INTRODUCTION
Once the basics are understood, navigating a blockchain becomes no different than logging into a website. Read about Bitcoin and Ethereum to begin the journey of blockchain basics. Bitcoin teaches us the concept of the blockchain, and Ethereum teaches about dApps (decentralized applications). To interact with the blockchain and access dApps, a user needs a wallet that verifies ownership. A wallet allows a user to store cryptocurrencies such the blockchain’s native token or other blockchain assets such as NFTs. To claim ownership of a “wallet” on the blockchain, a user needs access to the “private keys”. There are various ways in which a user can store their blockchain asset: a centralized exchange, a hot wallet, or cold storage.
SEED PHRASE
The keys to a user’s cryptocurrency are tied to the seed phrase (mnemonic phrase) that is generated when a wallet is created. Depending on the wallet, a 12 or 24 word phrase is presented to the user when initially creating a wallet. The user is asked to store these words in a safe place, ideally written down on a piece of paper. The next step of wallet creation involves confirming some or all of the words in the seed phrase. Wallet creation will also incorporate creating a password to access the wallet. The seed phrase is cryptographically turned into a hash string which becomes the user’s private keys. The important concept to understand is that a user’s “wallet” is the digital hash that is generated from the seed phrase.
The hash becomes a part of the blockchain and assets associated with that hash are accessible with the seed phrase. To avoid inputting the seed phrase every time, a password is associated with accessing the seed phrase. Users need to understand this password is only to access the seed phrase. If the user for some reason forgets the password or loses access to the wallet, creating a new wallet with the old seed phrase will regain access to the original wallet. The password that a user inputs has no function other than to access the private keys.
PRIVATE VS PUBLIC KEYS
The seed phrase creates private keys and public keys. Private keys are used to send and public keys are used to receive. Having access to the seed phrase also gives access to the private keys. Users are instructed to never share their private keys or seed phrase. Doing so is essentially giving your wallet or claim to the blockchain away. On the other hand, public keys are meant to be shared with other users in order to receive blockchain assets. Some wallet allow the creation of multiple public keys, but it is important to remember that the newly created public keys are associated with the original private key.
To summarize the process:
| User initiates wallet creation |
| A seed phrase is generated |
| The seed phrase creates private/public keys |
| A password is created to access the keys |
| Private keys receive, public keys send |
| Use seed phrase, not password, to recover lost wallet |
NOT YOUR KEYS, NOT YOUR CRYPTO
A user’s initial interaction with cryptocurrencies will most likely occur on a CEX (centralized exchange). A CEX functions as a hub to buy and sell cryptocurrencies. It is not likely that a CEX will involve a seed phrase creation. This means that the user doesn’t have access to any private keys. The phrase “not your keys, not your crypto” translates to “The CEX owns your crypto”. Without access to private keys, the user is allowing the CEX to custody the blockchain assets. This is not an issue if a user’s goal is simply to trade cryptocurrencies. If a user desires actual ownership of a cryptocurrency, creating a wallet and transferring off the CEX and into a wallet is a must. Not having ownership of a cryptocurrency a user has purchased is one thing, but other downsides exist such as these stories involving Coinbase and Celcius.
HOT WALLETS
Users have a variety of options when it comes to creating a blockchain/cryptocurrency wallet. Hot wallets are wallets that are connected to the internet. Users are provided a seed phrase and have access to private and public keys. Hot wallets allow for interaction on the cryptocurrency’s blockchain. As well as storing blockchain assets, hot wallets allow users to connect to dApps (decentralized applications) found on a blockchain.
Generally, hot wallets that connect to dApps are installed as browser extensions. The most popular hot wallet that exists as a browser extension is Metamask. Metamask is an “EVM compatible” hot wallet which allows users to navigate the Ethereum blockchain as well as any other blockchain that is considered “EVM compatible”. Users can also download hot wallets onto their desktop. An example of a downloadable hot wallet is the Exodus wallet. While a user won’t be able to connect to dApps, desktop hot wallets allow for the storage of multiple cryptocurrencies.
In terms of safety, users place themselves at higher risk when using hot wallets. Hot wallets are connected to the internet and their purpose is to be an “active” wallet. A user’s main concern is being hacked. Users have to be vigilant when connecting to dApps as connecting to something malicious can end up draining a wallet of all its blockchain assets. While keeping cryptocurrencies on a CEX gives custody to the CEX, self custody with a hot wallet requires users to navigate the blockchain in the safest manner. Phishing attacks are the most common way blockchain assets are stolen. The most crucial measure a crypto enthusiast can employ to keep their assets safe is to never disclose their seed phrase or private keys to anyone.
COLD STORAGE
The crypto community views cold storage as the safest way to self custody blockchain assets. Cold storage wallets are not connected to the internet. After creating public and private keys through a seed phrase, users use a password to access either a hardware or paper wallet. A hardware wallet is a physical device that generally accepts a PIN number to unlock access to private keys. A paper wallet is simply a seed phrase that is generated and written down by the user.
Cold storage is a passive form of crypto self custody, and hackers have to work harder to steal assets from users. Like with hot wallets, giving away the seed phrase or private keys associated with a wallet is handing a thief all of your belongings. The only people that will ever ask users for private keys are people that are trying to steal crypto.
Hardware wallets can be used in tandem with hot wallets to provide an extra layer of security. Two popular hardware wallets are Ledger and Trezor. A user can link a hot wallet such as Metamask or Exodus with a Ledger or Trezor. While this adds an extra step a user needs to implement when interacting with dApps, it offers an enormous amount of security a hot wallet cannot provide on its own. However, there is no real safety in the cryptoverse. Many would argue that having a user’s personal address available to hackers is not worth the “security” a hardware wallet is entrusted to provide.
CONCLUSION
To own blockchain assets, a user needs access to the private keys associated with the assets. Keeping cryptocurrencies on a CEX is not true ownership. It is simply third party custody as the user does not have any private keys associated with the blockchain asset. Hot wallets allow crypto users to navigate the blockchain in an active manner. Users have full custody of their blockchain assets but must remain alert at all times as hackers will have the easiest time stealing from hot wallets. A cold storage wallet is passive self custody which functions as a safe. If any entity is asking for seed phrases or private keys, assume it to be a thief. The most important lesson that new crypto users need to learn is to never share your seed phrase or private keys.