Fiat currencies like the euro are stored on a bank account, to which only the account owner has access. Others can send money to the bank account, but only the owner can spend the money on the bank account.
The ownership of cryptocurrencies is stored on the blockchain. When someone wants to access their cryptocurrencies, the blockchain’s network needs to be certain that it is dealing with the rightful owner. To this end, public and private keys are used. The public key is used to create the wallet address and is public.
The private key can be compared to the wallet’s password, and should be known only to the owner. A user will only be able to access the cryptocurrencies linked to the wallet address with the correct key combination of the public and private key.
What is a crypto wallet?
A cryptocurrency’s ownership is recorded in the blockchain’s ledger. However, the cryptocurrencies there are not linked to the user’s personal data (such as a name). Instead, the cryptocurrencies are linked to a user’s private key.
The user’s private key is stored together with the public key in the crypto wallet. With a crypto wallet, the user can access the cryptocurrencies linked to the user’s private key.
Every blockchain uses a different technique, and this is why every blockchain has its own keys. A wallet can contain multiple private keys, because of this it is not necessary to use a different wallet for each cryptocurrency. This is not true for every wallet: there are wallets that can only store the keys of one specific blockchain.
How does a crypto wallet work?
Every user holds a public and a private key. The public key is public, and therefore known to the entire blockchain network. However, the private key is only known to the user and cannot be shared with others. To make it easier to understand, the private key can be compared to a secret password known only to the user. The secret password gives a user access to his or her cryptocurrencies.
When someone wants to send cryptocurrencies, they will put in a request with the blockchain’s network. From the wallet, the user can indicate how many cryptocurrencies he or she wants to send, after which a digital signature is created with the private key and sent to the network.
The network nodes will then check whether the keys appear in the public ledger. Once it is confirmed that the combination of public and private key is correct, it is checked whether the user is indeed the owner of the entered transaction amount. This way, the network prevents a user from spending cryptocurrencies that he or she does not actually own.
If everything is correct, the cryptocurrency’s ownership is transferred to the transaction’s recipient. Only the wallet address is needed for this. The user sending the transaction after all does not hold the recipient’s private key.
Is it possible to access a wallet after losing the keys?
It is important to carefully store public and private keys. If these keys are lost, the crypto wallet can never be accessed again. This is one of the main reasons crypto wallets are used, as this removes the need to remember the keys yourself.
Fortunately it is possible to create a back-up of a crypto wallet. This makes it possible to access the crypto wallet from a different device. What such a back-up looks like, differs per wallet. In most cases, the wallet creates a seed phrase. This is a number of words, the order of which is crucial.
The words must be stored in the correct order. For security reasons, it is important that these words are not stored on the same device as the wallet. Instead, it is better to store it in a place not connected to the Internet, such as on paper.
If access to the wallet is ever lost, it is possible to enter the seed phrase, which will give the user access to the wallet again.
What is a wallet address?
A crypto wallet address is the hash version of the public key. This address can be compared to the IBAN number of a bank account. Once someone wants to send cryptocurrencies, he enters the wallet address to indicate where the cryptocurrencies should go.
This means that a wallet address is not the same as the public key, as is often thought. Each public key is 256 bits long. The resulting hash is 160 bits long and case-sensitive. It is therefore best to copy the wallet address rather than typing it.
There are cases where a user’s wallet address was spoofed. When a user copies his wallet address, hackers ensure that the copy is replaced by the hacker’s wallet address. The victim then pastes the wallet address, and the cryptocurrencies are upon execution of the transaction sent to the hackers. To prevent this, it’s important to always double check the wallet address.
Various types of crypto wallets
Users can choose from various wallets to store their public and private keys. Each wallet gives access to the cryptocurrencies, but the way in which that happens varies by type.
Hot wallet
Most people use a hot wallet, also known as a software wallet. This is a wallet in the form of a software application running on a device. This crypto wallet app can be downloaded for example on a laptop or smartphone, but can also run on a different location.
Software wallets are very easy to create and use. While it varies by provider, most hot wallets are very safe. Another advantage is that users can quickly access their cryptocurrencies. This is useful when a user trades in cryptocurrency and needs to be able to quickly sell his currency.
But hot wallets also have a number of drawbacks. The biggest disadvantage is that the user’s public and private keys are always linked to the Internet. This implies a risk that hackers can access the keys. It is therefore wise to properly secure the device holding the hot wallet, and not to connect it to a public Wi-Fi network.
The wallet you use with Bitvavo is an example of a hot wallet. Users can access their cryptocurrencies via a web application. The majority of the digital currencies kept by Bitvavo are stored in cold wallets. This is why you don’t have to worry about the security of your cryptocurrencies.
External hot wallets
A hot wallet can be linked to a crypto exchange like Bitvavo. Following purchase, the cryptocurrencies are moved immediately to this wallet without any further action needed.
However, it is also possible to move cryptocurrencies to an external hot wallet. This is a wallet that is not linked to a crypto exchange, but that must be downloaded externally. This may be an application that works locally on a device, although there are also external browser wallets. These wallets store keys in the web browser. The advantage is that the wallet can be quickly linked to the exchange where cryptocurrencies can be traded.
A browser wallet by the way is not the safest type of wallet. This is why it is not advisable to store large sums in a browser wallet.
Cold wallet
Cold wallets can be regarded as the safest way to store cryptocurrencies. This wallet, also known as the hardware wallet, stored the public and private keys on a hardware device that is secured by cryptographic. This crypto wallet can be compared to a USB drive.
It is only possible to access the keys if the wallet is connected to another device, such as a laptop. This makes the cold wallet incredibly safe, because hackers cannot access the keys if the hardware wallet is not connected to a device.
Security is therefore the greatest advantage of this wallet. Additionally, the wallet can easily be connected to another device.
A disadvantage is that it takes longer to access the keys on the cold wallet. You’ll also need to store the hardware wallet in a safe place, since in case of loss both the private and public keys will be forever lost.
A hardware cryptocurrency wallet is best purchased directly from the manufacturer or authorized seller. Others could possibly copy the public and private keys of a hard wallet before on-selling the wallet. When the buyer of the wallet then buys cryptocurrencies and links these to his keys, the seller of the wallet can spend the cryptocurrencies.
Paper wallet
The paper wallet is the least commonly used form to store keys. However, it is easy to understand how this wallet works. First, a private and public key need to be created, which can be done with a number of applications. These keys will then need to be stored somewhere. For example, this can be done by writing the keys down somewhere, hence the name of this wallet.
A paper wallet can be very safe if the keys are safely stored. However, this also indicates the disadvantage. If the paper wallet is lost, the cryptocurrencies can no longer be accessed. The finder of a paper wallet, however, will be able to access the wallet owner’s cryptocurrencies.
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A crypto wallet stores the public and private keys with which someone can access their cryptocurrencies. This means that the cryptocurrencies themselves are not actually stored in the crypto wallet, which many people think. This is why a crypto wallet cannot be compared to a bank account.
When a wallet user wants to access their cryptocurrencies, for example to send them to someone else, the wallet is used to create the transaction. After entering the desired number of cryptocurrencies, the wallet will send this information along with the keys to the blockchain network. The transaction is then processed.
The public and private keys should not be confused with the wallet address. A public key consists of 256 bits, while the wallet address consists of 160 bits.
There are various types of wallets, with the hot wallet being the most commonly used. This is a wallet on a device that is always connected to the internet. This makes the hot wallet less secure than the cold wallet. The cold wallet is a physical wallet that can be disconnected from a device, after which it is no longer possible to access the keys stored on the wallet. It’s also possible to use a paper wallet. In that case, you save both the public and private keys by manually storing them somewhere, such as on paper.