You can’t own cryptocurrency without a cryptocurrency wallet. A crypto wallet is a software program that works with a blockchain to select and track the addresses where your cryptocurrency resides. It makes your cryptocurrency assets accessible only to you. Wallets perform the complex calculations needed to coordinate with the blockchain when you send and receive cryptocurrency, so you don’t have to understand the underlying formulas and mathematics. Wallets come in several forms, depending on how much security you need for your crypto assets. You must take extra precautions to protect your wallet so you don’t lose your cryptocurrency forever.
Your wallet doesn’t store your cryptocurrency. It stores the address where your crypto resides on the blockchain, and the key to access it. Because each blockchain might have different rules that define the format of a valid address, a wallet must be designed to support the cryptocurrency you own. Some wallets only support a single cryptocurrency, such as a wallet created for the release of a new altcoin. Other wallets support a variety of blockchains. With thousands of altcoins available, it’s not unusual to use more than one wallet to keep track of all your cryptocurrency assets.
Each blockchain defines the format and range of its valid addresses and assigns the initial address of every new altcoin it creates. However, once a coin is circulated and has an owner other than the blockchain, the owner’s wallet is responsible for selecting, tracking and storing its address.
A wallet essentially selects a random address from a blockchain’s valid range by creating a new public/private key pair and performing a series of complex calculations to cloak the public key and put it in the correct format according to the blockchain’s rules. A blockchain’s range of valid addresses is so large that it’s more likely for the Earth to be destroyed in the next five minutes than it is for two wallets to randomly select the same address. The address the wallet creates is the address that the sender uses to transfer cryptocurrency, and the address that’s publicly recorded on the blockchain. The private key is required to unlock the cryptocurrency at that address. For maximum privacy, it’s common to use a different address for each cryptocurrency transaction.
In addition to performing the required calculations to receive cryptocurrency, a wallet stores the address and key for the cryptocurrency assets by transaction. In a non-deterministic wallet, each new address and key is random. The wallet has no ability to recreate a former key. Backing up the wallet is essential, since a lost wallet means lost cryptocurrency. A deterministic wallet uses the wallet’s seed phrase or password to create the private key. It uses the private key to create each of the subsequent transaction keys. If the wallet is damaged or destroyed without a backup, a deterministic wallet can recreate the former keys from the seed phrase or password.
You can’t choose your own password to secure your crypto wallet. When you initialise a new wallet, the wallet tells you what the password is, and you can’t change it. The password is typically a 64-character string consisting of the digits zero through nine and the letters A through F, such as:
Technically speaking, it is a hexadecimal number and the private key of a public/private key pair. Since anyone who can log in to your wallet can transfer, spend or steal all the cryptocurrency the wallet tracks, keeping your password a secret is critical. Just as important, however, is that you don’t lose your password. There might not be a way to recover a lost password, and you lose access to your crypto assets until you find it. Some people write down the password and place it in a bank safe deposit box for safekeeping.
The Wall Street Journal estimates that 20 percent of all bitcoins – more than $25 billion – won’t ever be spent because the owners lost the keys to their wallets.
Some wallets provide a “seed phrase” as an easier way to remember your password. A seed phrase typically consists of 12 words in a specific order that the computer selects at random from 2048 possible choices. For example, a seed phrase might be:
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Mathematically, the seed phrase provides about the same level of security as a 64-character password and is easier to remember than:
Behind the scenes, the wallet converts the seed phrase to a number and uses that number to create your private key or password.
If you’re provided with a seed phrase, write it down immediately and keep it safe. You are usually only given the seed phrase once.
Types of Wallets
There are several types of free and paid wallets available. Most cryptocurrency exchange websites provide a free software wallet. The Coinbase wallet is popular as a wallet hosted in the cloud by Coinbase and as a wallet you install on your computer. The Binance wallet is a popular choice for those who want to store a wallet on a mobile device.
All software wallets have some risk of being hacked, because they are connected to the Internet. There’s an additional risk for each type of software wallet. For example, it’s harder to protect the physical security of a mobile device, which increases the risk of theft for mobile wallets. The assets stored in a hosted wallet might be stolen if someone hacks the exchange that hosts the wallet, although some exchanges provide limited insurance if this happens. If a user downloads an installed wallet from a phishing website, this version of the wallet will be modified with malware designed to steal the addresses and keys of the cryptocurrency stored in it. Verifying the domain of a wallet download site is therefore critically important.
If your cryptocurrency assets are substantial, it’s worth spending a few hundred dollars to purchase a hardware wallet, also called a cold-storage wallet.
These are software wallets bundled on a hardware device that resembles a USB flash drive. When the wallet is not inserted into a computer, it is offline and in cold storage. When it’s in cold storage, nobody can steal the cryptocurrency assets because nobody can access the addresses or keys. To make a transaction, you insert the wallet into a computer and execute the transaction. Then you eject the wallet and it goes back into cold storage. The only time that you risk having your wallet hacked is the short time it’s inserted in the computer. While this significantly limits the ability for someone to hack your wallet, it increases the risk of losing your cryptocurrency forever.
If the hardware device fails or is destroyed and you don’t have a backup, it’s the same as losing the password to your wallet.
Security Best Practices
Your wallet protects your cryptocurrency, but you must protect your wallet. In addition to the password or passphrase, many wallets add an optional layer of protection that requires something you know (a password or pin) and something you have (a fingerprint or cell phone), called two-factor authentication. Turn on this option if it’s available.
You should also back up your wallet regularly in case something happens to it or the data in it. Never share your password or passphrase with anyone, but make it accessible to someone you trust in case you die unexpectedly. Take standard safety precautions online to guard against phishing and malware specifically designed to harvest cryptocurrency addresses and private keys. Understanding what a wallet does and the information it stores should enable you to provide better security for it and your cryptocurrency assets.