Simply Explained: Crypto Wallets

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A brief Overview

The phenomenon of cryptocurrency has intrigued many since the inception of Bitcoin by the pseudonymous person (or people) named Satoshi Nakamoto in 2009. Along with the rise of cryptocurrencies, the digital storage mediums, known as crypto wallets, also gained prominence. Let's break down these tools that are indispensable to the modern crypto enthusiast.

Understanding Wallet Keys

Historically, cryptography has often utilized key pairs to ensure data security and privacy. In the realm of cryptocurrencies, this tradition is maintained. Every external wallet, at its core, recognizes a pair of keys: public and private. Additionally, there's a seed phrase, typically a string of 12 or 24 words, seemingly arranged randomly. This seed phrase feeds into a mathematical algorithm that produces the private key. The private key, in turn, triggers a secondary algorithm to derive a public key.

The Role of the Keys

Your private key signs messages. This signing turns any text message into a unique set of numbers, a "digital signature." Conversely, the public key verifies these signatures. If you have a signature and the corresponding public key, you can confirm that the owner of the private key truly created that signature. While public keys are distributable, private keys remain confidential. However, the utility of these keys doesn't end there. They also play a role in encryption and decryption of messages. Anyone with a public key can encrypt a message, making it almost impossible to decipher unless the recipient possesses the private key for decryption. This dual utility gives them the designation: asymmetric keys.

Deciphering Internal vs. External Wallets

All the previously mentioned wallets are external, meaning they act as gateways to the actual wallet residing on the blockchain: the internal wallet. An external wallet encompasses the asymmetric keys and occasionally retains a comprehensive record of the digital assets within. External wallets bifurcate into:

Hot Wallets: Always online, these are at risk of cyber-attacks due to their continuous internet connection. Among them, custodial wallets - held by third parties on the user's behalf (e.g., cryptocurrency exchanges) - stand out as particularly vulnerable. Entrusting your assets to someone else's management inevitably entails risks.

Cold Wallets: Offline and thus more secure, these wallets sign transactions without internet connectivity. The subset of cold wallets, known as "air-gapped" wallets, comprise hardware devices that interact with the blockchain via QR codes, ensuring complete network disconnection and superior safety. Conversely, internal wallets are replicated files across all blockchain instances. Typically in a text format, these wallets carry data about their respective assets. They have an address (often derived from the public key), a nonce (a unique number for each transaction, primarily outgoing ones), and are usually visible on public blockchains. Innovations in the crypto world have ushered in more sophisticated wallet paradigms. Some now house executable code that defines access parameters. Despite these complexities, the essence of crypto-wallets remains simple. Their fortitude largely stems from the blockchain's decentralized structure.

Initiation of a Wallet in the Blockchain Ecosystem

Generally, users establish an external wallet through specific software, online platforms, or hardware devices. During this process, the asymmetric keys and a corresponding address materialize. Once generated, there are two primary methods to register this wallet into the blockchain:

Explicit Registration: The user deliberately records the wallet.

Implicit Registration: The wallet is automatically registered upon its inaugural use on the blockchain.

From this juncture, an internal representation of the wallet becomes active on the blockchain, accessible for any relevant transactions. Critically, any outgoing transfer or change concerning the wallet necessitates the employment of its private key to authenticate and sign off on the transaction.

Gianluca De Novi is a co-founder of Circular Protocol, a faculty at the Harvard Medical School, Harvard Extension School and is Director of the Medical Device and Simulation at the Massachusetts General Brigham. He holds a Ph.D. in Robotics and Control systems from the University of Bologna (Italy) and is an expert in High Performance Computing.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts and opinions expressed here are the author's alone and do not necessarily reflect or represent the views and opinions of Circular Protocol.

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