Wallets 101

This article first appeared in print edition 4.1 of yBitcoin. Click here to see the full issue. Click here to order your copy.

While digital currency in itself is not a new concept — for instance, most U.S. dollars were already digital even before the invention of Bitcoin — a money purely based on cryptography is. Something truly unique about Bitcoin is that within its protocol, “ownership” is not based on the rule of law, or user accounts, or even identity. It is solely based on math.

More specifically, Bitcoin addresses, the strings of seemingly random numbers and letters, can have bitcoins attached to them. These bitcoins can be spent if someone proves to know another seemingly random, but mathematically corresponding, string of numbers and letters: the “private key.” 

Whoever owns a private key owns the corresponding bitcoins. So, needless to say, these private keys are very important — and potentially valuable — sets of letters and numbers. If you own any bitcoins, you need to keep your private key safe.

Private keys are typically stored in bitcoin “wallets.” Today, wallets come in all sorts of shapes and sizes, on all types of different platforms. Different kinds of wallets can store keys in different ways, often specifically designed for particular use cases.

The kind of wallet you will want to use depends on the type of Bitcoin user you are.

Choosing Your Wallet

If you don’t plan on using your bitcoins for regular payments, but instead plan to store them safely as a long-term investment or savings, you could consider a paper wallet. These are pieces of actual paper that have private keys printed on them. If generated securely (which, it should be noted, is easier said than done), paper wallets have a great advantage in that the keys are not stored on a computer at all. This means your wallet cannot be hacked into or otherwise digitally compromised. Of course, you will need to take good care of the paper wallet itself as it is not protected from being physically stolen, lost in a fire or otherwise destroyed by real-world elements. It is possible to make copies of the piece of paper as backups and store these elsewhere.

If you do want to use bitcoins for payments but also require top-notch security for your private keys, purchasing a hardware wallet is a good option. Hardware wallets are devices specifically designed to sign Bitcoin transactions, but not much else, which should make them impossible to hack into. Hardware wallets do typically need to be used in combination with some other wallet, and this often requires some level of trust, because hardware wallets do not validate all of Bitcoin’s protocol rules. But, at least, the hardware wallet keeps private keys safe.

Alternatively, if you do want to partake in the Bitcoin network without a real need to trust third parties at all, a full node wallet is the way to go. These wallets are the only wallets that keep track of the entire Bitcoin blockchain and fully validate all transactions themselves. Many argue that this is really how Bitcoin is supposed to be used, as you, for example, don’t need to trust anyone else to tell you what your balance is or whether an incoming transaction is valid. The downside is that a full node can be a relatively heavy load for your computer to handle. Getting started with a full node requires that you download and verify well over 100 gigabytes of blockchain data, which will likely take over a day even with newer computers.

That’s why there are more user-friendly and accessible options as well. Known as “light clients” or “simple payment verification (SPV) wallets,” most mobile wallets and some desktop wallets don’t verify the entire history of the blockchain and therefore don’t need to download all of its data. Instead, they require only transaction data that’s directly relevant to you. This has some slight trust implications, as you are to some extent trusting whomever is providing this data, or Bitcoin miners, or both, while privacy typically suffers as well. But it is much easier to get started with and to use one of these wallets, and since you hold on to your own keys, your money should be safe barring any hacks.

An even more accessible option is web wallets. Web wallets themselves come in different flavors, for which trust is the main differentiator. Some web wallets are relatively safe, as they let you generate your keys on your own computer and store them in your web browser. This is not really recommended for large amounts, as it is easier to hack than many alternatives. But it is very quick and easy, and probably fine for smaller amounts and day-to-day spending.

And finally, there are custodial wallets. Typically a type of web wallet, and often a de-facto part of a Bitcoin exchange, custodial wallets hold on to the Bitcoin private keys for you. In these cases, you are not at all protected by the security offered by the Bitcoin system itself. Rather, you are fully trusting the service that offers the wallet.

Most dedicated Bitcoin users likely utilize a combination of the above options, similar to how many people have a savings account, a checking account and some cash in their pockets. Where your savings account (say, a paper wallet) may be best for holding serious funds that are meant for long-term storage, the cash in your pocket (say, a web wallet) is meant for daily purchases.