Blockchain technology has come a long way since the anonymous figure Satoshi created Bitcoin using this technology in 2009. Blockchain is a distributed public ledger that records cryptocurrencies transactions. The maintenance of this blockchain ledger is performed by a network of communicating nodes running the same version of blockchain software. Every digital currency like Bitcoin, Ethereum, Bitcoin Cash, Ripple, Litecoin, or any other has its own blockchain software platform, a ledger, and a community of miners.
In the last 10 years or so, cryptocurrencies based on blockchain technology have overcome all blockades in their way, destroying all kinds of myths and cynicism. Passionate followers have not only adopted these digital currencies but they have been fast enough to update themselves with this ever-changing technology. With a total crypto market cap at $500+ billion, millions of transactions are executed each day as blockchain technology is being adopted by top-level companies. Therefore, in this fast-changing world, it would be worth knowing, how to store and secure your precious Bitcoins and other cryptocurrencies using digital wallets.
What is a Digital Wallet?
Similar to fiat currencies, digital currencies need to be managed and stored somewhere. As we keep dollar bills securely in a wallet so do we need to store our digital currencies like Bitcoin in wallets.
A digital wallet refers to a smart electronic device or a software program that allows an individual to make electronic transactions online. This can include sending-receiving digital currencies or purchasing items with a computer, tablet, smartphone, or any other smart device. A digital wallet uses software for proving the authenticity of the device/user, based on information stored in the device itself. So a digital wallet has both a software and information component inside it.
How to use a digital wallet
The software in combination with information like password, pin, or a master key provides required minimal security and encryption for online transactions. There are two types of digital wallets available in the market: One is operated at the client-side or user side, where private keys are stored on the user device itself. Another type of digital wallet can be maintained at the server-side and private keys are usually stored on the service provider server or exchange. The latter one is slightly easier to operate for end-user as most of the setup hassle is handled by the exchange. Let us explore these digital wallets further.
A cryptocurrency wallet is a digital wallet that stores the information necessary to transact bitcoins, basically, a master key (private key to be more specific). These are special digital wallets used to store cryptocurrencies like Bitcoin, Ethereum, Ripple, Litecoin, etc and sometimes also called Crypto Wallets. Like normal wallets, one can add, send or receive digital currencies from crypto wallets using private keys. These private keys/master keys are generated using strong cryptographic algorithms. This master key is used to authenticate a device/person’s identity to a wallet system. Once user identity is verified, only then can someone make crypto transactions. Usually, private keys are made up of alphanumeric strings of different lengths. A cryptocurrency wallet stores public and private key combinations, which can be used to buy or send the cryptocurrency from your address to a new address. A wallet can contain multiple pairs of public and private keys.
How does a Crypto wallet work?
Cryptocurrency transactions work much like a traditional banking system and need to trust third-party service providers usually a cryptocurrency exchange or a miner, in case you are not running a full node. This third-party exchange/miner keeps a record of all cryptocurrency transactions on a blockchain, acting as a fully functional digital ledger. These service providers have huge computation power and charge a nominal fee for operational cost coverage.
Unlike banking systems these cryptosystems are decentralized and all work in a democratic way, by majority agreement. Service providers usually link the individual wallet to their core wallet. So just like with a bank for debit or credit card, the user needs to trust the provider to keep the cryptocurrency safe. Even though crypto wallets are extremely safe, sometimes due to poor management of private keys by exchanges, hackers can trick systems to steal user’s cryptocurrencies. This happened in the case of Mt. Gox exchange hacking in Japan, where exchanges lost most of their clients’ bitcoins in a single hack incident.
Crypto wallet vs Bank
Similar to how a bank allocates a unique savings account number to a user, crypto exchanges assign a unique Digital Address (an alphanumeric string) and a unique Private Key to a user. This crypto address is just like your bank account number and can be shared publicly without any concerns of hacking. Only a person having access to the private key of a digital address can view and operate transactions from that account. The private key is used for authentication during sending and receiving bitcoins or any other cryptocurrency. On the other hand, access to the receiving wallet is not required for sending any cryptocurrency. The sender only needs to know the destination address and anyone can send cryptocurrency to that address.
If the private key of a crypto wallet is not compromised/leaked then it is almost impossible to break into your digital account. It’s a well-known fact that the National Security Agency (NSA) of the USA, has the highest computational power on earth. It is mathematically calculated that if all of NSA computational power is used even then it may take years to break into your digital account with the brute force hacking method. These systems are so secure that if you forgot or lose the secret private key for your account then your bitcoins and cryptos are lost forever.
At present, there are four varieties of cryptocurrency wallets widely in use.
What is a web wallet?
A web wallet is a web-based service that allows users to store and control their private keys and other useful information at a service provider server. All crypto transactions are performed by using any standard web browser like Google Chrome. While using a web wallet users’ private keys are managed by a third-party provider. Due to several Bitcoin and other crypto hacking incidents, several exchanges have started providing a two-factor authentication (2FA) feature to their customers.
A common example of a web wallet is MyEtherWallet (MEW). One can further visit https://www.myetherwallet.com/ to know more about how this web wallet works. The most important thing to remember is, users should always make sure whether they are using the right URL/website and if the entire communication from your browser to server is encrypted using the “HTTPS” protocol. If a website is not starting with HTTPS, always avoid it to create any accounts or send and receive any cryptocurrencies.
Pros of a web wallet:
- Easy to use.
- No additional cost.
- No need to carry an extra device while you are traveling or outside home.
Cons of a web wallet:
- Unsafe as hackers and keyloggers can hack your account and steal your funds.
- Difficult to transact on public wifi.
What is a software wallet?
A software wallet is like any desktop application installed locally on your computer, or a mobile app installed on your Android or iOS-based smart devices. For example, the ImToken Mobile Wallet app is installed and used as we use any other app from Google Play or iPhone App stores. IMtoken is among the best software wallets with ample features supporting multiple cryptocurrencies. However, all software wallets might have known or unknown vulnerabilities which can be used by hackers to perform illegal transactions from your digital wallet. With a software wallet, you have the option of using the same private key for your software wallet as well as a web wallet. But for all cases securing your private key is of utmost importance.
IMtoken is downloadable on both Android and iOS.
Pros of a software wallet:
- Easy to use.
- No additional cost as most apps is freely available.
- Much more secure than Web Wallet.
Cons of a software wallet:
- Require regular software updates with product version releases.
- For security reasons, a user needs to remove all data related to an app when changing or selling the device.
What is a Paper Wallet?
Paper wallets are yet another kind of wallet used for cryptocurrencies management. Individuals can print their digital addresses and private keys in the form of a QR code on a piece of paper. This piece of paper acts as a physical wallet and should be always kept in a safe place. Actually, it provides pretty good security as the private key is stored offline and not vulnerable to hacking. However, this advantage is only applicable till the private key is on paper. Once you enter the private key in a wallet to operate your transaction then it is equally vulnerable as is your underlying OS and software. In fact, there is the additional hassle of entering a private key again and again. Although one can use a barcode reader that again leaves a loophole in the safe operation of the private keys.
Pros of a Paper Wallet:
- Easy to store and can be kept in a cupboard or a physical safe.
- Since it is stored offline it’s always protected from hackers.
- It’s portable as it is much easy to carry paper and can be kept in a normal fiat wallet.
Cons of a Paper Wallet:
- Can be easily destroyed intentionally or unintentionally.
What is a Hardware Wallet?
These days our computers and smart devices are always connected to the internet. Each device usually has multiple apps, web browsers, and software. These web browsers and apps can have known or unknown vulnerabilities which can be easily exploited by a seasoned hacker. Moreover, it was found from a survey that end-users tend to ignore regular software updates, posing a great risk to their device and investments. It’s a possibility that private keys on an internet-connected device are compromised. These are some of the loopholes exploited by hackers during several Bitcoin and other high-value cryptocurrencies hacks.
How does a Hardware Wallet work?
A hardware wallet is the best existing solution to all of these hacking concerns, as the user’s private key is never shared with anyone and never leaves the hardware device. When a hardware wallet performs a transaction, the wallet’s software creates an encrypted value from the private key. This encrypted value is then shared with the remote device (or exchange) to complete the authentication of the transaction. This way hardware wallet provides the best security among all digital wallets.
Ledger and Trezor are two of the best hardware wallet companies with a variety of products with different safety features. Both companies have created devices that require users to physically enter a pin by pressing the button on the device to finally trigger the transaction. Some hardware wallets also have an additional layer of security where the user is required to enter a secret pin to open the hardware wallet. All these new safety devices and features have forced hackers to burn more midnight oil. If a user is taking all precautions then it is almost impossible to hack such devices by anyone.
Pros of a Hardware Wallet:
- Extremely secure as private keys are never exposed.
- Since it is a stand-alone, separate device chance of virus infection is minimal.
- Devices have an additional layer of security possible like pressing a button or pin entry.
- You can do transactions safely even on public wifi networks.
- Can be used for multiple cryptocurrencies.
Cons of a Hardware Wallet:
- Usually, hardware wallets are expensive. A good hardware wallet can easily cost $100 plus.
- The device should always be with you to make any transaction.