3.01 – What is a Bitcoin Wallet?
Taking Control of Your Wallet (and Hodling Your Bitcoin)
We show you how to buy and sell Bitcoin using other peoples’ wallets – the custodial wallets of the exchanges – in Chapter 2 of this course. Here we show you how to manage your own wallet. Before we jump in, though, we start by talking about what a wallet actually is (because it’s not entirely clear even to most Bitcoin owners).
Bitcoin purists believe that unless you manage your own wallet, you don’t truly own your Bitcoin. Legally you do own Bitcoin that you buy from an exchange, for instance, even if it’s held by the exchange and you use a custodial wallet provided by the exchange. That hasn’t helped all the people who have had their Bitcoin stolen from exchanges! To really understand Bitcoin, and have total control over your Bitcoin, you need to understand wallets. You need to hodl (that is, hold) your own Bitcoin for yourself. (For more about hodl, see the sidebar, “Hodl?”)
HODL?
Okay, so it’s a bit of Bitcoin jargon, a cryptocurrency joke. Instead of “holding” your Bitcoin, you – in Bitcoin parlance – hodl it. It all comes from a message posted in the Bitcoin talk forums (https : //bitcointalk. org/) in 2013, from a forum member named GameKyuubi, explaining (reportedly while drunk) that he couldn’t figure out the ups and downs of Bitcoin, and thus intended to simply hold (mistyped hodl) his Bitcoin for the long term. The long term has been good to GameKyuubi, if indeed he did hold long term. He created a widely used term in the Bitcoin community, and his Bitcoin went from an exchange rate of $716 per Bitcoin down to $438 and then, over the years, up to a peak (so far, at the time of this writing) of almost $64,000.
What Is a Wallet?
Physically, a wallet can be a number of things. It may be a piece of software running on a Windows PC, a Mac, or Linux machine, or any number of other computer types. It may be a piece of software running on a web server or on a smartphone or tablet. But it may also be a small device similar to a USB thumb drive. It could even be a piece of paper, a piece of metal, or even a brain! What, then, defines a wallet?
Wallets store private keys
So here’s the very basic thing about wallets (without this, they’re not wallets): At the very least, a wallet holds one or more private keys. (Or at least a way to get to your keys. A wallet may hold a wallet seed, which allows you to rebuild a wallet and get to the private keys, as we’ll explain in this chapter.)
Your Bitcoin is associated with an address (maybe multiple addresses) in the Bitcoin blockchain ledger. That address is mathemagically associated with a public key (see Chapter 4 of this course). And that public key is mathemagically associated with a private key.
The address is totally public, of course; anyone can see it. Remember the blockchain explorer from Chapter 2 in this course? You can dig around in the blockchain and see anybody’s addresses. (You can’t tell who each address belongs to, but you can see how much Bitcoin is associated with each address.)
But the associated public key is also totally public. It doesn’t matter who has it or who sees it. In fact, as explained in Chapter 4 in this course, the public key is used to sign the messages that go to the blockchain, to prove ownership of the address.
So the single most important thing that a wallet does is to store your private keys (or seed). As you’ll learn reading this chapter, that’s all some wallets do: store private keys. That’s essential – lose the private key, and you’ve lost your Bitcoin. Lose your public key or address, and that’s okay; you can always re-create them if you have the private key.
Although wallets store private keys, you may never see them. Some wallets, like the BlueWallet (which we look at later in this chapter), hide them from you. Others, such as Electrum, provide a way for you to find them.
Wallets create and store keys and addresses
Some wallets can be used to create private keys, public keys, and addresses, and to store these things. We’re talking now about software wallets, of course. Wallet software uses complex math to create your private keys – you’ll see this in action later in this chapter – and from the private keys, it creates public keys, and then it creates addresses from the public keys; again, all three are mathematically associated.
Even if you have other forms of wallet, you need a software wallet to get started; that’s where you’ll get your private key to begin with.
Wallets communicate with the Bitcoin network
Software wallets are designed to help you communicate with the Bitcoin network, so you can adjust the Bitcoin ledger held in the blockchain. You do this by using your wallet software to send messages to the blockchain asking the network to transfer Bitcoin from your address to someone else’s. If you sell some of your Bitcoin, for instance, you’ll send a message to the network, saying, “Send a bit of my Bitcoin from my address to this other person’s address.”
Wallets provide a way for you to remember your address so someone else can send Bitcoin to your address, such as when you are buying Bitcoin. You don’t really need a wallet to receive Bitcoin, of course; it’s your address that receives the Bitcoin, not the wallet. So you can just store your address, or the QR code, outside the wallet, and tell people where to send money.
Wallets often create new addresses so that each time you receive Bitcoin, it goes to a different address. (Although not essential, this can be a good privacy practice; see Chapter 4 of this course, where we discuss security issues.)
Wallets can be hot or cold
There are two important classifications of wallets: hot and cold. The distinction is simple. A hot wallet is a software wallet of some kind operating on a computing device – a laptop, smartphone, or whatever – that is connected to the Internet.
A cold wallet is any kind of wallet – software, paper, metal, anything holding private keys – that is not connected to the Internet. If you have a smartphone with wallet software running on it, and your device is connected to a Wi-Fi hotspot, which in turn is connected to the Internet, that’s a hot wallet.
A paper wallet is a piece of paper with a seed or private key written on it. It’s a cold wallet because (obviously) it isn’t connected to the Internet (and never will be).
Some people even use old computers to do nothing but run Bitcoin wallet software. Or they have dedicated hardware wallets that operate in conjunction with wallet software running on a computing device that is connected to the Internet. The hardware wallet itself stores the private keys but is never connected to the Internet itself.
Why this distinction? It’s all about the degree of security you want. A hot wallet can be hacked. For the moment, understand that cold wallets can’t be hacked, because nobody can get to them across the Internet. (If you use weak passwords, perhaps a cold hardware wallet can still be “hacked” by someone who gets hold of the device, but at least it can’t be hacked from afar.)
Companies with large amounts of Bitcoin often keep the bulk of it offline, in cold storage wallets. Coinbase, for instance, has something it calls the vault: cold wallets storing most of its Bitcoin (and probably in some kind of actual vault, too).
