What is a Blockchain Wallet?
14 August, 2020
With the advent of cryptocurrency, blockchain wallets have emerged as instruments for sending and receiving crypto funds and keeping a history of transactions. These seemingly simple tools come in different types and offer a variety of features to ensure high security of funds.
Blockchain technology powers many industries as a decentralized, secure, and efficient means of digital asset management. One of its main use cases, however, is to serve as infrastructure for cryptocurrency exchange. Following the success of Bitcoin as the firstcomer, other coins started to populate the market and, as of today, we have over 5000 cryptocurrencies.
For anyone who owns cryptocurrency, a blockchain wallet is an essential asset-management tool. Blockchain wallet can be a device, physical medium, software program, or a cloud service that allows the exchange of cryptocurrency and monitoring transactions. Every transaction on a blockchain is visible and manageable in a blockchain wallet.
Blockchain wallet usage continues to grow just as fast as the proliferation of cryptocurrency payments. With the top brands like Tesla, BMW, Domino’s, Subway, and many others accepting crypto as payment for their services it’s no wonder we are closing in on 51 million global blockchain wallet users.
Read on to find out how blockchain wallets work, what are the types of blockchain wallets, what are the best practices to ensure security, and how to add funds to these wallets.
How blockchain wallets work
A blockchain wallet, similar to a bank account, has its unique address. While the address looks like a randomly generated string of letters and numbers, it is a result of the encryption process. For Bitcoin wallets, the address is an identifier of 26-35 alphanumeric characters, beginning with the number 1, 3, or bc1 that represents a possible destination for a bitcoin payment. Other cryptocurrencies have their own address formats.
Anyone can create a new wallet by generating a key pair with a particular algorithm. In the case of Bitcoin and Ethereum currencies, this algorithm is the elliptical curve digital signature algorithm (ECDSA). The results of this algorithm are the public key and the private key. There is a “one-way” mathematical link between these two keys that allows the derivation of the public key from the private key, but not the vice-versa (better known as asymmetric encryption).
Public and private keys serve different purposes. The public key is a wallet address, analogous to the bank account number. It is safe to share the public key with anyone. On the other hand, the private key should be known only to the wallet owner as it proves ownership of the wallet.
The transfer of funds between cryptocurrency wallets is simultaneously included in the blockchain. Wallets make use of private keys to sign transactions proving that they come from the owner. This signature with the private key also prevents the transaction from being claimed by anybody else.
Transactions are broadcast to the blockchain and get confirmed after a short period through a mining process. Mining is a consensus system that confirms pending transactions by including them in the blockchain. Mining ensures the chronological order in the blockchain, helps the network stay neutral, and allows different participants in the blockchain to agree on the state of the network. Confirmed transactions are placed in blocks that obey very strict cryptographic rules.
The cryptocurrency network relies on the blockchain that includes all of the confirmed transactions. The blockchain is similar to a massive spreadsheet of verified transactions. When users want to spend funds from a wallet, they must prove the ownership by matching public and private keys.
To fully understand how a blockchain wallet works, let’s take a look at its main functionality:
- Synchronization. When users first create a secret key or recover existing, the wallet performs an initial synchronization with the blockchain network by downloading the longest chain. After the initial synchronization, the wallet keeps up with the network by performing incremental synchronization. In this way, the wallet stays up to date with important events, e.g. receiving a new transaction.
- Transaction. For transferring funds to another wallet, users have to specify the recipient’s address (derived from the public key) and the amount they wish to send. The wallet users utilize their private keys to initiate the transaction.
- History. Users always have access to the history of their transactions. To display the most recent history, the wallet needs to be synchronized.
- Balance. The wallet also keeps users up-to-date on their current balance of funds. It derives this information from the history of verified transactions.
Types of blockchain wallets
Wallets vary in architecture design and each has its own characteristics based on their connectivity to the internet, the way they communicate with the blockchain, the types of networks and coins that are supported, and other specifics.
Cold wallets do not have an active internet connection. Hence, they are immune to cyberattacks. These wallets are plugged into payment gateways and user devices and use special software to enable cryptocurrency holders to perform transactions.
Hot wallets, on the other hand, stay actively connected to the internet and don’t need additional tools for users to make payments. They are convenient for frequent transactions but are more vulnerable in terms of security.
Full Node Wallets store the history of all transactions written into the blockchain. They do not depend on other nodes to verify the transactions. For the sake of independence and transaction certainty, the companies and individuals with significant crypto holdings should use the full node wallets.
Simplified Payment Verification (SPV) Wallets are lightweight clients that depend on other nodes to verify the transactions. SPV wallets use a copy of the block headers of the longest chain on the blockchain to make sure payments have been verified and accepted.
API-Based Wallets interact with the full nodes running on the cloud and perform the wallet operations through a series of API calls. API-based wallets don’t use the device’s memory for payment data storage, they just retrieve information from the blockchain network.
Multi-currency wallets can be used to manage a set of cryptocurrencies like Bitcoin, Ethereum, Ripple, Litecoin, and etc. These wallets offer an end-to-end solution to organize, transact, and keep all of your crypto funds secure.
Blockchain software wallets are installed on desktop or mobile devices and are used to participate in cryptocurrency exchange. These wallets are connected to the internet and are responsible for generating public keys for executing transactions. There are three groups of software wallets:
- Desktop wallet is a dedicated software developed for desktop use. The software is downloaded and installed on a local computer and can be accessed only from that computer. All of the sensitive information is stored locally on a hard disk in a wallet.dat file. The security of a desktop blockchain wallet depends on the capabilities of the anti-malware software installed on the local computer. Desktop wallets are a suitable solution for those who don’t need remote access and trade only small amounts of cryptocurrency from their computers.
- Mobile wallet is a smartphone application that allows making transactions and managing your funds on-the-go. They make use of QR codes to simplify peer-to-peer payments. These wallets can be either SPV or API-based and their security completely depends on 3rd systems they communicate with. Mobile wallets use Secure Enclave (for iOS) and KeyStore (for Android) encryption to protect private keys stored locally.
- Cloud wallets run in the cloud as full blockchain nodes and are accessible through web or mobile clients anytime and from anywhere. The cloud wallets are suitable for companies managing multiple accounts or trading currency on the stock exchange. The security of these wallets entirely depends on 3rd party cloud providers. Client-side encryption ensures that only the owners have access to their accounts and funds.
Hardware wallets are electronic devices that store private keys in secure memory chips. They are cold wallets that can store sensitive information securely but cannot verify transactions independently. Hardware wallets work in combination with desktop, mobile, and web applications. Since they do not have an active internet connection, they are the safest option for storing cryptocurrency. Most popular hardware wallets include Trezor, Ledger, and KeepEye.
Making transactions using hardware wallets is easy. It is enough to plug them to a computer or mobile device with an internet connection and enter the pin. Hardware wallets are suitable for individual users and are rather impractical for companies and organizations.
Paper-based wallets keep the public and private keys as a printout on the paper, usually as QR codes. To complete the transactions from a paper wallet, users need to enter their private key into a software wallet. After that, all the funds are ‘swept’ or transferred to that wallet and the holder loses the advantages of cold storage security.
Paper-based wallets are valuable documents with private information that must be protected. Holders are advised to keep them in a sealed plastic bag and store them in a dry and safe place to avoid humidity and fire hazards. Some people prefer to laminate their wallets and deposit them in a safety box.
Security of blockchain wallets
In public blockchains, such as the ones used for cryptocurrency exchange, the transactions are transparent to all members of the blockchain. Naturally, security concerns arise with the possibility of transaction falsification and the stealing of private funds.
Nevertheless, blockchains are inherently secure architectures. Their most prominent features are decentralization, immutability, and the use of cryptographic algorithms. These features make the blockchains immune to cyberattacks.
Participants of the blockchain verify the transactions mostly either using “proof of work” or “proof of stake” mechanisms. Verified transactions are grouped, encrypted, and stored in blocks. It is almost impossible to decrypt the hashed blocks into original data without knowing the encryption key. Even if an attacker manages to decrypt and change the data, the blockchain will reject the changes, thanks to its block immutability property.
Even though blockchains are some of the most secure architectures in modern software, blockchain wallets have a single security weak spot and that’s private key storage. The exposure of the private key gives the attacker access to the blockchain wallet and the holder’s funds.
Software, hardware, and paper-based wallets all have different approaches when it comes to storing the private key. Regardless of which wallet you use, here are some of the best practices to safeguarding your keys.
Never share the private key
Never share the private key with anyone, no matter the circumstance. Once the transaction on the public blockchain takes place, your non-critical information becomes public. Attackers may reach out to you by sending emails from legit-looking addresses and asking for sensitive information. Never store your private key in a location with public access, such as a shared folder on a local network.
Update your wallet software/firmware
To keep up with the latest security protocols, software and hardware wallet providers regularly update software. Desktop, mobile, and hardware wallet users have to make sure their software is always up to date.
Use both hot and cold wallets
Blockchain wallets with internet connectivity bear a security risk from cyber attacks aimed to steal or corrupt private keys. The best practice is to keep small amounts of cryptocurrency in hot (online) wallets and store most of your funds in cold (offline) wallets.
Add additional authentication steps
When using online wallets, make sure to use only wallets from trusted providers. It is a good security practice to add multiple authentication procedures. Companies offer two-factor authentication as an additional layer of security next to the password. Some authentication steps may also include pin numbers sent to user phones and biometric authentication using face or fingerprint recognition. Multi-signature wallet providers offer secure authentication by requiring that all account co-signatories authorize the transaction.
How to add funds to a blockchain wallet?
Users can exchange fiat currency for cryptocurrency either through an online marketplace or a cryptocurrency broker. The marketplace-based trade of cryptocurrency is peer-to-peer, as originally intended. Online marketplaces commonly include a trust score for each trader based on the history of their transactions.
The safety of this option is purely dependent on good faith between parties. When purchasing cryptocurrency through an online marketplace, the owners may introduce additional transaction fees for the sake of profit. The exchange value of cryptocurrency is determined based on the global supply and demand and its perceived value.
A cryptocurrency broker is a company or an organization that owns a considerable amount of crypto funds and facilitates the crypto trade between the participating parties. The broker acts as an intermediary between the parties and profits by charging transaction fees.
Many broker companies now require KYC (know your customer) verification. Broker services require the customer to verify their government identity before using the services. Although some people consider this as privacy infringement, it offers additional protection from scams and hacks.
Using either the marketplace or the broker option, you can add funds to your blockchain wallet using the following steps:
Step 1 – Choosing a Wallet. Due to the growing popularity of cryptocurrency exchange, there are many wallet alternatives. You may choose between software, hardware, or paper wallets.
Step 2 – Generating a Wallet Address (public key). Once you obtain a wallet, you have to generate a public address that is associated with a particular currency (Bitcoin, Ethereum) in your wallet. Think of this address as your crypto bank account number. Anybody can send you money using this address, and only you can claim it since you have the private key.
Step 3 – Purchasing cryptocurrency. At this step, you can either choose to purchase cryptocurrency through an online marketplace or a broker company. Some of the most reputable brokers to buy the cryptocurrency from are Coinbase and Blockchain.
Custom blockchain wallet development
Businesses turn to the blockchain as they are looking for new ways to provide customers with seamless and personalized digital experiences. Off-the-shelf blockchain wallets don’t always fit their business requirements.
Custom blockchain wallets offer many benefits, including:
- Convenient interface & improved user experience
- Support for chosen blockchains and crypto exchanges
- Full Integration into existing financial systems
- No additional fees from 3rd party providers
- Cross-platform support for all your devices.
The key is choosing an experienced blockchain development partner with experience in delivering diverse cryptocurrency wallet projects, as well and surrounding software within the crypto ecosystem.
Blockchain wallets serve as the mechanism for sending and receiving cryptocurrency and monitoring their transaction history. Most users who are used to making on-the-go transactions, mobile wallets are the best option. However, hot storage systems are exposed to hackers constantly on the lookout for security loopholes and vulnerabilities. hardware and paper-based versions of wallets are the most secure alternatives.
To safeguard your privacy, it’s important never to share your private keys or the seed phrase, keep both your wallet and mobile/desktop software up to date, make regular backups, and enable multi-factor authentication features. For companies looking to ensure the ultimate level of security and easily integrate the wallet into their financial processes, it’s highly recommended to consider custom development.
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