Company updates

Bitcoin Wallets. Part 1: How Do They Work?

, May 19, 2014

The easiest way to describe a Bitcoin wallet is to think of it as the place where your bitcoins are stored, but it’s really much more than that. There are many different types of wallets that people use these days, and understanding how to use a Bitcoin wallet is the only way to make sure that you learn how to use the Bitcoin payment network correctly. After all, there’s no need for banks in Bitcoin, so you can be in complete control of your bitcoins if that’s what you want to do.

Public and Private Keys 

Like most other forms of online wallets or bank accounts, your Bitcoin wallet comes with a username and password. In the case of Bitcoin, the username is your public Bitcoin address, and your password is the private key associated with that address. You can share your public Bitcoin address with people if you want them to send you a payment. Your public Bitcoin address is kind of like your email address. If you want to send payments to someone else, then you’ll need to have access to the private key associated with the Bitcoin address. It’s also important to note that you can actually have as many public key and private combinations as you want in your Bitcoin wallet. It actually makes sense to give different people different public Bitcoin addresses for payments if you don’t want people to be able to track your financial activities.

Bitcoin takes advantage of cryptography to secure everyone’s accounts, and you can look at your private key as your signature confirming that you are who you say you are. The only difference between this cryptographic signature and the one you use to sign real documents is that this one cannot be forged.

Your Private Keys are Your Bitcoins

Once you understand how Bitcoin works, it becomes obvious that you aren’t actually holding any bitcoins in your wallet. All you are holding is the private key that allows you to make adjustments to the public, decentralized ledger known as the Bitcoin blockchain. In reality, your private keys are the most valuable aspect of your wallet, so that’s what you need to think about more than anything else when it comes to security. As long as your private keys are secure, no one will be able to hack or steal your bitcoins. It’s also important to remember that you won’t be able to use your bitcoins either if you lose your private keys. This is due to the fact that there’s no “forgot password” function on the Bitcoin network.

Web Wallets

Web wallets are usually considered the most convenient Bitcoin wallets for beginners. In most cases, the website behind your web wallet will store your private keys for you, and you will only be able to access them with a normal username and password to the website. The most secure web wallets also allow for forms of two-factor authentication. For example, you can have a text message sent to you every time you login to your CEX.IO account. That text message will contain a secondary password that changes every time you login to your account. This means that someone would have to have your account’s password and physical access to your phone if they wanted to get into your account. There have been many thefts and hacks in the web wallet space due to the fact that users are not in full control of their private keys. MtGox was the most famous case of users losing their bitcoins, and you always need to be careful about where you’re storing your private keys. Remember, the person who owns the private keys is the person who owns the bitcoins.

Don’t Lose Your Wallet

One last point that needs to be made when it comes to Bitcoin wallets is the bitcoins in those wallets are like the cash dollars, euros, or other fiat currencies you keep in your normal wallet. If you lose your Bitcoin wallet, you lose your bitcoins. Remember that bitcoins are essentially digital cash. Once you hand your bitcoins to someone else or happen to misplace your private keys, there is no central authority who is going to be able to get those bitcoins back for you.

Learn more about securing your private keys in part two of this series on Bitcoin wallets.

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