The number of cryptocurrencies that exist in the world is upwards of 1600 with this number increasing even as you are reading this article. Whereas, the number of transactions on the Bitcoin network alone amounts to approximately 234,000 per day as of September 2018.
This begs the question: Where does all this crypto go when one person sends it to another?
This is where cryptocurrency wallets come into the picture.
A cryptocurrency wallet is a software application which allows a user to interact with other users on the blockchain enabling him/her to send and receive cryptocurrency and track their own crypto balance.
This is done by using a combination of public and private keys.
Public and Private Keys
When you receive any currency over the crypto network, you are actually receiving it on to a hashed version of your public key. The public key is shared with anyone who needs to send you cryptocurrency.
There is another key called the private key which is used to derive the public key and remains confidential. You should not disclose your private key to anyone else. Both the public and private keys are strings of integers and are encoded in the Wallet Import Format which is made up of letters and numbers.
An example of such a key is:
Private Key: When a transaction is issued by you, it has a signature which is generated using the private key. This certifies that the transaction has been granted by you and prevents anyone else from making any changes to the transaction.
Public Key: The public key is derived from the private key mathematically. It is then transformed into a hash function. This gives the public address that other people use when sending you cryptocurrency. The process of deriving the public key from the private key is irreversible, i.e., the private key cannot be obtained from the public key.
Important: You should never share your private key with anyone nor should you note it down or enter it where anyone else can have access to it. In simple words, your private key is your email’s password that grants you access to authenticate any mail saying it is from you. On the other hand, the public key is the email address itself that is to be used by anyone to send you mail, or cryptocurrency in this case.
Note: For every different cryptocurrency you own, you will have a different key pair, i.e., public and private key. This means you cannot use the same key pair for your Bitcoin and Ethereum.
How does a crypto wallet work?
A crypto wallet cannot be compared to a physical wallet that stores physical coin. Since cryptocurrency doesn’t exist physically, it cannot be “stored” in a crypto wallet. When someone is sending you Bitcoin or other digital currency, they are transferring the ownership of that coin to your wallet address. This wallet address is merely a hashed version of your public key.
For you to be able to spend that coin, the private key in your wallet must match the public key that the sender is using to assign the currency to. When this happens, your wallet balance will increase, and you can then spend the currency.
Types of Cryptocurrency Wallets
Cryptocurrency wallets can be broadly classified into two categories:
- Hot Wallets: connected to the internet
- Cold Wallets: not connected to the internet
Hot wallets can be of two types. There are online crypto exchanges such as Coinbase and Poloniex which store your crypto while you are involved in trading. Also, software such as Exodus or Dash QT Wallet that can be downloaded on your mobile phone or desktop are examples of hot wallets.
Cold wallets are closer to real-world wallets in that they are cold storage facilities for your crypto which is not connected to the internet. A cold wallet can be in the form of a QR code that you print out and which can be used to generate the private key needed for transactions.
Cold wallets can also be by way of hardware wallets that store your private and public keys and, are plugged into a computer whenever a transaction needs to be carried out. Examples of some of the best hardware wallets are Ledger and Trezor.
Which one should I choose?
Hot wallets are connected to the internet, which makes them easy targets of hackers putting your funds at risk of being stolen. Malware, insider hacking, denial-of-service attacks, etc. are all possibilities with a hot wallet.
However, they possess the advantage of ease and speed of carrying out transactions. Cold wallets, on the other hand, are much more secure since they are not connected to the internet. Hacking is not a threat with cold wallets. Moreover, you are in complete control of your keys with no interference from any third-party.
There is no definite winner when it comes to choosing the best cryptocurrency wallet. However, there are some solid contenders. In the hardware wallet segment, you cannot go wrong with the Ledger Nano S. When it comes to online wallets, Exodus is a great one. Liteaddress is an excellent paper wallet service.
One idea that is of the essence while making cryptocurrency transactions is not to store all your digital currency on one platform. Store some of it on hot wallets which can be actively used for trading. The majority of your funds must be stored on cold wallets so that they are safe from the risk of being hacked.