08 - Wallets don't hold your crypto they hold your keys
One question on the mind of many new crypto users is: “where should I hold my crypto?” “Holding” crypto is a bit of a misstatement. You never actually “hold” bitcoin or any other blockchain-based asset just like the Yapese never held any stone. What we are going to talk about today is controlling your digital assets. Most people control their assets through an exchange like Coinbase, but this industry was built on self empowerment and the ability for anyone to control their wealth without needing a centralized company like Coinbase to help them do so. Blockchains allow participants to do this using something called wallet software. Wallets are a key blockchain innovation but in order to understand them we should first talk about the primary way which users enter this space, exchanges.
Exchanges
Exchanges are online platforms where anyone with an account can swap (“trade”) one kind of digital asset for another. The experience of buying and selling digital assets on an exchange is similar to that of buying and selling a stock. When logging into your exchange account, it shows your “portfolio”, the current price of an asset, and buy/sell buttons. With a single click you can move in and out of an asset. The experience is seamless and predictable.
While there is a lot to love about these platforms, there is a major downside: they control your money. When you buy or send crypto to an exchange, you are giving the exchange control of funds. It’s like going to a bank and making a deposit. You may have some numbers on a bank statement, but the actual money, the thing of value, is out of your control.
We give up our rights to control our money for convenience. Historically, we did not want the responsibility of keeping $100k under our mattress. In crypto, a similar event is happening when you use an exchange. You are making a deposit at an exchange in order to gain the convenience of being able to easily buy or sell crypto and outsourcing the risk of losing your crypto.
The average person might find this completely acceptable considering this is the model that has historically been used. BUT as we learned in But... why?, the crypto industry exists as an antidote to the historical standard. The beauty of crypto is that it provides another option. Blockchains are designed explicitly to allow anyone, anywhere, to hold their digital assets without the involvement of a third party depository. The means by which this is accomplished is by mechanism known as a wallet.
Wallets
In order to better understand what wallets are and do, it’s helpful to return to the idea discussed in How the Island of Yap works Today– that every blockchain participant is represented on a blockchain network by something called a wallet address. Wallet addresses are like names in the Island of Yap ledger. They describe who owns each digital asset that is being tracked on the network. Every blockchain participant must create a wallet address. The process for creating such an address once required a deep technical understanding but has recently become incredibly simple. Despite the simplicity, anyone using a wallet should have a high level understanding of the way that they work.
A wallet address is best compared to a locked mailbox. Every mailbox has a street address just like every blockchain wallet has a wallet address. In both instances the address identifies a location. For a mailbox, it's a physical location whereas for a wallet, it is a digital location. We can send mail to this mailing address just like we can send crypto to our wallet address. An important characteristic of both our mailbox and wallet address is that it’s locked. In the case of a mailbox, once a letter goes into the box, only the person with a key can access that letter. Blockchain wallet addresses work the same way. Once a digital asset is sent to a wallet address, only the person with the digital key to that address can access the asset.
Wallet addresses are linked to their “keys” through math. Going back to the concept of a hash function we discussed in Understanding the Chain, a similar but different equation is used to create a wallet address. Instead of using the transaction information as the “x” value in our formula to get our hash function “y”, we use a random variable called a secret phrase (a set of 12-24 randomly generated words) for “x” to our private key “y”.
Private keys look like a long string of random letters and numbers, but they are extremely important. They grant the person who knows the private key access to the digital asset in the wallet they are associated with. Just like their name suggests, they need to remain private. If a wallet's private key is discovered, it will forever be accessible to anyone who knows the private key. It would be like leaving a sticky note with your lock combo attached to your mailbox. Once someone knows the combo, that mailbox will forever be compromised.
Once you have created a private key, you then conduct this process twice more: first by sending your private key through a math formula which creates a public key (also a long string of random letters and numbers); and then by sending your public key through the formula to create a wallet address, which involves the creation of still another a long string of letters and numbers. The result is that you now have to create a private key, something you keep private and don’t show to anyone, and a public key and wallet address, two objects you show to the rest of the network so that they know where to send digital assets.
Here’s what is important: a wallet is the application someone uses to create and store private and public keys. Wallet’s don’t hold your digital assets. Digital assets never leave a blockchain. They are not like cash where sending them results in the transfer of the actual asset. Sending a digital asset results in the transfer of ownership. Remember on the Island of Yap, the stones never moved, and similarly neither do digital assets on a blockchain. Wallets are really more like key chains than they are wallets.
Back at the dawn of the crypto industry, this process required extensive technical knowledge. Today, wallet companies have created seamless applications for anyone to easily and efficiently create private keys, public keys, and wallet addresses. Anyone can simply download an application like Exodus or Metamask and create a set of keys and addresses which would allow them to operate directly with a blockchain instead of using an exchange.
Not your keys, not your crypto
The difference between an exchange and wallet is in who holds the private keys. When you hold assets on an exchange, you have an account with an exchange but actual control over the asset remains with the exchange. They interact with a blockchain and have the exclusive ability to access and move the funds. If you use a wallet, you are the one in control of your funds because you control the private key. No person, exchange, or even government can prevent you from sending or receiving digital assets if you use a wallet. Wallets provide individuals total access and autonomy to their money like no other technology that's been created before.
How keys enable this will be the topic of next week's discussion.
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