You will recall from our article, What is Cryptocurrency, that to participate in the buying and selling of crypto, you need access to the internet, and you must have a crypto wallet. But what is a wallet, and how does it work? It’s likely not the trifold wallet that initially comes to mind!  In simple terms, crypto wallets allow you to send and receive cryptocurrency and “store” your cryptocurrency…well, sort of. 

Today in Part 1, we will take a deep dive into crypto wallets to understand how they work and their utility beyond cryptocurrency exchange. In Part 2, we will explore the various types of wallets available, so you can officially start your cryptocurrency journey!

 What Does a Cryptocurrency Wallet Contain?

Crypto wallets don’t actually store cryptocurrency like traditional IRL wallets hold cash because cryptocurrency “lives” on the blockchain. Crypto wallets store what is called your private and public keys. Keys are a long series of unpredictable letters and numbers that are unique to each wallet. These encryption keys confirm the user’s identity and link them to their cryptocurrency on the blockchain. Also, your wallet has access to all transactions on the blockchain and recognizes the ones using your keys, and therefore maintains your balance at-a-glance, so you know how much crypto you have at any given time. These keys are what allow for anonymity. Your public key is the only thing shared with others and doesn’t hold any identifying information. Let’s explore the differences between private and public keys a bit more.

Private Keys

The private key allows you access to your wallet’s contents on the blockchain, confirms your identity and ownership of your assets, and is used to verify/sign transactions. Transactions cannot be processed without your private key attached to them. 

In literal terms, private keys are long strings of numerical codes that you may not know or see. Many wallets use a “seed phrase,” which is a long chain of random words that can be used to unlock your funds. This method tends to be more user-friendly, and your private key is hidden in the technology behind the seed phrase. 

Your private key/seed phrase should NEVER BE SHARED, as anyone with this key has direct access to your funds and can conduct transactions on your behalf or, in a worst-case scenario, steal all your assets. It would be like giving someone the password or PIN to your online banking account, a big no-no! I will say it again for those of you in the back. Under no circumstances should you share your seed phrase or private key with anyone, no matter what someone says to you! On that same note, should you lose your private key/seed phrase, you lose access to your holdings connected to that wallet and can never recover them. There is no bank to call for help or “forgot my password” link to click. Be sure to have multiple hard copies of your seed phrase and store them in a safe place! Some people even memorize their seed phrase. It’s not recommended to store them digitally in any format on your devices (list, documents, pictures) because they can be the target of hackers. The good news is that you will typically be asked to create a password or PIN to sign in to your wallet quickly. In this case, the only time your seed phrase is needed would be if you forgot your password/PIN.

Public Keys

The public key is the address shared with others to conduct transactions. It’s equivalent to a bank account number that is safe to share with third parties. Anyone can look up public keys, but rest assured, they will just see the unique series of numbers and letters, not your name or any identifying information. 

How Transactions Work

Transactions are completed via a complex process called asymmetric cryptography. Essentially, asymmetric cryptography ensures that the funds/assets are sent and received securely and can only be accessed by the recipient. Here’s a basic example of how the technology works. Let’s say Bob wants to purchase a cup of coffee from Amy:

  • First, Amy must share her public key with Bob to receive payment. 
  • Bob verifies the sending of funds to Amy’s public key with his private key. Typically, your wallet will ask for a digital signature (click of a button) to confirm the transaction. The funds are subtracted from Bob’s available crypto.
  • Amy’s public key receives and encrypts (locks) the transaction.
  • Amy's private key decrypts (unlocks) the transaction, and the funds are now hers and added to her crypto total.

In addition to the above process, the transaction is broadcast to the nodes on the blockchain’s peer-to-peer network, verified to confirm Bob indeed has the funds to pay Amy and is recorded on the blockchain to demonstrate the subtraction of funds from Bob and the addition of funds to Amy (learn more about this process in The Basics of Blockchain Technology). 

When sending assets, be sure to triple-check the public key involved in the transaction, as once the cryptocurrency is sent, it cannot be reversed. There are no re-dos or central office to call to stop or dispute a transaction. Getting just one digit wrong will send the coins to the wrong recipient! 

Other Utility of Crypto Wallets

In Web 3.0, wallets have a purpose beyond just the exchange of cryptocurrency. We will highlight three use cases here, but know there are and will be many more wallet utilities beyond this list. 

  1. In our article What is Web 3.0, we discussed having a single sign-in across websites and applications. Well, the wallet is the way this is done! In my opinion, this is the most convenient feature of a crypto wallet to date. Despite being in the very early stages, you can currently use your wallet to sign in to many websites and decentralized applications (dApps) in the Web 3 ecosystem, such as the decentralized social media app Lenster (https://lenster.xyz/). Some non-decentralized sites (aka Web 2 sites) utilize wallets as the sign-in as well, one of the most common being OpenSea (https://opensea.io/), the NFT marketplace.
  1. Crypto wallets also can be used to buy, sell, and trade other on-blockchain digital assets such as NFTs (non-fungible tokens) and decentralized finance protocols (DeFi). Just like with cryptocurrency balances, wallets also provide an at-a-glance list of your digital assets.They can also be used to verify that you hold a specific NFT for entry into gated communities on sites such as Discord (https://discord.com/). 
  1. Wallets are used to verify identities for participation in the governance of DAOs. (Learn more about DAOs in DAOs 101)  Many DAOs utilize dApps for participation in voting, such as Snapshot (https://snapshot.org/#/), where you must sign in to verify your identity and membership before casting your vote. 

By now, I hope you’ve gained a solid understanding of cryptocurrency wallets and how they work. Stay tuned for Part 2, where we will explore the various types of wallets available!

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Resources

https://www.coinbase.com/learn/crypto-basics/what-is-a-crypto-wallet

https://crypto.com/university/crypto-wallets

https://n26.com/en-eu/blog/what-is-a-crypto-wallet

https://www.cnet.com/personal-finance/crypto/the-best-bitcoin-and-crypto-wallets/

https://www.cnet.com/personal-finance/crypto/the-best-bitcoin-and-crypto-wallets/

https://www.coindesk.com/learn/a-crypto-must-know-public-vs-private-keys/ 

https://www.youtube.com/watch?v=jiDK5WexyRU

Photo credit: <a href="https://www.freepik.com/photos/litecoin">Litecoin photo created by master1305 - www.freepik.com</a>

The content is for informational purposes only. Nothing contained in this article constitutes a solicitation, recommendation, endorsement, or offer of a security, token, or application. This is not investment or legal advice. Please do your own research.