How are cryptocurrency wallets structured?

21 June 2023
How are cryptocurrency wallets structured?

What is a cryptocurrency wallet?

Any cryptocurrency wallet is software that interacts with various blockchains (Bitcoin, Ethereum, and others). This interaction allows the user to create a public address in the blockchain (it can be called something like an account) and make transactions with one click. The cryptocurrency wallet acts as a buffer between the user and the blockchain.

For a proper understanding of how cryptocurrencies work, let's separate the concepts.

There are cryptocurrencies, which we talked about above. They allow you to interact with the blockchain and your assets in it.

There is the cryptocurrency wallet, which is part of the blockchain itself (your account).

Many people have a big misconception that a wallet installed on their phone or computer stores your crypto-assets. It doesn't. Your crypto-assets are stored inside the blockchain. An installed wallet stores data that allows you to access the "true" crypto-purse (your account) and perform various transactions via the blockchain.

The reliability of a "true" blockchain crypto-purse is based on cryptography. The principle on which most such wallets are built uses three things: a private (private) key, a public (public) key, and a public address.

Every time you send cryptocurrency from your wallet, it must use a private (public) key to "sign" or validate the transaction. This signature is similar to your fingerprint, unique to each person and their private key. This allows you to prove that the transaction comes from the legitimate owner of the wallet and has not been tampered with.

cryptocurrency wallet

Now let's pay attention to the presented scheme.

The private key is used to create the public key in the encryption process. The peculiarity of the encryption method does not allow a reverse transition. That is, you can get the public key from the private key, but the public key cannot be used to decrypt the private key.

This approach allows you to share the public key without worrying that someone can get the private key and steal the cryptoassets.

When creating any cryptocurrency wallet, your journey starts exactly with creating a private key. 

Very often, a mnemonic phrase (seed phrase) is used to make the private key easy to remember (and it is quite complex). The private key is converted into 12-24 Latin words.

crypto currency wallet

The public key is subjected to a mathematical function that "compresses" it into a public address.

From a single private key, multiple public keys can be generated, each with its own public address.

The public address is the identifier of the user on the blockchain network. It is the classic address that you use to send cryptocurrency to someone or have it transferred to you.

Types of cryptocurrency wallets

Types of cryptocurrency wallets

Custodial (exchange) crypto wallets

Custodial (exchange) - wallets created by centralized exchanges. In essence, it is a virtual wallet, which is created by the exchange for transactions. Funds are stored in the central wallet of the exchange, so you are not the true owner of the asset. As long as the asset is on the exchange - it is not yours, because you do not own the private key. We talked about it earlier.

Pros: they are free, very easy to use. You register and can fully use the wallet. You do not need to store a private key, as exchanger does it for you. To regain access you need to write to support and reset the data you used in the KYC procedure.

Disadvantages: you do not control your funds, if for some reason exchange decides to block your funds, you will not get access to them anymore. De-anonymization of identity, at the moment almost on all acceptable for work exchangers need to pass KYC-procedure - confirmation of identity. The risk of hacking the main wallet of the exchange.

Custodial (exchange) crypto wallets

Hot (software) crypto wallets

Hot (software) - software that allows you to manage your crypto-assets. Such wallets are most suitable for people who regularly use cryptocurrencies (transfers, speculation). Software wallets are divided into desktop wallets (Exodus), web wallets (Metamask) and mobile wallets (Trust Wallet).

Such wallets are called hot wallets because they are connected to the Internet. Transactions of such wallets are authorized immediately on the device. Cracking occurs when connecting to the internet. The wallet's mnemonic phrase/private key is also at risk.

Pros: free, fairly easy to use, but not as custodial solutions. You have full control over your funds since the private key is with you. Anonymous enough, you don't need to pass KYC, but as the crypto market develops, such applications collect more and more different personal data: ip addresses, geo-location, device type and so on.

Cons: vulnerable to hacking as they are used on regular personal computers, in addition people don't really care about the security of their personal computer. It is necessary to keep the private key and the seed phrase carefully, since a loss can lead to loss of access to the wallet, or to the theft of assets.

Hardware (cold) crypto wallets

Hardware (cold) crypto wallets

Hardware (cold) - are electronic devices that consist of a processor, touchpad and display. These devices generate public and private keys and store them. To process a transaction on such a device, you need to connect it to your computer via USB or Bluetooth (Trezor, Ledger, SafePal).

A cold wallet has no connection to the Internet. The risk of introducing a virus that will steal your recovery keys is minimized. Your keys are stored in the safest possible environment - only on this device.

The main difference between a hot wallet and a cold wallet is that in a hot wallet all the actions take place on it, while a cold wallet only signs your transactions and transmits them to the network by linking them to a device that is connected to the network.

This is why they are notable, although you see the balance of your wallet in its application on the phone, but to make a transaction without a hardware wallet you can not, so do not worry about the fact that you lose your phone, someone will find it before you and steal the crypto, or some virus steal the keys.

Pros: This is the safest way to store cryptocurrencies. Private keys are under full control. Just like with hot wallets, they are anonymous, you don't have to go through KYC.
Cons: They're fee-based. Popular products start at $50, and you also have to factor in the cost and delivery time by mail. Most wallets only support one network, ERC20. At this point, depending on the load, the transaction fee can be quite hefty, this should be taken into account. It can be difficult for newbies to understand the interface of cold wallets. Since it's a physical device, it can be lost, broken, and so on. You'll have to order a new one.

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Frequently asked questions about cryptocurrencies

What is a cryptocurrency wallet?

A cryptocurrency wallet (or cryptocurrency wallet) is a software or hardware device that allows you to store, send and receive cryptocurrency such as Bitcoin, Ethereum and other cryptocurrencies.

What types of cryptocurrency wallets are there?

There are several types of cryptocurrency wallets including online wallets, mobile wallets, hardware wallets and paper wallets. Online wallets are accessed through a web browser, mobile wallets are installed on smartphones, hardware wallets are physical devices, and paper wallets are paper media on which keys are written.

What are public and private keys?

A public key is the address of your wallet that you use to receive cryptocurrency. A private key is a secret phrase or code that gives you access to manage the funds in your wallet. Never share your private key with anyone as this can result in loss of funds.

What if I forgot my private key or lost access to my wallet?

If you lose your private key or wallet access, your cryptocurrency funds could be lost forever. Therefore, it is important to take care of the security of your keys and make regular backups.

How to choose the right cryptocurrency wallet?

Choosing a cryptocurrency wallet depends on your needs and preferences. If you want convenience, then a mobile or online wallet will do. If maximum security is important to you, a hardware wallet would be the best choice.

Can I use one wallet for different types of cryptocurrencies?

Some wallets support multiple types of cryptocurrencies, but not all. It is important to make sure that the wallet you choose supports the cryptocurrencies you need.
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