What is a crypto wallet?

Definition

Crypto wallets are a software program or physical device like Ledger that are used for storing and accessing cryptocurrencies. They consist of a public key and a private key,  allowing you to send and receive cryptocurrencies like Bitcoin and Ethereum. 

Key Takeaways :

• A wallet is a piece of software or hardware that is designed to provide access to funds stored on a blockchain and store a users private key(s);
• Wallets consist of two key components : a public address which is used to store digital assets on a blockchain, and a private key which is used to sign off on transactions sent from the public address;
• Wallets exist in a variety of forms but can be categorized into two broad groups : hot wallets, which are always online and connected to the internet, and cold wallets, which are stored offline and only connect to the internet when in use.

Introduction

When you think of your wallet, you probably picture a folded piece of leather that holds your cash and credit cards. While this description may be accurate for some, its true definition is far less specific. Simply put, a wallet is something that holds money. 

Cryptocurrency wallets are your gateway to the crypto economy. Your wallet is what provides you with access to your funds, and allows you to interact directly with blockchains to send and receive digital assets. It functions like a combination of a bank account and an email address. When a wallet is created a unique key, called a private key, is given to the owner that grants exclusive access to the funds held by that wallet. This key must be entered in order to move funds out of the wallet. Similar to email, once this key is created it can never be deleted - it belongs to the owner forever. Funds can be sent to the address by anybody, but funds cannot be sent from the address unless the private key is entered. 

How Do Wallets Work?

The definition of “wallet” as “something that holds money” loosely applies to cryptocurrencies, but technically speaking one could argue that by this definition a crypto wallet is not a wallet at all. Unlike a conventional wallet that physically holds cash, crypto wallets technically do not actually hold any funds. Rather, they provide access to funds that are stored on the blockchain.

All cryptocurrencies live on a blockchain, meaning that they are stored on a decentralized network (similar to the internet). 

Let’s pause for a minute to understand the concept of a decentralized network. An example of a decentralized network that you likely interact with on a daily basis would be the internet. The internet is a distributed network of service providers that work together to provide access to information in the form of data. If one of these service providers were to go offline for some reason, such as a power outage, as long as the remaining service providers remain online the internet would still exist. It would simply be one “node” supporting the network that went temporarily offline, while all of the information would continue to exist on the network. Where the internet works to decentralize information, blockchain networks work to decentralize finance. The decentralized model helps protect the network from downtime, security threats, corruption, and censorship. 

Let’s go back to our email example. Email accounts consist of two pieces of information: the email address and the password. One piece of information is public, and the other is private. Anyone with the address is able to send messages to the account, but only the password holder is able to send messages. 

Crypto wallets work the same exact way. When a wallet is created, there are two pieces of information generated: the public key and the private key. The public key is analogous to the email address, and the private key to the email account password. Anyone who knows your public key is able to send funds to your wallet - but only you (the private key holder) can send funds out of the wallet. 

Crypto wallets can also be likened to another familiar concept commonly found in “traditional” wallets - credit cards. A credit card itself is not money, but it represents access to money. If the card is lost, it can be replaced so long as proof of ownership of the account can be provided. Crypto wallets are the same: they are not themselves value, but represent access to value on the blockchain, and can be restored by proving ownership via the private key. (potentially remove section, gotta think about this some more)

Now that we understand private and public keys, we can paint the full picture of a crypto wallet. A crypto wallet is simply a piece of software that stores both your public and private keys and encrypts them for safety. It is your window into the blockchain, and allows you to easily send and receive funds with the click of a button.

Types of Wallets

There are a wide variety of wallet types, but the main three are: software wallets, hardware wallets, and paper wallets. All three have the same fundamental structure in storing a private key, but will fall into one of two categories: “hot” and “cold” wallets. A “hot” wallet is a wallet that is connected to the internet in some way. A “cold” wallet is stored offline, making it impossible to lose funds unless the wallet is physically stolen. 

Software wallets are stored on your computer or smart device, making them fall in the “hot” category. These are generally less secure than cold wallets, as the private key could be stolen in the event that your device becomes infected with a virus. Software wallets can be web based, desktop based, or mobile based. 

Hardware wallets work similarly to a flash drive in that they store information and then disconnect. The ability to disconnect removes a major security vulnerability, making this the most secure - although least accessible - option. 

Paper wallets function similarly to a hardware wallet, except slightly less secure. The paper literally has your private key printed onto it, so if it is lost or stolen - so go the funds. Paper wallets also make it difficult to send only partial amounts of funds. 

Best Practices

It’s a good idea to keep a written copy of your private key, as this can be imported into a different wallet in the event that you lose access to your device. The private key - whether on a piece of paper or a hardware wallet - should be stored in a secure location. It’s also possible to translate your private key into a mnemonic - a series of words that, if entered in the right combination, can be decoded into your private key. 

In Summary

Crypto wallets are pieces of software or hardware that hold and encrypt a “private key”. This key is what gives you permission to access and move funds secured by the blockchain. While no one can “hack” a crypto wallet, it is still possible for a wallet to become compromised if the private key is compromised. For this reason, it is imperative to protect your private key by storing it in a safe location. By taking proper measures, these risks can be fully mitigated.