What exactly is a crypto ‘wallet’ and how does it work? — By DeFi Dev Nic
The term “wallet” is actually badly chosen in the crypto context since it suggests a similarity to your physical wallet, a container of sorts in your possession that holds or contains your money.
As you have hopefully learned from the previous video about how bitcoin actually works, this is not the case in the digital space. All addresses and actions on a blockchain are based on sets of private and public encryption keys.
One private key has exactly one public key, or address (and vice versa).
A crypto wallet is a piece of hardware or software that manages your private keys, and allows you to interact with the blockchain in a user-friendly way.
Your tokens, such as $FLUID or $DUSD never actually “sit” in the wallet, they are only an entry on the public blockchain token contract.
You can think of it as a table or excel sheet that records the address to the current balance:
address | balance
0x01 | 100
0x02 | 33
0x03 | 1,000
etc.
…The only way to move these tokens is by providing a digital signature that corresponds to the given address.
The only way to create this signature is with the help of the private key.
Whoever has access to the private key can generate a valid signature and transfer all tokens, NFTs etc. that the address holds. Since the private key exists in a digital format there can be multiple copies of it at the same time.
A private key is usually a long and cryptic string of letters and numbers.
To make it easier for humans to handle, there is a way to represent a private key in the form of a sequence of words, called a “seed phrase”.
Example seed phrase:
‘’life view chef favorite patrol live tenant movie this source sail eternal’’
This seed phrase is equivalent with the private key. Whoever has the seed phrase has the private key and can transfer all tokens!
From a single seed phrase, multiple private key + address pairs can be created and controlled.
The single seed phrase then has access to all these private keys.
A crypto wallet then, is a piece of hardware or software that manages one or multiple of your private keys.
It often provides some form of access control (such as a password or pin code) before the private keys can be accessed or used.
It can be just software (Metamask), or a hardware device (Trezor, Ledger).
If someone else ever gets a copy of your private keys though (discovering your seed phrase on a piece of paper for example) that person has full control over all the crypto assets of this address, or addresses!
Also, if you ever lose access to your private keys, your crypto assets are lost forever and nobody can recover them!
This might seem daunting if you’re just getting started. But this is the nature of the blockchain, where everyone has complete ownership, and complete responsibility.
We’ve compiled a list of some best practices, to keep your funds secure.
- Use a hardware wallet such as Ledger, Trezor or NGrave
- NEVER EVER enter your seed phrase on any website
- NEVER EVER give your seed phrase to a “support agent”, or anyone for that matter. (if they ask for it, it is a scam)
- NEVER store your seed phrase in digital form. Not as a word document, not taking a photo of it with your phone!
- NEVER share your screen with someone you don’t fully know and trust while working with a crypto wallet
- If you write your seed phrase down on a piece of paper, make sure to keep it safe, and in a place that nobody has access to!
- If you hold a significant amount of crypto, make physical backups of your private keys / seed phrase that are water & fire proof
- Ideally use a form of key splitting such as ‘Shamir Secret Sharing’ to make back-ups so your key can be recovered with 3 out of 5 codes for example. (more on this in a future article)
Disclaimer: in order to make this as simple as possible to understand, some of the underlying technical concepts have been simplified a lot.
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