Before we dive into the world of Bitcoin Wallets, Bitcoins and Cryptocurrencies, let us first take at how the real-world banking system functions
In the world of cryptocurrencies, Bitcoin Wallets act as these bank accounts. Bitcoin Wallets allow you to store your money online. You can have multiple accounts where your bitcoins can be spread across.
Similar to how the bank gives you an account number, a bitcoin wallet gives you an ‘address’ which is a string of letters and numbers. This is a public address which can be given out to the users you want to collect payments from and has to be entered into your bitcoin mining software and provided to your Bitcoin mining pool which ensures that you recieve your due amount.
Now that you know what Bitcoin Wallets are and how they stand compared to their real-life counterparts, let us take a look at the kinds of Bitcoin Wallets:
There are basically two broad categories of wallets. Before we proceed further with the kind of Bitcoin wallets, it is critical to know the concept of Hot Bitcoin Wallets and Cold Storage Bitcoin Wallets.
Hot Wallets are those wallets which are connected to the internet and can be accessed from any device. These are generally considered less secure compared to cold wallets because they are always connected to the internet which risks them being hacked. These are the likes of software wallets and web wallets.
Cold Storage Wallets on the other hand are considered more secure because they do not have to be connected to the internet at all times. These are the likes of hardware wallets, paper wallets and brain wallets.
Let us take a closer look at each of these wallet types.
Software wallets are basically hot wallets. These wallets work with the help of a software which connects the miners’s PC to the blockchain. It is with the help of these software wallets that miners can download the blockchain on to their PC.
What makes this a tedious process for some users if the fact that the Blockchain is massive! It is over 100GB in size and and can be tough to download and store for users who are on a limited bandwidth or on a limited storage. However there are some desktop software wallets which allow you to build a wallet without having to download the Blockchain.
Software wallets are particularly useful when it comes to mobile devices. There are dozens of wallet apps for Android as well as iOS. However, these wallets are as safe as your PC or phone is. If your phone or PC get infected by a spyware/malware chances are that your wallet might be at a major risk.
Web wallets are a type of Hot Wallets and they are among the easiest to use. These bitcoin wallets need not be downloaded and set up and work almost as the equivalent of PayPal in the bitcoin world. These wallets can easily be created and accessed from any device that runs internet.
However, all the biggest disadvantage of these wallets is that you have no control over their security. Web based Bitcoin wallets are only as secure as the server they are hosted on. There have been cases where Bitcoins worth hundreds of millions have been stolen from wallets in the past. Web wallets are good for beginners or those who trade with smaller amounts. However those who trade in bigger volumes need more security.
When it comes to securing your bitcoin wallets, cold storage wallets are the safest. Paper wallets are a type of Cold Storage wallets. What is different here is that the key to your wallet is not stored anywhere electronically, but it is printed and kept with you.
Since the only way anyone can tamper with your bitcoin wallet is if they have your key, and your key is only in form of a printed piece of paper, it’s quite secure. The process is secure because you create a key when your computer is not connected to the internet and keep your key with you on paper so no electronic evidence of it remains.
However since it is a piece of paper it can easily get wet, torn, lost or damaged. Users need to ensure that they maintain multiple copies of these papers.
Also Read: How to Mine Bitcoins
Brain Wallets are basically Bitcoin Wallets where you get to set your own password instead of using the key provided by the Wallet app. Theoretically it allows you to create a passphrase which only you know and is more secure. However, practically speaking most users create keys which are less secure than the randomly generated ones.
These wallets are at the greatest risk of being hacked as not only there’s a chance of brute force methods and hacking there’s also the good old guessing game that might put your account in danger.
While these aren’t a ‘type’ of wallet per say, but this deserves a mention as this is a defining feature of many wallets. Commonly known as ‘Multisig’, this feature adds another layer of protection.
Wallets which have mutlisig feature need more than one key to send Bitcoins. For example imagine if you are into mining with three of your friends. The four of you are good friends but are not comfortable in having one common key - just in case someone goes rogue. Multisig wallets allow you to set up a system in which more than one key will be needed to send Bitcoins.
If any of you goes rogue, they will still not be able to run away with the Bitcoins as it requires minimum two keys to send Bitcoins.This number can be increased too, depending on how secure you want the transactions to be and how much you can trust the people you are mining with. This is an important feature, especially when making escrow payments.