All the cryptocurrencies, , like Bitcoin, form a decentralized P2P payment network. This means that there is no intermediary (such as a bank or company) that opens an account for you.
Anyone can create as many “accounts” as they want for free. to these accounts they are called addresses and each one is always associated with a password or code that allows certify that you are the owner of the corresponding address and the funds it contains.
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What allows us to control these accounts and our funds are the cryptocurrency wallets or purses. A special type of software that makes it easier for us to control our cryptocurrency “accounts”. Thanks to this software we can send and receive payments from anywhere in the world at any time.
Best of all, these wallets allow us to store our coins safely and very easily. That's what they were made for, and despite the fact that there are a wide variety of options, they all have something in common: They are our door for the use and enjoyment of our cryptos.
NOTICE: This article contains a developed explanation of how the storage of currency units works within the Bitcoin network. If you already have knowledge about it and are looking for a specific article about Types of wallet by devices and those recommended by Bit2Me Academy, click here.
How does a wallet to store coins like Bitcoin?
Simply put, cryptocurrencies work much like digital payment systems like PayPal. At PayPal, your email address is used to uniquely identify you as a user of the system. Through this identifier you can receive payments, but you can also do it using someone else's email.
In the case of critical currencies like Bitcoin, instead of using your email address, a special unique and unrepeatable address is used. An example of this type of address would be: 1DgTsw8THYhC4XGqaCMdcGS3p9g3dhb9Ru. These addresses have a key mathematically related to the private key that we generate when we create our wallet. Suffice it to say that the addresses we can create are practically endless, which helps us maintain our privacy and security.
Every time you generate a new address, you can use it to receive payments and, thanks to the password, you will be able to manage your balance whenever you need it. These private keys are entirely controlled by your wallet.
Now let's remember that Blockchain is a ledger that associates balances with identifiers (addresses). This means that what Bitcoin wallets really store are not the bitcoins themselves, but the private keys that give you authorization to perform operations on the bitcoin addresses to which they are associated.
A phrase as common as saying "I have X bitcoins" is not technically true. Really, the only thing you have are the private keys capable of managing the addresses that are assigned those amounts of bitcoin in the chain of blocks.
This is one of the biggest bitcoin curiosities: Bitcoins do not exist as such, only the records in the blockchain that have a balance associated with them. What is actually recorded and confirmed on the blockchain are changes in ownership of the corresponding amounts between different directions, changes in balance.
So, a Bitcoin or any other crypto wallet is nothing more than a space (digital or physical) to store private keys. However, when we talk about software (computer, mobile) it is normal to use a client (an installable program). This is both an area to store private keys and an interface to operate on the blockchain network of the cryptocurrency that we use. It is precisely this that allows us to send, receive and store coins.
What types of purses are there and what are their peculiarities?
Now, there are many types of wallets, each with its pros and cons. We are going to see and explain each of them so that you can understand and choose the one that best suits your needs:
Full wallet and Lightweight wallet purses
In the case of software-type wallets, it is important to understand the difference between these two forms of clients that exist:
- Complete purses or Full Wallet are those that download the entire cryptocurrency block chain. These make you a node network (node only, not miner). Of course, downloading the complete blockchain takes up a lot of space. Currently the Bitcoin blockchain exceeds 500 GB of storage space. An example of this type of purse is Bitcoin Core. All Bitcoin wallets are related in one way or another to this development, because it was the first full wallet that existed in the crypto world.
- Light purses or lightweight wallets, they store the private keys locally, but not the blockchain. To perform any operation, they must access the blockchain through third parties. These wallets have the advantage that they do not take up much space and do not require a lot of power to work. However, it has serious security and anonymity problems.
Hardware wallets
All the hardware wallets they are one of the safest options to store your cryptocurrencies. These wallets are physical devices that are used to store our private keys securely. They are created in order to offer the best possible protection and secure our funds against any theft or hacking.
To read our article dedicated to Hardware Wallets and see in more detail how it works and what are the best alternatives on the market, click here
paper wallets
This is a special type of wallet that only stores keys, although it is technically a wallet, lacks direct connection to the Bitcoin network (and the Internet in general, since it is a paper).
The paper wallet is a private key printed on a paper, either encrypted with another key or put directly, but it is interesting to mention it.
It is a rudimentary and uncomfortable way to manage your cryptocurrencies, but it can be considered very safe. It is perfect for “Cold Wallets” (very secure cold wallets). Its main benefit is that you are safe from hardware failures or cyber attacks.
You can see in our article how to create a Paper Bitcoin wallet step.
To read our article dedicated to Paper Wallets click here
Hot Wallet and Cold Wallet
You will hear these words a lot when talking about cryptocurrency wallets. We are not talking about two subtypes of wallets, but two ways of using wallets. Remember that in Bitcoin, and cryptocurrencies in general, you are your own bank, therefore you have to pay attention to how you manage your money.
In the same way that you do not carry 10.000 euros in your wallet, you should not keep all your BTC in a single wallet either. Instead, a certain practice is used: what is known as hot wallets and cold wallets.
Un hot wallet It is the one you use often, the one you carry on your mobile phone / computer, for example. Anyone in which an unfortunate accident or theft does not mean anything more than a bad experience.
Example: Imagine carrying about €200 in bitcoin in the Bitcoin wallet of your smartphone and later downloading a malicious APP that copies your private keys from your phone's memory, stealing your money in a matter of seconds. If this happens, you will have a bad day, but you will not end up in ruins since €200 is not an excessively high amount (at least in Spain).
On the other hand we have the cold wallet (“cold wallet”). This is used for the opposite of what you use the hot wallet, that is, it is the one you use very little: large amounts, savings... The creation of these wallets is somewhat more complex, since they depend on being generated under absolute security to prevent the used environment may be compromised and therefore are generated with software / hardware without the possibility of viruses and without Internet connection.
As in everything, but especially in Bitcoin, it is a matter of using well-sharpened common sense and, why not, the degree of paranoia according to the amount of money to handle.
It is important to know that you have the capacity to make backups and, in the event of a loss, to act quickly to move the funds to a new wallet.
Does it seem complicated? Luckily, this process is simplified thanks to HD wallets.
HD purses
It is not about high definition wallets (High Definition), far from it, the HD comes from "hierarchically deterministic".
It is a common mistake of many beginners use a wallet with a “simple” address (which is not generated under an HD structure), and to think that by making a single backup copy of the private key at the beginning they will be able to recover their bitcoins in the future.
Mistake. Because these wallets create addresses on the fly back. With what almost every transaction they should make a backup, something that would be tedious.
In case of not knowing what is the operation of the transactions in Bitcoin, click here to learn how they work.
In a non-HD wallet, for each address created a new private key is generated, (as we have explained to you, it is the password that allows you to manage that Bitcoin address). And we must understand that, due to the internal workings of Bitcoin, almost every transaction needs to add an extra address of its own when sending a payment, known as return address. Typically, these addresses are new addresses (with a new private key), although it depends on how the Bitcoin wallet you use has been programmed.
Exactly, those new keys are not in the initial backup. In other words, if you send 300 euros in a wallet in which you have 500 euros, and your wallet sends the remaining 200 to a new address for which you do not have a backup, you are buying tickets for a scare. This is where you should make a new backup.
Thanks to the magic of mathematics, there are HD wallets.
Simplifying: one HD wallet part of a “seed” (a variable number of characters). Using a graphical example so that you can see it mentally, "a tree" is generated where each "branch" has a private key and a public key and a Bitcoin address are extracted from it.
With the same seed you can always generate the same tree. That is to say, if you save your seed, you will always be able to access all the branches (all the private keys) and, with it, the funds that are in the addresses without doing any extra backup in the future, only the initial one.
If you want to know the guts of how mathematics works under this concept, we recommend the following link: BIP0032 (The BIP These are documents that the community creates by proposing an improvement in Bitcoin: Bitcoin Improvement Proposals, full listing here)
SPV purses
SPV is the acronym for Simplified Payment Verification. They are an intermediate step between the full and light wallet to take advantage of both worlds: they take up little space, but they cryptographically verify the received data to avoid showing the user false information due to a possible attack on the server that sends the information.
What they do is download a complete copy of the headers of all the blocks available on the blockchain.
Through this implementation, we can determine if a transaction belongs to a block in the chain without the need to download the entire Bitcoin blockchain. That is, the wallet has just enough to allow you to validate transactions without depending on a trusted third party (in the case of light wallets it would be the server that provides the information and that could be corrupted).
Are the purses safe?
Some more than others, but security essentially depends on how you use them. Private keys are the only way to access the bitcoins associated with them. If you lose your private keys or they get corrupted, you lose your bitcoins, so the way to keep your bitcoins safe is to prevent anyone from gaining access to your keys at all costs and avoid losing them.
Avoid using unknown Bitcoin wallets and, in the case of software, better if they are Open Source with public code. In addition, we recommend that you read how make a secure backup of your cryptocurrency at all times.
As a general rule, a paper wallet that has been generated without an Internet connection and its key has been stored on a printed piece of paper and kept safely is usually one of the safest ways to store bitcoin. Now, it is much slower than making an online wallet, for example.
In the end, it's up to you to decide what you want to use based on your own needs.