CRYPTOCURRENCY WALLETS AND WHY WE NEED THEM?
The main purpose of the creation of Bitcoin as a decentralized currency was to give the masses the power to control and manage their own money.
You might ask “Well, do I not have full control of my money?” Since the money you deposit in the bank is usually used to lend it out to others, you technically do not have full control over it. What you own is simply a promise by the bank to pay you. Bitcoin offers you the power to have absolute and total control over your money.
And given the fact that Bitcoin and other cryptocurrencies have been increasing in value, it is vital to have your own crypto wallet to store and manage your coins.
What is a Crypto Wallet?
Simplified Definition: It’s a software program that stores your coins
Technical Definition: It’s a software program that stores your private and public keys (they come in pairs), enabling you to send and receive coins through the blockchain, as well as monitoring your balance.
How Does It Work?
First off, digital wallets are quite different as compared to your physical wallet. Instead of storing money, digital wallets store private and public keys. Private keys are like your PIN number to access your bank account, while public keys are similar to your bank account number. When you send Bitcoin, you’re sending VALUE in the form of a transaction, transferring the ownership of your coin to the recipient. In order for the recipient to spend the newly-transferred Bitcoin, his private keys must match the public address that you sent the Bitcoins to.
Ownership of your private keys gives you total control over the funds associated with your corresponding public keys. That’s why it is vital to make sure you keep your private keys secretly hidden so that ONLY YOU know your private keys. If any other person gets hold of your private keys, they will have control over your coins. It is also equally important to have a back-up of your private keys, so as to protect yourself from accidental loss. You’d also lose your funds if you cannot recover your lost private keys.
Can I Just Keep Them on an Exchange to Avoid the Complexities?
You could, but you wouldn’t want to. Although you would automatically have a wallet when you open an exchange account (exchange-hosted wallet), you do not have control of the private and public keys. Having control of your keys means having control of
your coins. Exchanges work like a bank; it is a third-party service provider that you trust to keep your coins safe. However, there is always a probability of the exchange shutting down or being hacked, resulting in a loss of coins. I will give you two examples for exchanges being hacked:
Hack date: 19 June 2011
Amount stolen: 2609 BTC | +750,000 BTC Mt.Gox is the most famous Bitcoin hack.
Japan-based Bitcoin exchange Mt. Gox had been operating since 2010 and was the biggest Bitcoin exchange at the time.
But very few know that this big exchange was not hacked only once, but twice.
The first one happened in June 2011 when the hacker was able to get ahold of Mt.Gox’s auditor’s credentials and transferred 2609 bitcoins to an address for which Mt. Gox had no keys. This led to the suspension of Mt. Gox operations for several days; but they sustained themselves in the market, and they were able to regain the trust of users.
The second attack happened in 2014, at a time when Mt. Gox was handling almost 70% of Bitcoin transactions in the world. This time, the leaked BTC amount was humongous enough to completely sink the business of Mt. Gox.
Soon after that, Mt. Gox halted operations and filed for bankruptcy, stating that more than 750,000 BTCs (around $350 million) were missing from the exchange. Sadly, investors lost their funds and no refunds were made.
Hack date: August 2016
Amount stolen: 120,000 BTC
This was the second largest Bitcoin hack ever made after Mt.Gox. The breach claimed 120,000 BTCs (worth $72 million).
It happened because attackers were able to exploit a vulnerability in the multisig wallet architecture of Bitfinex and BitGo.
But the good thing was that Bitfinex issued BFX tokens for victims that were redeemable in USD, and hence, most of their investors were refunded their money back slowly and steadily by a schedule.
Bitfinex continues to operate and currently has one of the heftiest volumes on BTC/USD pairs in the crypto-world.
Given the lack of regulatory frameworks on exchanges and cryptocurrencies as a whole, as well as the infancy of the industry, the best way to keep your coins safe is to have total control of your coins. You can only have absolute control by having your own wallet.
Types of Cryptocurrency Wallets
Hardware wallets are dedicated devices that are intended to provide an additional layer of security to cold storage options such as paper wallets. With a paper wallet, for example, your funds are secure until you use a computer – but if the computer you then use to access your currency is compromised, you could then find your accounts hacked.
By contrast, hardware wallets have a secure chip in them (or equivalent) that means when you connect them to a computer to send your currency you never need to input your private key on the computer itself. The private key stays on the hardware device, never leaving it and appearing on the computer. You simply input a pin code on the piece of hardware, meaning that trading on a compromised computer is safer. If the hardware breaks or is lost, then you can restore your access to your currency on a new device from the ‘seed words’ you receive with your hardware wallet (i.e., a string of random words used to restore your wallet and recover your currency).
Warning: Do not use wallets with pre-generated seed/mnemonic key. This might be a trick by a re-seller to get access to your funds at a later point. Always execute the process of generating the mnemonic key yourself.
Although hardware wallets are the most secure means of storing your currency, their price means that whether or not you feel they are worth the investment may depend on the amount of currency you hold. To use hardware wallets, you will first need a software wallet to interact with the device. Although all hardware wallets have their own default software wallets, some software wallets, such as MyEtherWallet, may also be used along with your hardware wallet.
The two most popular hardware wallets are Trezor and Ledger.
Software wallets are, unsurprisingly, based on computer software. Software wallets are available in three formats: desktop, mobile and online:
Desktop wallets are computer programs that store your currency locally on your PC or laptop. One of the primary advantages of the desktop wallet is that it offers complete control of the currency to the users, without having to rely on any third party interface. However, on the flip side, it means that security is entirely your responsibility. If you get hacked or compromised or if your computer or hard drive breaks down, you may lose your coins forever. The fear of hacking is one of the reasons that some people prefer to use unused or spare computers that never have access to the internet to store their currency, known as ‘cold’ storage.
Mobile wallets operate through an app on your mobile phone. The primary advantage of mobile wallets is that it allows users to quickly access and easily use their coins in a physical retail store. Mobile wallets come in two formats: one type of app stores your coins locally on your phone (and comes with the same advantages and disadvantages as desktop wallets) while the other format of mobile wallet merely provides you with access to online storage servers (which comes with the same advantages and disadvantages as online wallets).
Online wallets are web based wallets that can be accessed from anywhere and are thus more convenient as they can be accessed from any device, and may also be linked to desktop or mobile wallets. However, the major disadvantage is that the private keys are being stored by the website owners rather than locally on your device and this type of wallet therefore requires you to put a lot of trust in the owners of your online wallet and their levels of security.
There are many different types of software wallets available. Some can store multiple currencies, others are designed to store only one. Some require you to download the code to your device, others provide that most of the processing power required is carried out by network servers.
In my opinion good software wallets are: JAXX, Exodus, and MyEtherWallet.
A paper wallet is simply a printed piece of paper that contains a cryptocurrency address and private key that are accessed using a QR code. The advantages of paper wallets are that they take the form of cold storage, as they are not connected to the internet and thus reduces risk of hacking. In addition, they are the cheapest options for cold storage.
However, paper wallets are considered to be more confusing and complicated to set up and use than software ones. If you lose the paper wallet and have not created a backup copy, there is no means of restoring your access to your currency. In addition, as stated above, as you still need to use a device to access your currency if you are using a paper wallet, and if your device is compromised or hacked then your currency could still be vulnerable.
Finally, if you are regularly using the currency for trading or purchasing products, it can be somewhat of a hassle to access your currency through the paper wallet on each occasion and, if you’re not familiar with how they work, you could end up locking yourself out from accessing your own currency.
Although no method is ever truly 100% safe for storage of your currency, the ever-increasing range of wallets that are becoming available provide users with a greater range of products that can be used for storing currency depending on their requirements. If security is your primary concern, choose a hardware wallet. If convenience is most important to you, choose an online or mobile wallet.
The ideal method would be to combine a number of options to provide the greatest level of security. For example, if you have $10,000 dollars in savings, you don’t generally carry it around in your pocket all day. This principle applies in the same way to cryptocurrency. For large amounts, perhaps consider a method of cold storage or a hardware wallet, with which you can transfer smaller amounts for everyday use into your mobile or online wallet.
Whichever method you use, make sure that you make backup provisions. Although hacking is a real and definite risk in the cryptocurrency world, when it comes to cryptocurrency, there is far more currency lost due to personal carelessness than as a result to hacking. Always keep backups of your details in a safe place. If your wallet has ‘seed’ words, then make sure you never lose them.