Sometimes there is a little confusion about what a wallet can and cannot do, so we will start with what it can’t. Wallets generally don’t allow you to buy cryptocurrencies, that is what exchanges are for. All exchanges provide you with wallets to store your coins in after you buy them, but wallets usually don’t provide you with an exchange service.
What a Wallet Does
A wallet is a program that has three main functions:
- Generating, storing and handling your keys and addresses
- Showing you your balance
- Creating and signing transactions to send funds
The first function is the main function and main differentiator of all wallets: generating, storing and handling your keys. As we said in the last article about identity in blockchain, having access to your private keys means to be able to spend your money.
Where you store your keys determines the safety of your funds and at the same time the convenience of using them. With wallets there is usually a trade-off between safety and convenience: Having some funds on your mobile wallet (your smartphone) makes them easy to spend, but not very secure. Keeping larger amounts of money on a hardware wallet is very secure, but not as convenient when you want to spend it. In the Advanced Level, we explain the different types of wallets out there.
A Wallet Acts as a Keychain
We would like to introduce an abstraction, that might help you wrap your head around the concept of your keys and the importance of their safety. Although the term wallet might be more intuitive, the function of a wallet is closer to that of a keychain rather than an actual wallet. To make it crystal clear:
You don’t actually store any cryptocurrency in your wallet. You just store the keys to access them on the blockchain.
The blockchain records the amount of coins associated with a key pair (your identity on the blockchain). It calculates the amount of money the keys have access to based on all the transactions on the blockchain. Remember: the main function of a blockchain is to store all transactions in the correct order. Say you receive 10 ZEN in a first transaction and receive another 10 ZEN later on. It is clear that you, the owner of the key pair, owns 20 ZEN.
To spend your money you need the private key stored in your wallet. This is why a keychain feels like a good analogy for what a wallet does. If you don’t control your keys, you don’t control your funds. You don’t need to understand how public-key cryptography works in detail in order to use cryptocurrencies but the concept of your keys giving you access to your funds is still important to remember.
Wallets create a layer of abstraction and are becoming more and more user-friendly. Wallets show you your balance, generate an address to receive funds by just clicking “deposit” or “receive”, and provide you with a simple interface to send funds. All you need to do is enter the address that you would like to send money to and the amount you want to transfer. The signing procedure using your private key will happen in the background when you click send.
What if I Lose My Keys?
You don’t have to ask anybody to join the network and you don’t have to register with a central authority to create a wallet. Being able to do this comes at the cost of you being responsible for the safety of your coins. There is nobody that can help you recover your keys if you lose them. If anybody was able to recover your keys for you, they would also be able to steal your funds. This would eliminate the trustless aspect of blockchains. You may have heard stories about people searching for old hard drives because they have “lost their bitcoins”. More accurately, they lost the keys to access their bitcoin.
But there is a sort of recovery mechanism with many wallets called a mnemonic phrase or backup phrase. A mnemonic phrase usually consists of 12 or 24 words. With these words, you can recover your keys. You receive your mnemonic phrase when you install and set up your wallet. Be sure to write it down on a piece of paper and keep it in a safe place. You should have at least two versions of your backup phrase stored in different locations.
It’s essential to understand that your backup phrase is just as important as your private key itself. If anybody gets their hands on your backup phrase, they can access your money. Saving it as a screenshot or text file on your computer is not a good idea!
A wallet is a program that helps you manage your keys and create transactions easily. Your wallet looks at the blockchain to determine how much money you own by reviewing the transaction history. To send funds it writes a transaction and signs it, meaning the wallet encrypts it with your private key.
Try our wallet, Sphere by Horizen to become more comfortable with the concepts we covered in this article. To do a test transaction you can visit our Faucet where you will get a small amount of free ZEN! You can use it to receive and send your first cryptocurrency transactions without having to buy some coins first. Simply install Sphere by Horizen, create a wallet (and save your Recovery Phrase on a piece of paper), provide your address to the Faucet and soon you will have your first ZEN to play around with!
You can visit our Advanced Level for an overview of the different types of wallets.