the private key for safe keeping.
The only time in which we would say it’s ok to use a mobile wallet, is in conjunction with a hardware key, which we’ll talk about in a moment.
On the other end of the security spectrum is the cold wallet. The simplest way to think of this is to imagine a wallet that has no Internet connection at all – making it virtually immune to being hacked. Cold wallets can come in a number of forms such as hardware, paper and…even your own brain.
A paper wallet is just that. A scrap of paper with your seed phrase (or full private key) written down on it and stored away somewhere safe. Instead letters and numbers, you can print a QR code to represent them – just be careful as hell with witch service you use as there’s a common scam here! Paper wallets aren’t perfect either; if you spill your latte on them while you have them out, or they get burnt in a tragic domestic incident, then your bitcoin goes with them. The other thing to consider is that you won’t be sending or receiving bitcoin with that scrap of paper alone. At some point, you’ll need to use the seed phrase to import your bitcoin in to some kind if digital wallet. Not ideal.
Simple one this – a brain wallet is just the same as a paper wallet except you remember a set of seed phrases, perhaps by making them into a sentence that you remember. Pretty poor if you ask us – easy to forget, easy for a motivated hacker to guess (you’d be surprised – there are many stories of this happening!).
Ahhh, here we are finally – the nirvana of wallets! A hardware wallet is a physical device that stores your private keys but is not connected to the Internet itself i.e it’s a type of cold wallet. This is great from a security standpoint as it means your bitcoin is safe from hackers. Like many, the hardware wallet will probably ask you to create a seed phrase. This is useful in case you lose your hardware wallet or it somehow gets destroyed – allowing you to simply buy a new hardware wallet and recover your bitcoin onto it. In order to use a hardware wallet, it needs to be connected to your computer or mobile device where some software is installed, either with a cable or wirelessly. Only then will you be able to send from it as it stores your private keys that allow you to do so. Great examples of hardware wallets are made by companies such as Trezor and Ledger.
Well, that’s it for this lesson, by now you should have a good understanding of what a bitcoin wallet is and how different types of wallet work. See you soon for Part 3!
- You don’t actually ‘own’ bitcoin, you simply have the keys that allow you to access it on the blockchain
- Private keys allow you access to the wallet and make up part of your wallet ‘address’
- Some wallets are safer than others. Use web wallets only when you have to (and setup 2FA) but use hardware wallets for longer term storage of any cryptocurrency.
- Hot wallets are somehow connected to the Internet, cold wallets are totally offline.
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