Hardware wallets and why should I care?

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Blog

Published

Dec 10, 2021

Author

nbx.com

What is a cryptocurrency wallet?

Before explaining what a hardware wallet is, it’s important to clarify what a cryptocurrency wallet is, in general. First and foremost, a crypto wallet isn’t really a wallet. It’s really more of a piece of software that specializes in holding passwords, which prove that you have the right to the cryptocurrencies you’ve bought. In a technical sense, these passwords are called “keys”, and there are two of them, called the public and private keys.

Both look like long strings of randomized letters and numbers, almost identical in their basic form, but the public key gives you access to the cryptocurrencies you’ve purchased, effectively functioning as an account number and identifier, while the private key acts like your account password and routing number, allowing you to spend the funds the wallet is tied to.

So, all in all, your cryptocurrency wallet is less of a wallet and more of a password manager.

Considering this, it’s important to remember that you should never disclose your public or private keys to anyone or you’ll risk losing access to your cryptocurrencies held in that wallet forever.

Wait, where are my Bitcoins stored?

Your public and private keys prove you have access to a certain amount of Bitcoin that exists on the Bitcoin blockchain. When you purchase Bitcoin or any other cryptocurrency, you receive the right to what you’ve purchased through a ledger entry being made, tying your wallet to that which you’ve purchased. So, if you buy one Bitcoin, your transaction is “mined,” and stored in a block, tying you to that amount forever in a publicly verifiable fashion. If you’re not familiar with mining, just imagine a horde of computers, all of which always maintain a full copy of the Bitcoin blockchain (ledger). These computers work together to record all transactions on the Bitcoin blockchain by running them through a “hash function.” Generally, a hash function is an algorithm that takes in data like the date, time, location, and amount of a transaction and spits it out in a format like a secret code. The bitcoin users with enough processing power to meet the threshold needed to successfully run transactions through a hash function are called miners. Once a transaction has been run through a hash function, it may be placed upon the Bitcoin blockchain and is then considered completed. At that point, your wallet is tied to that transaction, which means that you have perpetual access to the crypto you have purchased, unless you, yourself decide to sell or trade it to someone else.
With the above knowledge, we now hope it’s clear where your Bitcoins are stored, as well as how you have access to them.

What about moving my cryptocurrencies, what gives me the ability to do that?

On top of its public and private keys, your cryptocurrency wallet has a third feature, called a public address. Fundamentally, your public address looks quite similar to your keys, since it’s a random string of letters and numbers. It’s in how it works, however, that it differs from its other two partners. Any time you want to buy, sell, or transfer your crypto from your wallet to somewhere else, all you need is your public address. Therefore, it’s best to think of it as an account number, a routing number, an IBAN, and anything else related to moving money, all rolled into one. Today, most cryptocurrency wallet providers even make it as easy as scanning a QR code any time you want to move your crypto.

Why a Plain-Vanilla Crypto Wallet Isn’t Enough

Understanding what a cryptocurrency wallet is and how it works is only half of the battle. It’s also vital that you understand what the different types of cryptocurrency wallets are (yes, there are more than one!), and why one is more secure than the other. To kick things off, keep in mind that all cryptocurrency wallets are software.

Generally, they can be split into two types: “hot" and "cold" wallets. The first refers to a wallet that’s native to the internet or always needs to be connected to it, like a desktop or mobile wallet. In the latter case, it’s enough for now to imagine a USB device that maintains your cryptocurrency funds offline, unless you allow it to have internet access.

What is a hardware wallet and how does it work?

A hardware wallet is this USB device that we’ve mentioned above. On a technical level, it mostly functions in the same way as a general cryptocurrency wallet, with a few small, but important differences:1. It can hold your cryptocurrency without internet access, which takes away the risk of your computer being hacked and your wallet’s keys being compromised in the process. This is because like a hot cryptocurrency wallet, it is really just a password manager that stores the two keys which give you the right to the crypto you’ve purchased.

2. Since hardware wallets are USB-devices, they aren’t really connected to your computer at all. In fact, just to communicate with it, they need what’s called “a bridge program”, which is like a walled-off tunnel for sending data to and from the wallet without ever actually exposing it to your computer and its operating system at all. Think of this bridge program as software you can download to your computer to see what’s in your wallet, track your funds, and move them.

3. All reputable cryptocurrency wallets allow you to create a password or PIN number, just as you would for your email or any other service you use, but hardware wallets allow for the usage of PINs and passwords together. Typically, your PIN is recoverable with your seed phrase, but your password isn’t so make sure never to lose your password. Copy it to multiple locations, ideally on paper, as it runs less of a risk of being compromised in that case.

4. Last but definitely not least, if you hold your cryptocurrency funds with a third-party “hot” wallet or even on an exchange, you don’t really own them. Just like with a bank, the service provider acts as your custodian, guaranteeing you access but holding your funds for you. Using a hardware wallet is the most reliable way to have access to your cryptocurrency at all times.

How do I choose a hardware wallet?

Two providers, called Trezor and Ledger rule the hardware wallet space though more options do exist, both due to their longevity and the level of trust they’ve gained from their customers, both new and old over time. Overall, most cryptocurrency investors and traders choose either of these companies as their first hardware wallet provider. Since both companies began their operations in 2014 and both employ some of the leading experts in cryptography and security, choosing which wallet is right for you really comes down to the features each company offers.

If you want your wallet to support as many cryptocurrencies as possible, then Trezor would be your best bet, since it currently supports 1649 altogether, while Ledger supports 1526. With this in mind, however, it should be noted that regardless of the company you choose, some wallet models support less coins than others. Therefore, it’s important to carefully choose the provider as well as the wallet model that’s ideal for you.

If you’re particularly cost sensitive, you’ll find that both Ledger and Trezor’s cheapest models are roughly 59 euros at the time of penning this post. Admittedly, you can easily find cheaper prices from resellers, but you should never buy your wallet from a re-seller since it can be easily tampered with and outfitted with backdoors for hackers once it leaves the manufacturer.
As you run through most of the rest of the features offered by both companies across all of their wallet models, you’ll find a few more key differences, such as in the third-party wallets and exchanges they support. Ledger currently supports just about 50 services in both respect and Trezor coming in second at 15. Considering this, if you’re a trader who likes to frequently search for new opportunities across multiple services, you might opt for a Ledger. Even so, it’s important to consider the downside of this situation as well. The more services that a hardware wallet is compatible with, the more theoretical attack vectors exist. While your hardware wallet is connected to an exchange or “hot” wallet, it’s vulnerable to any sort of hack that might be engineered on that service. Therefore, it’s always also best to consider the benefit of buying a hardware wallet that doesn’t allow for any and all compatibility with other cryptocurrency services.

In the end, if there’s one final difference to note, it’s that Trezor’s software is open-source (while Ledger’s partially is), which makes it possible for anyone to audit the code that the former depends on.

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