What is a Bitcoin Wallet? Beginners Complete Guide

What is a Bitcoin Wallet?

A Bitcoin wallet is a program to send and receive Bitcoins, store Bitcoins and monitor Bitcoin balances. Just like you need an email program like Outlook or Gmail to manage your emails, you need a Bitcoin wallet to manage your Bitcoins. Wallets interface with the Bitcoin blockchain; that global ledger of bitcoin transactions that we will talk about in next content.

Wallets monitor Bitcoin addresses on the blockchain and update their own balance with each transaction. Now here’s one of the most important things to remember about a wallet: What defines a wallet is where its private key is stored.

A Private key?

What does that mean? Well, a private key is just a very long string of numbers and letters that acts as the password to your Bitcoin wallet. It’s from this number that your wallet gets its power to send your Bitcoins to other people.

You can also think of it like the secret coordinates for locating your Bitcoins. In other words, whoever knows your private key has control over your Bitcoins. The private key is also used to generate your Bitcoin address.

This is just like your email address. It’s something you want to give out to people who want to send you Bitcoins. However, even though the Bitcoin address is generated through the private key, there’s no way to figure out what the private key is just by examining a Bitcoin address.

To sum it up, the wallet’s core function is the creation, storage and use of the private key. In other words it automates Bitcoin’s complex cryptography for you.

HD Wallets

As Bitcoin wallets evolved HD wallets, or hierarchical deterministic wallets, were created. HD wallets generate an initial phrase known as a seed or mnemonic phrase. This seed is a string of common words which you can memorize instead of the long confusing private key. If your wallet gets destroyed or stolen, you can enter the seed in order to reconstruct the private key.

Additionally, an HD wallet can create many Bitcoin addresses from the same seed. All of the transactions sent to addresses created by the same seed will be part of the same wallet. Because these private keys and seeds have complete power over your Bitcoins they must be kept secret and safe. If you fail to protect your wallet’s private key or seed, the bitcoins it controls could be irretrievably lost.

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A standard Bitcoin wallet will create a wallet.dat file containing its private key. This file should be backed up by copying it to a safe location like an encrypted drive on your computer, an external flash drive or even copying it to a piece of paper and hiding it away.

An HD wallet on the other hand will supply you with a seed phrase with up to 24 words that you should write down in a safe place. Okay. So much for wallet theory. Let’s move on to the different Bitcoin wallets available to us.

Types of Bitcoin Wallets

1. Full Nodes wallets

Some wallets hold a full copy of the Blockchain in order to validate each and every transaction. These are also called full nodes. Other wallets, also known as SPV wallets or lite wallets, don’t hold a full copy of the Blockchain. They rely on full nodes that they are connected to in order to validate transactions.

2. SPV wallets

SPV stands for Simple Payment Verification, these wallets are faster and consume less disk space. Since the blockchain today is becoming increasingly big in size many wallets offer an SPV solution for limited capacity devices such as mobile phones, tablets and desktops.

3. Hot wallets

Moving on to hot wallets. A Hot wallet refers to any form of Bitcoin wallet that is connected in some way to the Internet. This can be a wallet that is connected to a web service, a wallet installed on a computer connected to the Internet or even a wallet installed on your mobile phone, assuming you have data transfer to and from your phone.

Hot wallets, although the most popular, are also the least secure since they allow access to their inner workings through internet connections. Let’s view the different hot wallets available starting with web services wallets. Markets, exchanges, betting sites and other Bitcoin services frequently require you to deposit funds into their online wallets in order to conduct your business.

These web wallets are the least secure option for storing Bitcoins since you don’t have any access to your private keys. You’re basically asking someone else to hold your coins for you. Such wallets are also more vulnerable to hackers since they have many loopholes along the way.

For example, the website in question, the device you’re using to connect to the website or the internet connection can be monitored to steal your Bitcoins. This forces you to rely upon both the site operator’s honesty and their security practices. In the event of internal fraud or external hacking, your bitcoins will likely be irretrievably lost.

On the other hand, web wallets are highly convenient as they allow you to buy, sell and send Bitcoins at a moment’s notice. More competent web wallet services will provide Multi-Factor Authentication options like validating every account login with a text message, to guard against external hackers.

Even so, for storing any significant amount of coins, web wallets are not worth the risk. That’s why we advise that you avoid the number one newbie mistake and never to keep your Bitcoins in an exchange wallet.

Now let’s move on to desktop wallets. These type of hot wallets store your private key on your computer. So as long as your computer is free of malware or any security weaknesses your Bitcoins are safe. However, we all know that’s not the case for most of us.

Today it’s hard to be 100% protected and this makes desktop wallets that are connected to the internet a valuable target for hackers. Moving on to mobile wallets. These are wallets that store your private key on your mobile phone.

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Although many wallets are accessible via mobile apps, doing so presents the worst possible scenario for security. Mobile wallets offer low security and terrible privacy, given the potential association of your Bitcoin wallet, phone number and geo-location.

As phones are frequently lost, broken or stolen, it’s strongly advised that you enable multi factor authentication, password-protect your wallet and create a private key backup. Mobile wallets are highly convenient and designed to provide as much security as possible in an insecure environment.

Nonetheless, substantial sums should not be stored on a mobile wallet unless used in tandem with a hardware wallet which we will discuss in a minute. Now let’s talk about the most secure form of Bitcoin wallets, cold storage wallets.

4. Cold Storage wallets

Cold storage refers to any type of wallet that is independent of any Internet connection and therefore cannot be hacked remotely. Some examples of cold storage wallets are hardware wallets, paper wallets and brain wallets. Let’s go over them now.

Paper wallets are just pieces of paper with the private key or seed written on them. By keeping your private key on a piece of paper, only someone who can physically access that paper can steal your Bitcoins. However paper wallets are easily destroyed and therefore it’s advisable to create multiple copies so that if one is lost your Bitcoins can still be retrieved.

Another thing to consider is that to send the Bitcoins you have on your paper wallet to someone else you will have to import the private key into some form of digital Bitcoin wallet. This is easily explained in one of the many tutorials we have on this site. The next form of cold storage is hardware wallets.

These are physical devices which safely stores your private key such that it cannot be hacked even if your device is compromised by malware. You can even use them with a public computer that you don’t trust. Most hardware wallets provide a seed backup in the event that the device itself is lost or stolen.

To send your Bitcoins to someone with a hardware wallet, you’ll need to have your hardware wallet connected to a computer and use some sort of web page that allows control over the wallet. Hardware wallets offer the optimal mix between security and ease of use.

Their only limitation is that you need to keep your hardware wallet on you at all times in order to send the coins. Lastly we come to brain wallets.

Brain wallets are just a way to create a private key out of a predetermined text or set of words. So instead of getting a randomly generated seed you decide for yourself on a passphrase and use some basic algorithms to generate a private key from that passphrase.

However Brain Wallets have a significant disadvantage, they have a higher probability of being hacked. This is because people are usually very predictable in what to use as passwords or supposedly random text and hackers have a way of knowing that. Some tests have been done where simple passwords have been used for brain wallets and deposited with funds. They have been quickly stolen.

Also one Bitcoin user lost 4 Bitcoins from his wallet after using a brain wallet private key generated from an unknown Afrikaans poem. This proves that even if you think you’ve found some obscure text for a passphrase you’re still in danger of being hacked.

Now before I show you exactly how you should choose a Bitcoin wallet I want to talk about one more important feature some Bitcoin wallets have – Multisig.

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Multisig stands for multisignature, a wallet that allows sending of Bitcoins only with the approval of enough private keys, out of a set of predefined keys. Don’t worry… I’ll explain. Let’s say that Alice, Bob and Charlie all want to open a business together and invest some of their Bitcoins – but none of them actually want only one person to have the private keys to this money. So they each get one key and use a multisig wallet that requires two out of three of those keys.

This way none of them can run away with the money alone, but they also don’t need all three of them to pay the expense. For example, if Alice wants to run with the money, she can’t because she only has one key. But if Bob is missing and Alice and Charlie want to pay an expense, they can do it with their two keys.

Multisig doesn’t have to be only two out of three – it can be almost any combination. For example, a couple wants to have a shared account and decide that only if both of them agree they can spend the money, or a Company’s board of directors that allows payments only by vote of the majority.

Multisig is often used for escrow services where 2 parties decide on a transaction that requires 2 out of 3 keys. If the seller and buyer don’t agree, a trusted 3rd party will arbitrate and release the funds. You did it!

How To Choose The Best Wallet For Your Needs

Now you know all there is to know about Bitcoin wallets, so let’s see how to choose the best wallet for your needs. The first thing you need to know is that different people will use different Bitcoin wallets for different purposes.

For example, if I need to store a large amount of Bitcoin safely I will use a different wallet than if I just want to have some small Bitcoin change to pay for a cup of coffee. Usually wallets vary on a scale of security vs convenience and you need to decide where you want to be on that scale.

Some of the questions you should ask yourself include: How many Bitcoins will I be storing? How frequently will I use the wallet? Can I afford to pay for a hardware wallet? Do I need to carry the wallet around with me? Do I need to share the wallet with someone else? Am I tech savvy? How much do I value my privacy? Do I trust myself to safeguard my wallet or do I want to give some 3rd party the task of doing so?

Depending on the answers to these questions it should be easier for you to choose a wallet. Most of the popular Bitcoin wallets are listed on our Bitcoin wallets page on this site, so now it’s just a matter of choosing the best wallet for your needs.

Before we conclude keep in mind that you may want to use more than one wallet. For example, you can use a hardware wallet for large sums of Bitcoins and also have a mobile wallet with a small balance on it for daily payments. This way even if your mobile phone breaks or gets stolen you’re not risking a lot of money.

So I hope you’ve enjoyed today’s lesson of Bitcoin wallet and I can’t wait to see you in our next content. If you still have any questions or comments on this content feel free to leave them in the comment section below and I’ll see you… in a bit.