We all know what a purse or wallet is, but how about a Bitcoin wallet? Well, you can’t store this digital asset in the back pocket of your jeans. I’m going to explain everything you need to know about crypto wallets so that if you do buy Bitcoin, you understand how to store it properly.
How Bitcoin works
The first thing to understand about Bitcoin wallets relates to how Bitcoin actually works. By purchasing Bitcoin, you basically own a small piece of the digital network.
Because the Bitcoin blockchain is just one big digital accounting ledger, you don’t actually get handed anything tangible. The Bitcoin network just keeps a record of what you own.
What a Bitcoin wallet is
Just as you need a program to send, receive, and store emails, a Bitcoin wallet lets you send, receive and store Bitcoin. Your Bitcoin wallet is a program that allows you to do things with your Bitcoin like:
- Send or receive it
- Monitor your balance
Your wallet lets you participate in the network using what are known as private and public encryption keys – more on these later.
The wallet doesn’t store any actual Bitcoin. All Bitcoin remains on the network. In a wallet, you just store your proof of ownership in the form of your private and public keys.
The different types of Bitcoin wallets
Crypto wallets come in a few different formats, each with its own benefits and pitfalls. The three main types of crypto wallets are:
1. Software wallets
Sometimes referred to as ‘hot wallets’, these are connected to the internet. If you store your Bitcoin on an exchange like Coinbase, it will likely be done using a software wallet.
The major software wallets are:
- Web wallets
- Desktop wallets
- Mobile wallets
These can be good because they provide quick and easy access. However, they’re the least secure option. They can potentially be hacked through the internet.
2. Hardware wallets
These are known as ‘cold wallets’ or ‘cold storage’ because they’re not connected to the internet. They usually come in the form of a physical device like a USB stick that generates and stores your keys.
They’re a secure way of storing access to your Bitcoin. However, they’re not great if you need fast or frequent access because adding or removing information can be long-winded. In addition, if you ever misplace your device, you run the risk of losing access to your Bitcoin.
3. Paper wallets
Paper wallets are another type of ‘cold wallet’ and they work in a similar way to hardware wallets. The main difference is that instead of using something like a USB stick, a private key and a blockchain address are printed out onto paper, usually using a QR code.
Storing your access codes on paper comes with obvious risks.
Private and public encryption keys
The easiest way to think of encryption keys is just as a way to encode or decode data. Cryptography is a fancy word for codes and cyphers.
This is your personal gateway to the Bitcoin network and is a long string of letters and numbers. Whoever controls the key, controls the Bitcoin associated with it.
It’s usually better to buy Bitcoin directly through something like a cryptocurrency exchange. Because often, using something like a share dealing platform doesn’t give you access to your private keys.
Imagine public keys as your digital security middlemen. If you want to use the network, you don’t want to use your private key because this would give people access to your funds.
So your private key is able to generate a public key. This then creates a temporary Bitcoin address using a secret code. This allows you to securely move funds around the network.
Security of Bitcoin wallets
You might have read stories about people who’ve ‘lost’ Bitcoin. What they’ve actually lost are their private keys.
If someone’s Bitcoin is stolen, what’s actually stolen is the private key. Losing your private key means losing access to any Bitcoin you own.
Because cryptography is so complex and secure, if you lose your keys, it’s not as simple as just resetting your password. You basically lose your only proof that you own part of the network.
Choosing the best type of Bitcoin wallet
This will really depend on the type of Bitcoin user you are. If you’re buying some as a long-term investment and don’t plan on accessing the funds regularly, a cold storage hardware wallet might be best.
If you want regular and frequent access to your Bitcoin, a software wallet might be more suitable.
Desktop and mobile wallets are more secure than web wallets. However, as they’re all connected to the internet in some way, they do carry the risk of being hacked, so be careful!
Investing in Cryptocurrency is extremely high risk and complex. The Motley Fool has provided this article for the sole purpose of education and not to help you decide whether or not to invest in Cryptocurrency. Should you decide to invest in Cryptocurrency or in any other investment, you should always obtain appropriate financial advice and only invest what you can afford to lose.
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