What is a wallet and how does it work?
A digital wallet is different from a ‘real world’ wallet, as it doesn’t hold money or currency.
Currencies aren’t stored in one location or in physical form. The only records are the transactions stored on the blockchain. Cryptocurrency wallets are actually software programs that keep your public and private keys and access different blockchains, so people with cryptocurrency can check their balance or send and receive money etc.
If somebody sends you bitcoin or another digital currency, they have signed over ownership of those coins to your wallet’s address. To be able to spend the coins the private key stored in your wallet must be the same as the public address the currency is assigned to. If the public key and private key are the same, the balance in your digital wallet will go up and the sender’s balance will decrease in the same amount. No real coins are exchanged; the transaction is simply recorded on the blockchain.
What is a difference between public and private key?
Public addresses – such as the “Current Address” displayed on every wallet screen in both QR and text form – can only be used to receive funds. They’re what you share with the other party in a transaction. If someone were to get a screenshot of your main wallet screen, they wouldn’t be able to remove any funds associated with that address. To do that, they’d need the private key associated with that address.
Private keys “sign” the transaction; without that digital signature, the sender can’t “prove” they control the address associated with those funds, and no transaction will take place.
Like public addresses, private keys are really just data strings that can be represented in plain text or graphic form. Unlike public addresses, however, they should not be shared with third parties unless you want to grant them access to remove funds (e.g. a family member or trusted friend).
What types Cryptocurrency wallets are there?
There are a number of different wallets to access and store your digital currency, but there are the main categories:
Online wallets function in the cloud and can be accessed from any device in any location. These are the most convenient since online wallets store your private keys online which are controlled by a third party. However, online wallets may be vulnerable to hacking attacks and theft.
Desktop wallets are installed on a PC or laptop and can only be accessed from a single computer in which they are downloaded. Desktop wallets are a more secure option, but if your computer gets hacked or has a virus you could lose your funds.
Mobile wallets are kept in apps fun on your phone. They are useful because you always have access to your wallet and may be able to make purchases from retail stores. They are simpler than other wallets due to limited space on a mobile.
Paper wallets provide both a high level of security and are easy to use. A paper wallet is software used to securely generate a pair of keys which are printed. To send Bitcoin to your paper wallet you transfer funds from your software wallet to the public address of your paper wallet. To spend currency it’s a case of transferring currency to your paper wallet from your software wallet. Hardware wallets keep a user’s keys on a storage device like a USB which means that unlike other wallets they are kept offline which makes your cryptocurrency secure. To use this type of wallet it’s simply a case of plugging the device into any internet enabled device and entering a pin and you can then send money or view your balance(s) etc.
How secure are Cryptocurrency Wallets?
It depends on which type of wallet you use, the service provider and how much security you need.
Online wallets can be vulnerable to hackers who have been known to break into a wallet platform to steal funds. Offline wallets can’t be hacked since they are not connected to an online network.
It is important to think carefully about wallets in advance. While it’s true that some people’s online wallets are hacked and funds are stolen, most are not. You are just as likely to lose your funds by ‘losing your wallet’ i.e. losing your private keys. Rather than accessing your wallet only to find it has been emptied by an anonymous cyber-thief, you are more likely to have sent money to a fraudster with no way to get your money back. Common sense is as important as advanced security in making sure you keep hold of your cryptocurrencies.
There are sensible steps you can take to avoid these situations:
You should backup your wallet. Only keep smaller sums in an online wallet accessed via your computer or phone. But keep higher amounts of currencies in a more secure environment. Offline storage options such as Ledger Nano or paper or USB wallets are good if your computer fails and allow you to recover your wallet if it is lost. But no online wallet can guarantee protection from determined hackers.
Use more security layers. Extra security layers do help. The first measure is to set long passwords and making sure that any withdrawal needs a password. Only use wallets that have a good reputation and provide security measures like two-factor authentication and require pin code entry each time a wallet application is opened. Another option is a wallet offering multisig (multi-signature) transactions – this means the permission of another user must be gained before any transaction can go through.
Update Software. Your wallet, computer and mobile software should always be kept updated since potential security holes are regularly patched.
One wallet or many?
Bitcoin is the cryptocurrency that everybody is talking about, but there are other popular ones such as Ethereum, Bitcoin cash or Lite Coin. There are also hundreds of other cryptocurrencies called altcoins. The great thing is that you can use one multiple currency wallet to hold all of these currencies if you choose.
How about transaction fees?
In short, it depends but, sometimes fees don’t need to be paid at all. If not usually fees are very small – certainly much smaller than the real life equivalent of bank transaction fees.
Are cryptocurrency wallets anonymous?
In a sense they are, but in other ways they are not. Wallets are not linked to the identity of their owners, but all your transactions are permanently stored publicly on the blockchain. Some wallets do offer offer a higher degree of security and anonymity though.
Which is the best wallet out there?
It depends on how you want to use it. Before jumping in, consider whether you want to use multiple currencies or one. Do you want to buy digital currency as an investment, or do you intend to make real life or online purchases using your wallet? Do you need to use your wallet while on the move, at work, or just while you’re at home? It’s worth thinking about what wallet suits your needs.