I’m here to disabuse you of a notion. This notion is obscuring important information and could possibly lead to unintended adverse consequences. Here’s the notion:
An Ethereum or Bitcoin wallet contains your actual cryptocurrency holdings, such as ETH or BTC.
Many people believe this is so. It is not so. Your wallet can never contain cryptocurrency, or indeed digital value tokens of any description. These things reside entirely on a blockchain, a type of open-state database, distributed around the world on that blockchain’s many nodes. Your wallet, whether hardware- or software-based, actually contains one or more pairs of public and private keys. A cryptocurrency “wallet” is more akin to a keychain, not a real-world wallet.
First, a definition
In case someone reading this is unfamiliar with the term cryptocurrency, here’s a quick definition:
Cryptocurrency: A digital or virtual currency that uses cryptography for security, operating independently of any traditional banking system.
Cryptocurrency is often abbreviated to crypto, risking confusion with cryptography.
The belief that your cryptocurrency holdings are actually contained in something referred to as a “wallet” is totally understandable. Wallet was an unfortunate choice of names for this technology. If you forget the password or PIN to your crypto wallet, or your phone or computer is lost or stolen, as long as you have a record of your private key in the form of a recovery phrase or a QR code you can regain access to your funds. If your crypto holdings were actually contained in a so-called “wallet” and you lost access to it, you would lose access to the funds as well.
There’s no need to go into great detail about public-key cryptography. Just know three things:
1. Ethereum, Bitcoin, and other blockchains make extensive use of the technology;
2. Public-key cryptography uses two keys: a public key and a private key;
3. That private key is the most important piece of blockchain data that you possess.
The third point is worth stressing. You must keep your private key safe.
Private key -> public key -> Ethereum address
There are three related pieces of data used by Ethereum: a public and private key pair and an associated address on the blockchain. A private key is simply a very large random number¹ that would take many times the age of the universe to guess on today’s computers². The public key is derived from the private key and in turn, the blockchain address is derived from the public key. It can’t be done in reverse. This shows the importance of the private key: if you lose it or it is somehow stolen and you don’t have a record of it, you’ve lost your ETH.
Keychain vs wallet
So with all of this talk about keys, you can see why a so-called crypto wallet is much more like a keychain: it holds cryptographic key pairs, not ETH, BTC, LTC or any other cryptocurrency. I think this is a very important distinction. I use a hardware keychain (“wallet”) to keep my key pairs safe. If I lose it I can always regain access to my ETH holdings because I have stored a long recovery phrase (established when I activated the hardware keychain) in a very safe place. If my ETH were actually on my device and I lost it, I’d be out of luck.
I would love it if everyone started calling “wallets” cryptocurrency keychains instead. After all, they hold cryptographic keys, a virtual equivalent of real-world keys. I will push for this change in nomenclature whenever I have the opportunity. It is very important to understand what’s actually going on to avoid misunderstandings and potential monetary loss.
I hope this short explainer has helped you understand important aspects of blockchain and cryptocurrencies. Please leave a comment if you need further explanation.
¹ These numbers fall between 0 and 115 792 089 237 316 195 423 570 985 008 687 907 853 269 984 665 640 564 039 457 584 007 913 129 639 936, if you must know. (Commas removed to allow line breaks.)
² Estimates are that it would take 1.014 to 10.014 billion billion years to guess a single private key.