Entering the realm of cryptocurrencies can feel like deciphering a new language. In this chapter, we unravel the mystery of wallets, a critical component that differs significantly from traditional banking systems. By the end of this chapter, you’ll not only comprehend the workings of a wallet but also recognize the power held in the private key.
1. The Crypto Enigma: Cryptography Unveiled
Cryptocurrency, a digital form of money, relies on cryptography for its security. Within the intricate dance of ones and zeros, private and public keys play a crucial role.
The Power of Hashing
The backbone of the Bitcoin network is SHA-256, a Secure Hashing Algorithm. A hash function, a one-way street in computation, transforms an input into an alphanumeric code. Change a single element, and the entire hash alters. It’s the digital fingerprint that ensures the integrity and security of transactions.
For example, entering the text “Understand Blockchain” will produce the following hash: d1a05416e4b0d34e85de4618fd7e70ebb39e3fe007016d5ebbd479752d3d3203
If you change a letter in the input, the hash changes. It does not matter whether the input consists of a few letters or a text of 500 words or more, a hash of 64 characters will be generated. A hashing function is one-way encryption. Anyone who has a hash in hand cannot calculate the original input.
2. Crypto Wallets Unveiled: More Than a Storage
Contrary to common belief, a cryptocurrency wallet isn’t a digital safe for coins; it safeguards the private key. Let’s delve into the layers of understanding this critical aspect.
Public Key: Your Crypto Identity
Much like an account number, a wallet address is the face of your crypto holdings. This address, a combination of numbers and letters, allows you to send and receive coins. However, it’s not entirely anonymous. The bitcoin blockchain, a public ledger, reveals transaction details associated with each address.
- Public Key Origins: The address is a hash of your public key, which, in turn, is derived from the private key. A complex yet secure process ensures the creation of these cryptographic layers.
In the image below you can see such an address on the Bitcoin blockchain. Note that the Bitcoin blockchain is publicly available and you can therefore always see which transactions were sent or received by a certain address.
Source: explorer.btc.com
We see that the above address bc1q8k86sg9lr4xdv9l4a69xz5m8e34prdqehu30z4 has a balance of 0.00312930 BTC. By now you should understand that Bitcoin is not completely anonymous. As soon as you know who owns a certain address, you can track which transactions have been received or sent by this person.
Private Key: Your Crypto Signature
At the heart of ownership lies the private key, a sequence of characters almost impossible for human memory. This key initiates the generation of the public key and, subsequently, the wallet address. The private key is your proof of ownership, akin to a PIN code for a bank card.
- Protecting the Private Key: Keeping this key secure is paramount. Storing it on your PC for easy access makes you susceptible to hacking. For beginners, opting for an online wallet at an exchange is the starting point.
Understanding the intricacies of wallets is akin to acquiring a new skill. It’s not merely about storage; it’s about cryptography, security, and ownership. As you navigate the world of cryptocurrencies, recognize that your journey is more than a transaction; it’s a venture into the future of finance.
3. Types of Crypto Wallets
Understanding wallet options is pivotal for securing your cryptocurrency holdings. Let’s explore the diverse array of wallets available and their varying levels of security.
Online Exchange Wallets: Ease with a Caveat
The simplest way to secure your private keys is by entrusting them to a cryptocurrency exchange. Here’s how it works: when you buy Bitcoin through an exchange, they allocate a public key (your address) for you, managing the associated private key themselves. Your wallet then houses this private key, essential for spending your Bitcoin, though the coins actually reside on the blockchain.
- Security Measures: Reputable exchanges undergo rigorous security checks, with constant audits by experts. However, there’s a risk of hacking, especially with lesser-known or fraudulent exchanges. Remember, “Not your keys, not your coins.”
- Risk Mitigation: Opt for registered exchanges, adhering to regulatory authorities in Europe. Utilize 2FA (Two-Factor Authentication) for added account security against hacking attempts.
Mobile Wallets: Convenience with Caution
For self-managed keys, mobile wallets offer a solution. These apps generate a private key and require a chosen password or PIN code for access. Ideal for smaller amounts, but risky for significant holdings due to potential smartphone vulnerabilities.
Desktop Wallets: Localized Security
Wallet software installed on your computer stores the private key in a ‘wallet.dat’ file, safeguarded with a user-chosen password. However, the risk of hacking remains as your PC is connected to the internet.
Paper Wallets: Old-School, Low-Tech Security
For full control, you can print your keys onto paper. This physical piece is kept secure, providing a backup to regain access if digital files are lost. However, paper’s vulnerability and impracticality for regular transactions are notable drawbacks.
Each wallet type comes with its perks and pitfalls. While online exchanges offer convenience, self-managed wallets provide greater autonomy. Your choice hinges on finding a balance between accessibility and security, aligning with the value of your crypto holdings.
Hardware Wallets: Fortresses for Your Crypto
When security is paramount, opting for a hardware or cold wallet becomes the gold standard. These physical devices, like Ledger or the Belgian innovation NGRAVE ZERO, hold the key to fortifying your crypto assets.
Ledger: Security in Your Hands
Ledger, renowned for its USB-stick-like devices, stores your wallet’s private key. To execute transactions, you need the device and your chosen PIN. You can connect it to a PC or a smartphone via Bluetooth for transactions. When not in use, store the device safely offline, eliminating concerns of hackers breaching your computer or phone.
NGRAVE ZERO: Elevated Security Standards
NGRAVE ZERO, a Belgian breakthrough, redefines security with its air-gapped design—never connected to the internet. Transactions are initiated via the LIQUID smartphone app, generating a QR code scanned by the ZERO. The private key is then accessed and the ZERO generates a QR code that contains the confirmation. You scan this QR code with your LIQUID app and then the transaction is sent to the blockchain.The private key never leaves the hardware wallet, enhancing security. It’s the first hardware wallet with an EAL7 certificate, surpassing the Ledger Nano X’s EAL5+ security standard. Read our NGRAVE ZERO review. (Full disclosure: We are shareholders of NGRAVE.)
Backup: Recovery Seed
During key generation, a ’24-word recovery seed’ is provided. Jot these words on paper; they act as a backup, ensuring access to your private keys on a new device if needed. NGRAVE introduces the NGRAVE Perfect Key, a 64-hexadecimal character alternative stored on GRAPHENE plates. For security, keep both plates in different locations—essential to access the key. More information on the NGRAVE website.
Security Measures and Vulnerabilities
While cold wallets like hardware wallets offer exceptional security, they pose a ‘single point of failure’ risk. They’re akin to stashing cash under your bed. It’s prudent not to flaunt crypto holdings stored in a hardware wallet to avoid attracting unwanted attention.
Multisig: Sharing Security Responsibilities
Multisig wallets require multiple signatures for transactions, preventing theft with added layers of security. Even if thieves pilfer one hardware wallet and its PIN, they can’t siphon off your assets, averting a total loss scenario. Embracing a ‘2 out of 3’ setup offers flexibility in replacing a compromised wallet without losing everything.
4. Diversify and Deceive: Safeguarding Your Crypto Assets
Spread Your Crypto Wealth
To minimize risk, it’s wise to diversify your holdings across various exchanges and hardware wallets. Moreover, store these cold wallets in different locations for added security. Consider renting a safe, an excellent option for long-term bitcoin storage. For day-to-day accessibility, reserve a smaller portion on a cold wallet kept within easy reach.
Deploy a Decoy: The Dummy Wallet Strategy
Another tactic is to maintain a dummy wallet. Invest in an extra cold wallet and store a fraction of your crypto coins there. If ever faced with coercion to surrender your wallet and password, reveal this dummy wallet instead. Claim you’ve mostly depleted your holdings through buying stuff or gambling. Criminals, expecting more, might be content with what they’ve acquired, unaware of your actual holdings secured elsewhere.
