Understanding Crypto Wallets

via medium

A holistic guide for the beginner to the seasoned crypto veteran

To start, let’s talk about regular wallets, money and how we interact with those.

We’re all familiar with regular wallets, you probably have yours on you right now. In our physical wallets money takes on a few different forms, the most obvious being cash. Everyone takes cash, so it’s handy, but it’s also pretty insecure, and not practical to carry a ton of it. So, we carry cards.

To get a debit card, we open a bank account. Most folks do this because In exchange for giving the bank money they’ll pay us interest, secure our funds (become a trusted 3rd party), and allow us to do online banking. Most of us like to also find a bank willing to issue us a loan, i.e. a credit card. And that rounds out the forms of money we have in our physical wallet.

To summarize, the money in our physical wallets is comprised of cash , debit cards linked to our bank accounts , and credit cards linked to a loan .

It doesn’t end there though — we use apps that function as money too. For example, Venmo is an app to move money for free. You could use banks to move money, but it’s clunky and pricey, hence why Venmo has millions of users. By virtue of constantly sending & receiving funds P2P, users often carry a balance inside Venmo.

So overall — a typical money stack looks like

  1. Physical wallet with cash and cards

  2. Bank account to securely store money and access online

  3. Vehicle to move money digitally, for free, peer to peer.

The Crypto Wallet

A standard crypto wallet is a blend of all 3 of these things, a physical wallet with multiple forms of money in it, a bank account, and Venmo. It doesn’t have all attributes of all 3, but a bit of each. Sidenote: It does not offer credit, as credit comes from a trusted 3rd party.

First — How is a crypto wallet like a regular physical wallet?

  • It’s the place that YOU secure your (digital) currency. No one can charge you a fee on it, or freeze your account. You, and only you have control over these funds.
  • Potential downside: there’s no 3rd party (a bank) keeping track of your money. Like a wallet in your back pocket, if you lose it, it’s gone.
  • Like holding cash in your wallet, you have full access to your digital currency anytime. There’s no such thing as banking hours in crypto, this market is open 24/7.

Second — How is it like a bank account?

  • You can view your balance and take action on your money digitally.
  • Potential downside — if you make a mistake, and say send someone money accidentally, too bad. There’s no intermediary (a bank) to reverse transactions.

Third — How is it like Venmo?

  • You can send money from your digital wallet to another digital wallet for free. And even better, these transactions happen instantly!

So you can effectively manage your entire stack — sans credit — with a crypto wallet. You can check your balance, move money, and fully control your money, all with a crypto wallet.

Let’s walk through a quick example with Ethereum, known as “ETH”. MyEtherWallet.com is a free, open-source service that will generate you a wallet. A basic crypto wallet consists of 2 things, a public key , and a private key . If you go to their site, enter a password and click ‘Create New Wallet’, you’ll get both of these, and a recovery phase, but ignore this phrase right now. This is where we get a bit dicey, so bear with me.

A crypto wallet is a digital address — “public key“ — with an signing mechanism — “private key” to prove ownership. There’s no username and password. To create a wallet, you don’t have to provide an email, a name, or anything. Recall, crypto is digital money, so if a request comes in to the blockchain to create a wallet, it obliges. The owner could be a human, robot, toaster oven, or anything else.

If someone wants to send you 10 ETH, you simply give them your public key. They then ‘unlock’ their own wallet using their own public/private key combination, and can transfer you the ETH. Everyone on the blockchain observes this transaction, and confirms the person sending the 10 ETH signed the transaction properly with both the public and private key. If the signatures are correct, the transfer gets confirmed and you now have +10 ETH in your wallet address. The magic is in how the community is incentivized to verify transactions — this is known as “mining.” Not to get deep into that right now, but the network is all incentivized to verify that transactions are properly signed, and in that way can arrive at a consensus without a trusted 3rd party.

This is the simplest way to explain how a standard crypto wallet works, in theory. In practice, it has many shortcomings. Humans are forgetful, and thousands of bitcoins have been lost due to people forgetting their private keys, losing a computer, or wiping a hard drive.

Types of Crypto Wallets

If you go down the rabbit hole of googling “crypto wallet” you’re sure to find a thousand different companies talking about their wallets a thousand different ways. One of the most common ways people talk about wallets is a custodial vs. non-custodial wallet. This is a very important discussion that will be addressed with an entire future post, but let’s cover the basics right now as well.

Coinbase is a common service folks use to buy cryptocurrency for the first time. They don’t however, require users to use a standard crypto wallet, instead, they manage your cryptocurrency for you. Much like a Schwab or ETrade account, they’ll hold your assets for you, acting as a custodian. If you buy a stock you don’t actually hold a stock certificate or get mailed cash dividends, your broker handles that stuff for you. In the same way, Coinbase will keep track of your cryptocurrency for you.

Harkening back to the origin of why Bitcoin (or any crypto) was created, this is blasphemy. One of the main reasons cryptocurrency exists is to get rid of trusted 3rd parties as they are vulnerable to hackers. Case in point, look at the headlines about data leaks from any number of huge companies: Facebook, Google, etc… So there’s tension between the theory of cryptocurrency, and what works from a customer acquisition standpoint. Coinbase knows it’s easier to onboard a user with a process broker-dealers use already! It’s nice and familiar. But this model lacks some of the best features of a standard crypto wallet — namely, having absolute control over your funds. If Coinbase all of a sudden went out of business, there’s risk of them losing their customer’s coins. Not so if you always hold your own assets.

In this article, we first discussed regular money and the multiple forms it takes in our day to day lives. Then we explored standard non-custodial crypto wallets. Non-custodial meaning you, the end user/holder of the assets, has full control. Finally, we took a look at what custodial wallets are, and why they exist despite lacking crypto fundamentals.

The battleground for wallet companies is vast. Much like banks are willing to spend $$$$ to get new banking customers, wallet companies are fighting hard for new wallet users — the lifetime value appears high. Many crypto wallet companies are custodial, some are not, and there’s merit to both approaches. As a custodian (trusted 3rd party), the fees companies can charge seem higher. But taking a point of view from first principles, the creators of cryptocurrency would argue that custodial crypto wallets defeat the purpose of the technology. Yet, they make it easier for people to enter the ecosystem.

We’ll see how the landscape evolves as adoption continues to increase. Thank you for reading.

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