A cryptocurrency wallet is a digital wallet for holding digital currency. Cryptocurrency wallets rely on cryptography for security.
Public and private keys
Public key cryptography (also referred to as asymmetrical cryptography), is any cryptographic system that uses pairs of “keys”. A key is a piece of information that unlocks or decodes a cryptographic algorithm).
There are two types of keys – public keys which may be spread widely and known to many people and private keys which are only known to the key owner. The use of public and private keys accomplishes two functions – authentication and encryption. Authentication is where the public key verifies that the message was sent by the holder of the paired private key. Encryption is where the paired private key holder (and them alone) can decrypt a message encrypted with the public key.
Public and private keys in a cryptocurrency wallet
Now we completely understand public and private keys, let’s think about how this works in a cryptocurrency wallet. Obviously, there is no cryptocurrency actually stored in the electronic wallet.
In the case of Bitcoin (and cryptocurrencies derived from it), the cryptocurrency is stored and maintained in a publicly available ledger. Every piece of cryptocurrency has a private key. With the private key, it is possible to write in the public ledger, effectively spending the associated cryptocurrency
Your wallet stores your private and public keys. This allows and facilitates the sending and receiving of coins. Further, it also acts as a personal ledger of transactions.
Features, characteristics and types of cryptocurrency wallets
Wallets come in different formats with a range of features and benefits. Here are most of the main types with brief explanations.
Multi-currency cryptocurrency wallet
A wallet that supports different types of cryptocurrencies that can be “stored” at the same time.
Software cryptocurrency wallet
This is the main type of wallet as you might expect with a digital currency. It’s worth briefly considering the different types of software wallets. They come in different forms like:
- An application installed locally on a computer or device (smartphone or tablet)
- Some web-based wallet’s use additional security – you may have come across two step verification like Google authenticator. The main benefit of this additional authentication is it avoid a hacker using keystroke logging to try and gain access to the wallet.
- A cryptocurrency exchange (for example the Kraken exchange) links the user’s wallet to the exchanges centrally managed wallet. Any trades are written in the exchanges ledger as an off-chain transaction. When a user enters their cryptocurrency into the exchange or takes it out of the exchange then the transaction is written into the blockchain.
Hardware cryptocurrency wallet
It’s interesting that a hardware wallet exists when you consider cryptocurrencies and the whole concept of a decentralised digital currency. A hardware wallet is a small digital device that can be plugged into a computer to be used to authenticate cryptocurrency transactions. The rationale is to provide added security. Some types of wallets require the user to physically press or touch the wallet in order to sign a transaction.
When the user of a wallet requests a payment, the wallet creates the transaction and provides a public key which is sent to the network. In effect, the signing keys never leave the wallet.
Watch-only cryptocurrency wallet
With a watch-only wallet someone can keep track of transactions but transactions can’t be initiated since there is no private key stored in the wallet. The private key can be kept safe in another location.
Multi-signature (multi-sig) cryptocurrency wallet
A wallet where multiple users have to sign a transaction using their private key.
Brain cryptocurrency wallet
A brain wallet requires the owner to remember the information required to regenerate the private and public key pair. This is often facilitated by the user memorising a mnemonic sentence the seed (or basis) of which is generated by software.
Hot cryptocurrency wallet
A wallet connected to the internet that will allow cryptocurrency to be spent at any time.
Cold cryptocurrency wallet
A wallet not connected to the internet. To use a cold wallet (one example being an unconnected hardware wallet) then it has to be first connected to the internet.
Deep cold storage cryptocurrency wallet
Storing cryptocurrencies in cold wallets that were never connected to the internet or any kind of network.
Deterministic cryptocurrency wallet
A single key (or “seed”) can be used to generate an entire “tree” of key pairs. The single key serves as the “root” of the tree. The advantage of this system is if a hard drive becomes corrupted and the wallet unrecoverable, a new wallet can be created using the same seed. All of the addresses and private keys from the old wallet will return.
Non-deterministic cryptocurrency wallet
Each key is randomly generated on its own accord. Any backups of the wallet must store each and every single private key used as an address, as well as future keys that may have already been given out as addresses but not received payments yet.