Welcome back! In my last blog, I briefly defined the blockchain, provided a road map to getting started with cryptocurrency, and summarized how this technology would affect accountants everywhere — if it hasn’t already. This blog will dive into the technical aspects of a wallet in order to help accountants confidently use and secure them. Let’s start with the basics.
What is a wallet?
A wallet is the software that interacts with various blockchains (note each cryptocurrency is composed of its own blockchain). Anyone who wishes to exchange cryptocurrency must have a wallet. The wallet enables users to send and receive cryptocurrencies and it monitors their balance. It’s important for accountants to understand the basics of a wallet in order to maintain security and send and receive transactions as necessary.
How does the wallet work?
A cryptocurrency wallet has three main components — a private key, a public key, and an address. Each of which plays an important role in transferring and recording funds.
Private Key > Public Key > Address
The private key authorizes users to carry out transactions from their wallet. It is like a pin number on a debit card and should always be kept safe and secret.
Private Key: 03bf350d2821375158a608b51e3e568e507fe47f2d2e8c774de4a9a7edecf74eda
A cryptographic hash function (sounds technical but this is simply applied math) is applied to the private key to generate a public key. When a transaction is made, the public key is recorded on the blockchain to prove that the owner approved the transaction. It’s like the user’s signature and is public on the blockchain.
Public Key: 10b1ebcfc11a13df5161aba8160460fe1601d541
The wallet address is a hashed version of the public key. A wallet address is like a bank account number. It can be shared publicly for the transferring of funds. Just like a bank account number, each address is unique.
Wallet Address: 1A1zP1eP5QGefi2LMPTfTL5SLmv7FivfNa
Unlike traditional wallets the digital wallet does not store currency. Cryptocurrencies do not exist in a single location because the blockchain is pubic and lives on any computer that wishes to download it. All that exists are the transactions on the public blockchain detailing which public keys carried out transactions and the addresses affected. When a transaction is recorded on the blockchain there is a change in balance to the wallet corresponding with the public key and address.
Different Types of Wallets and Securing Them
There are different types of wallets. Desktop and mobile wallets can be download to your computer and/or mobile phone in the form of an app. If the computer or mobile phone were to end up lost, the wallets could potentially be compromised. It’s important to take proper security precautions when using a desktop or mobile wallet like password protecting the device as well as encrypting it.
There are also online wallets. These wallets are very convenient. You can access them on any device via a web browser. These are also the least secure because the provider may keep a copy of the transactions recorded on their own private server and if the sever were to be compromised so would the user’s funds. It’s important to connect with the online provider prior to using an online wallet to ensure proper security is in place. If two-factor authentication is available, it’s a good idea to enable it.
Paper wallets are a printout of the users private and public keys. When a user closes out a wallet and takes a copy of their funds with them the process is called “sweeping.” Having a paper wallet is equivalent to having cash. This should be kept safe and the information shouldn’t be shared with anyone.
Hardware wallets are the most secure form of wallet. They are created for the sole purpose of storing public and private keys and are password protected. Some resemble a small external hard drive while others are as small as a USB drive. Hardware wallets should always be kept in a safe place and the passwords secure.
What is the difference between a wallet and an exchange?
A wallet enables a user to send and receive cryptocurrencies and an exchange enables a user to buy/sell cryptocurrencies in exchange for other currencies. Some online wallets like Coinbase are both a wallet and an exchange. Not all wallets include an exchange service.
What does the wallet look like?
For this example, I am going to use Coinbase, an online wallet, and only cover the features that are common among all wallets. After the wallet has been paired with the user’s private key, all wallets have two basic features:
· Send and receive allowing the user to send and receive funds
· Access a history of all transactions (the ledger) while using the wallet
It’s important to note that transactions are recorded in the cryptocurrency and not in US dollars. Also some online wallets will generate a key for the user on setup, store the private key, and the user will never have access to it, which is the case with Coinbase.
How to send/receive cryptocurrency?
In case an accountant ever runs into a situation where a client uses cryptocurrency and they need to transfer funds between wallets, simply follow these steps:
· Request the receivers address
· Click “Send” in the wallet
· Enter the amount to send along with the receiver’s address
· Click “Send”
It’s the exact opposite if you are receiving funds to a wallet. Simply provide the sender with the wallet address the funds should be deposited to.
All wallets have send/receive functionality. However, what may vary is how the address is shared. Coinbase allows users to send funds via email address or by sharing a QR code. However, wallets that are not online are likely to have different ways to share the address including a manual entry depending on the wallet.
For accountants, it’s important to note that a wallet does not store funds, it simply calculates the users balance based on the transactions recorded on the blockchain. However, this does not mean that a wallet should not be secured. The user’s private keys must be kept private and the private keys are recorded in the wallet. Anyone with the private keys can access the funds and complete transactions. The public key is equivalent to a signature and the address is the bank account number. A wallet enables users to send and receive funds and posts transactions to the blockchain.
Are you an accountant actively using a wallet? Do you have any tips and tricks to share?