In this guide I will explain the security behind cryptocurrency wallets and how keys, seeds and passwords work together to keep your cryptocurrency safe and secure.
We take for granted how our bank accounts work, but imagine just for a moment you needed to explain to someone from Africa, Asia or South America who only uses cash, the mechanics of a bank account. They would have no concept of what an account number is, how the sort code identifies the bank and the role of a PIN number for withdrawing funds. You may feel the same about cryptocurrencies so let’s begin…
Main parts of a Wallet
A wallet can be either be a software program installed on a computer or smartphone like “Coinomi Wallet” (see below) or a physical device called a hardware wallet like the “Ledger Nano S” (see above) which looks like a USB drive.
Both support multiple cryptocurrencies (i.e. Bitcoin, Dash, EOS and ZCash) and enable you to receive cryptocurrency and pay for goods and services. Much like your bank account has various account numbers, passwords and PIN numbers to send and receive funds, so too does a cryptocurrency wallet.
A wallet has four main parts to it, namely a Public Key, Private key, Seed and Password. It also shows a history of transactions over time.
The example above shows a multi currency wallet with Bitcoin, Dash, EOS and ZCash currencies held inside it. Below shows a screenshot of all the Bitcoin transactions inside that wallet.
How the ‘Public Key’ sends and receives Cryptocurrency
Each currency inside a wallet has a public key (one for Bitcoin, one for Dash, one for Ethereum, etc…) which works like the account number for your bank account and so that someone else can send cryptocurrencies to you. In the example below Mary is sending John 0.5 Bitcoin using his public Bitcoin address.
An example of a Public key is the one below for my Bitcoin wallet (all donations gratefully received and help me to continue writing guides like this!):
How the Private Key keeps your funds safe
Pivotal to the security of each cryptocurrency inside a wallet is its Private Key. Its role is to sign a transaction in the background enabling you to send funds to another person’s wallet. Without the private key cryptocurrency cannot be moved out of the wallet and remains safe.
Unlike how when you sign a paper cheque your signature is visible and easily copied, the Private key remains hidden in an encrypted state and neither the sender or receiver get to see it (thats why its called a private key).
Above is an example of a private key (not a real one!), on the left hand side in its unencrypted state and on the right hand side in its normal encrypted state. Notice that in its normal state it is impossible to identify what the key is.
The Private Key always remains in its encrypted state which is great because your don’t want anyone to get their hands on it!
How the Password authorises sending Cryptocurrency
Similar to how you use a PIN to authorise withdrawal of money from your bank account at a cash machine, the cryptocurrency wallet password authorises sending funds out. The Private Key needs to be authorised to sign the transaction and it gets this from the wallet’s password.
Typically at the point where you want to send cryptocurrency to another person the wallet will prompt you to enter the password.
When you first set up a wallet, it will ask you to create a password which you should keep private. Just like you can change your bank card’s PIN, you can also change the wallet’s password. Most wallets also give you the option to enter the password when the wallet program first opens on your device for additional security.
The ‘Seed’ is the wallet’s best friend!
We are only Human and even with our best intentions at heart we may forget the wallet’s password or the device our wallet is on becomes lost or stolen. If this happens to your bank card, you would have to call the bank and jump through hoops to get a new card ordered and wait a number of days to be able to use your bank account again.
In the land of cryptocurrencies your wallet has a 24 word seed which is unique to your wallet. You can use this seed to move your funds to a different computer or device. If your old device was lost or stolen, wallets have the ability to generate a new seed and render the old wallet useless.
Ideally you remember the seed, however if this isn’t possible then keep a copy of the seed (written down) somewhere in a secure place that only you or a trusted other know about. If you lose the seed then you will not be able to restore your cryptocurrency to another device and effectively you have lost your funds forever! I always recommend after setting up a wallet and before sending funds to it to test out restoring the seed to another device.
Which Wallets should you use?
If you would like to learn more about the types of wallets available and which ones I recommend using them, please read my guide “Demystifying Cryptocurrency Wallets”.
How I can help you?
My background is in technology and training and for over 10 years I have provided IT Support to home and small business users through my IT company ithound.co.uk. In recent years I have added Cryptocurrencies to my product offering with cryptohound.me.
Whether you are a business wanting to accept cryptocurrencies or an individual interested in investing in them, I will help you get started and provide training and support to give you confidence using them.
I regularly write blogs on the Steemit platform so be sure to connect with me there if you want to keep up to date on cryptocurrencies and blockchain technologies.
Carl Hughes, The Crypto Hound
Signal Messenger: +447919 562 418
Telegram: @ flowingman