Wallets are used to provide “crypto” systems with the ability to engage with user-interactions.
In short, they are client-side software which gives you the ability to “store” the various “crypto” tokens that you may have, and the ability to “send” them to other users.
There are several types of “wallet”, ranging from software (“hot”) to hardware (“cold”).
Whilst they have a number of quirky names, the underlying functionality of them all is invariably the same – they are designed to give users the ability to store their crypto money without having other people steal it…
To better explain how they work, it’s important to discern exactly how the “blockchain” system operates, and how the way in which you’re able to “send” money to others actually works.
It’s important to state that almost all “crypto” wallets are freely available and most are open source. Whilst some offer extra functionality (such as being able to pay bills etc), they are all designed to store the “files” that represent the “coins” in a “crypto” system and then give you the functionality on top of those files to do different things with them.
In order to understand the process, we need to look at the way in which Bitcoin/Blockchain works behind the scenes…
Blockchain Requires Cryptography For Protection
The base-line of “wallets” is they act as the client-side software for “crypto” (“cryptographic”) systems that run predominantly on “blockchain” decentralization technology…
EVERY computer system works in the same way (takes input data, processes it and provides output data / results). Whilst the way in which the systems do this varies, the underlying method does not.
The reason this is important is because of how most systems essentially work on the “client/server” paradigm – meaning they provide users with the ability to interact with a “global” data-pool through a central service provider (think Facebook/Gooogle etc).
Whilst these work well, the problem is that these centralized services own your data, and thus end up being able to either sell or use it how they wish. This is why random people are able to find out your phone number or email (your data has been sold).
The promise of “blockchain” has been to “decentralize” the process of storing & processing the various pieces of data that a system may have. For example, the likes of “Bitcoin” actually just works as a “decentralized” payment network – designed to provide users with the ability to “send” money to other people around the world.
Regardless of how a system has been designed, the underlying paradigm still exists – a “client” system will send data to a processing facility, through which the user is able to receive processed data as a response…
The way this is handled is with the client-side software – which in the case of the “world wide web” would be a “web browser”; in the “crypto” world is a “wallet”.
How “Crypto” Wallets Work
The job of a “wallet” for the “crypto” world comes in the form of storing the “files” that act as “coins” or “tokens” in the various “crypto” systems you may wish to transact with.
This is quite important actually – most people have no idea what a “Bitcoin” actually is, nor why it is valuable at all. Bitcoin doesn’t “hold” any value, it’s merely a method through which people are able “send” money to each other…
The fact is that when you “send” tokens in the “crypto” world, you’re not actually sending real money – buts its virtual representation. This representation comes from the way in which users have attributed a “price” to each “crypto” token – which is something we’ll explain in another article.
The most important thing to understand is that each time you send a “payment” in the “crypto” world, you basically are sending a file which has a “public” and “private” key.
The “public” key is designed to give a reference to the file & how much it’s worth. The “private” key identifies the user who is able to receive / decrypt the file.
In other words, if you have 1 BTC file in your “wallet”, what you’re doing is sending a file that’s encrypted with a particular “key” from your device. The ONLY person who can “decrypt” the file is the one you’re sending it to. Not only does this mean that you’re able to protect the integrity of the file, but also determine who the recipient will be.
Imagine it like an email. Rather than sending an entirely unencrypted email, you’re essentially sending a message that has been “encoded” with a special password.
In order for the other party to receive & read said email, they need to input the password.
This is the role of a “wallet”, and is why the “crypto” system works the way it does – only particular parties are able to decrypt the transactions you’ve sent. This process is all handled by the wallet software, but is still how it works on a core level.
Types Of Wallet
There are several types of “wallet” used by blockchain applications.
The key difference is how “connected” to the Internet they are – with “online” wallets predominantly being targets for hackers etc.
If you’re not using the “currency” for an extended period, it’s recommended you store it in what’s known as “cold” storage (offline). “Hot” storage is typically used for currency that you wish to transact in the next few days.
There are currently no charges for “storing” “crypto” money in either “hot” or “cold” wallets…
Software (“hot”) Wallets
These are connected to the Internet and can be operated from either mobile or desktop, allowing for users to “send” money to other people.
Obviously, they’re not sending “money” but its representation as “crypto” tokens.
The tokens themselves are stored in the “wallet” software, which then allows you to “send” them to other people via typing in their unique address (what used to be an email, is now a Bitcoin address). These are the most common form of “wallet” and are available through mobile or desktop (typically at the discretion of your preferred exchange).
As mentioned, the different “wallets” have very little difference between them – save some minor tweaks to encryption algorithms or similar.
Hardware (“cold”) Wallets
These are basically “offline” storage facilities (which could be the equivalent of storing the “crypto” files on an external USB hard drive…
The reason they’re important is because of how they remove the biggest security weak point in the “crypto” system – Internet connectivity.
The connection to the Internet means that hackers are potentially able to gain access to the “crypto” files that you may have stored. By removing this (IE taking your tokens offline) removes the threat, and makes them much more secure.
To do this, a number of companies have created what are known as “hardware” wallets – small USB-powered devices which are pre-programmed to store the various crypto files you may require. These systems vary greatly, but all work in a similar way – storing the public/private key pairs for each of your “crypto” tokens.
Whilst the “hardware” wallet is most effective, it’s drawback is that it’s unable to send the currencies to other people. For that, you require an Internet connection, and thus you will need to put the tokens into a “hot” wallet to get it working properly.