A bitcoin wallet stores the private keys required to make bitcoin transactions. And while a bitcoin wallet is somewhat similar to a more traditional wallet used for storing cash and other wares, there are some important differences.
While a more traditional wallet may hold cash, bank cards and other methods of payment, a bitcoin wallet holds private keys, which give the key holder the ability to access bitcoin addresses and therefore send and receive bitcoin. In addition, bitcoin wallets permit users to both add or remove bitcoin addresses and see the balance held by each address.
The Foundation of Bitcoin Wallets
To understand bitcoin wallets, it is helpful to review some basic foundational information. Bitcoin addresses, which are strings of letters and numbers, contain both a private and public key.
A private key gives a user the means to spend bitcoin. A public key is more like a destination that lets a user to receive bitcoin.
Because a private key holds all information needed to access a bitcoin address, one can use it to derive the public key.
Types of Wallets
There are several different types of wallets, and each type comes with varying features. However, every kind of wallet must conform to the Bitcoin Protocol, a set of rules that governs bitcoin transactions and bitcoin mining.
Those looking for a more traditional approach may consider desktop wallets, which comes with its own unique costs and benefits. While it grants the owner more control than other options such as online wallets, the wallet files stored in this manner are only accessible using the desktop in question. Should the wallet files become contaminated, the user may be unable to use his or her supply of bitcoin.
Online wallets are wallets that function through a web browser. Several companies provide services like these, generally hosting these wallets and managing the security of the private keys involved.
The key information that is needed is stored online. By storing this data online, bitcoin users can protect themselves against the risk of inadvertently deleting their private keys from a computer.
However, some have voiced concerns that using this approach requires users to surrender their control over their keys by allowing hosting providers to manage keys for users.
Mobile wallets are simply wallets designed for mobile devices. This kind of wallet can be very helpful if you are out in public and trying to pay for items using bitcoin. Coinbase, a major bitcoin exchange, offers mobile wallets for both Android and iOS operating systems.
Hardware wallets are secure devices created for the purpose of securely storing the private keys of users. These devices use very little software to store this information, making them far less vulnerable to being compromised than desktop or mobile wallets.
Users interested in holding tangible stores of wealth may consider paper wallets, which are pieces of paper that include both a bitcoin address and a private key. By taking this approach, users can receive several benefits. Those benefits include:
- They retain ownership of any private key data.
- Pieces of paper are not vulnerable to being hacked, and users may find it easier to keep them safe (as opposed to digital means).
However, users should keep in mind that if someone else gets hold of a piece of paper containing the bitcoin address and private key, they have everything they need to spend those funds.
Securing Bitcoin Wallets
Just like a traditional wallet, keeping bitcoin wallets secure is of the utmost importance. Fortunately, there are many steps that users can take to accomplish this objective. One basic approach is following the old adage "don't put all your eggs in one basket." By holding bitcoin in many different places, a user can reduce their potential loss should one location be compromised.
There are also more specific approaches available. If users store a wallet offline, they can back up this information, reducing the chances that their crucial data will go missing. If they opt to store their backups online, they can encrypt these backups to improve security.
Users can employ multi-signature technology, a feature offered by bitcoin, to help manage risk. When using this feature, transactions cannot take place without several independent approvals. This feature can help eliminate the risk of a user losing their bitcoin due to a single device being compromised.
Bitcoin wallets are integral to transactions involving the currency, as they store the information needed to send and receive bitcoin. There are many different kinds of bitcoin wallets, and these types all come along with unique costs and benefits.
Regardless of which type of wallet a user selects, there are several steps he or she can take to make that wallet more secure and decrease the risk of theft or loss.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…