Cryptocurrencies are digital money. And being a form of money, it does make sense that tools used to store them are known as wallets. But crypto wallets don’t work like your regular physical wallet, precisely because of the nature of cryptocurrencies and blockchain technology. Much more goes into ‘holding’ digital assets in a crypto wallet than putting fiat notes in a physical one.
So, what does it actually mean to store cryptocurrencies?
What is a crypto wallet?
A cryptocurrency wallet can be a software application that you install on your computer, smartphone, or tablet. It can also be a hardware device, complete with its own custom software, that’s specifically designed for storing your private key. Some people even use paper wallets – crypto wallets that are simply a private key printed out on a piece of paper.
How do crypto wallets work?
Overall, no matter what kind of wallet you are talking about, they fundamentally work in the same way. Wallets use cryptography to let you access and manage your cryptocurrencies. There are two types of cryptographic keys involved in this process. These are the private keys and public keys, with the latter being derived from the former.
A public key is a unique string of characters representing your wallet’s address on the blockchain. It essentially identifies the ‘location’ of your wallet and is used by others to send crypto assets to it. This is why it’s also known as the public address.
You can think of it as the email address that people use to send you emails. It is public, meaning it can be freely shared with anyone.
Private keys, on the other hand, are a unique string of characters that serve as the wallet owner’s digital signature. It is used to prove ownership of the funds in the wallet and digitally sign transactions to authorize the transfer of outgoing assets. Because of this, private keys are confidential, like the password for your email address.
Private keys and seed phrase
Most crypto wallets, with the exception of paper and core wallets, have a seed phrase. This is a sequence of 12-24 words that is used to generate the public and private keys. It also acts as a mnemonic phrase– a word or phrase designed to help you remember information that is much more complicated.
Private keys typically consist of a random combination of characters. This makes them really hard for the average human mind to remember. So, rather than give you the private key in its raw form, you receive 12-24 random words (the seed phrase), that you can then record and store somewhere safe.
In this case, the seed phrase is a human-readable version of your private keys. Like the private keys, it acts as proof of ownership of the wallet and the funds associated with it.
This allows seed phrases to be used in crypto recovery. If you lose access to your wallet for one reason or the other, you can use the seed phrase to recover its public and private keys, which allows you to access all the funds associated with it.
Core wallets vs regular software wallets
Most software wallets that you find on the web, like Metamask, Trustwallet, TronLink, etc. have similar functionality. They are compatible with certain blockchains and can store certain crypto coins and tokens. However, there is another class of more advanced software wallets.
The most notable of these is Bitcoin’s Core wallet. Like other software wallets, it has private and public keys and can be used to store and manage crypto assets (Bitcoin in this case). But it’s also so much more than that.
Bitcoin Core also serves as the software client of the Bitcoin blockchain. This essentially means that it allows users to run a full node of the blockchain network on their computers. Being a node, the wallet will require you to download the full history of the blockchain and regularly sync with the network. This makes Bitcoin Core much larger than a regular software wallet. It is currently about 500 GB in size. It also requires an additional 5-10 GB of storage space monthly due to syncing.
Now, with all this foundational knowledge about crypto wallets, we can look at how and where cryptocurrencies are stored.
Where is cryptocurrency actually stored?
Crypto wallets exist to help users store and manage their digital assets. But contrary to what the name and definition of a ‘crypto wallet’ may suggest, these applications don’t actually store cryptocurrencies. They just let you access them.
How?
Well, being digital, cryptocurrency and tokens are just bits of data. This data is stored on the relevant blockchain network. So, no crypto assets are actually in your wallet. All ether (ETH) tokens are stored on the Ethereum blockchain as bits of data, all bitcoin (BTC) on the Bitcoin blockchain, Binance coin (BNB) on Binance Chain (BSC), and so on.
This brings up another question – if all tokens live on the blockchain, how come your wallet displays a balance when you open it?
Well, each transaction on the blockchain is associated with multiple public addresses. All your wallet has to do is scour the blockchain and find all the bits of data associated with its blockchain address and add them up. Therefore, your wallet balance is actually a sum of all the crypto transactions associated with your particular public address.
This means that when you send cryptocurrencies, you’re not really moving funds from your wallet to the recipient’s wallet. What you’re actually doing is changing which public address the assets are associated with from your wallet’s address to the recipient’s address. Your wallet will use your private keys to sign off on this transaction.
How do centralized exchanges store your crypto?
Crypto storage options can be non-custodial or custodial. Non-custodial options are what you get with wallets like Metamask, Trezor, Ledger, and Trustwallet. They give you your wallet’s private keys. This allows you full control over the wallet and the funds associated with it.
Custodial options, on the other hand, manage the wallet holding your cryptocurrencies on your behalf. They don’t give you the wallet’s private keys. Therefore, you don’t have full control over it. This is what you get with centralized exchanges like Coinbase and Binance.
Centralized exchanges facilitate the buying and selling of cryptocurrencies, usually by acting as an intermediary between buyers and sellers. Such platforms typically require users to open an account with them and deposit their funds in the account.
You can still access your funds via the account. However, the crypto coins/tokens are not held in the account. What you have in your account are essentially IOUs. The real funds are, instead, held in the exchange’s own wallets that the users have no direct control over. This is because the platform holds the private keys associated with those wallets.
Giving custody of your funds in this manner comes with a lot of conveniences for trading. But it also carries a fair number of risks. You are, after all, relying on another party to safeguard your assets. And considering that the FDIC does not insure crypto assets held on crypto exchanges, if the platform collapses, you stand to lose all your money.
This is why it’s recommended to use non-custodial wallets if you plan to hold cryptocurrencies for a long time.
Summary
While it is commonly said that wallets store cryptocurrencies, they don’t technically do that. All your crypto is stored on the blockchain as bits of data. Your wallet, on the other hand, is just the tool that lets you access and manage it.
If you ever have a problem with your crypto wallet, all is not lost. The experts at Professional Crypto Recovery can help you get your assets back.