How to Pick a Bitcoin Wallet
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How to Pick a Bitcoin Wallet

Alongside picking an exchange, selecting a bitcoin wallet is the most important decision a new bitcoin user will have to make.  We break down the decision for you.

Written on: May 25th, 2015 | Author: David M

What are bitcoin wallets?

Bitcoin exists only as a series of transactions. They possess no physical form. They are backed by no valuable commodity or reserve of any sort. To say they are stored within a wallet is inaccurate as in truth they exist nowhere, outside of bitcoin's digital central ledger, the blockchain. The blockchain records the journey of each bitcoin, from the moment of its creation by a miner, following it from wallet address to wallet address until the most recent stop, which serves to provide universally-recognized proof of ownership. The address, a random string of numbers, is mathematically linked to a corresponding private key, the ownership of which provides the ability to sign transactions for the associated bitcoin. Wallets are designed solely to protect that private key.

Bitcoin security, internet security

The most pressing issue in bitcoin today, the factor most likely to determine the success or failure of the bitcoin project, is the ability to protect those private keys. Each spectacular headline trumpeting another multimillion dollar bitcoin loss, the real toll this takes on people's lives and financial health, is directly related to failure, in one way or another, of wallets to fulfill their role as protector of private keys.

And in truth, while bitcoin security breaches have dominated many headlines there is a larger dynamic in play which is our ability, or inability, to protect against digital theft. This is something that plagues the internet. Seven percent of US residents 16 years or older were victims of identity theft in 2012, with 85% of cases involving credit card or banking information. We assume those numbers continues to grow. In February of 2015, a hacking network was discovered that had stolen over one billion dollars from banks over the course of the previous two years. In October 2014, 40 million credit and debit card numbers were stolen from Target's point of sale systems. So bitcoin, while not immune, is also not alone.

Bitcoin does stand alone in the realm of digital security innovation, which is pulling the entire internet security market forward. Many of the best developers in the world, dedicated to this amazing technology, have been working on enhancing wallet security to ensure the success of the bitcoin project.

This guide and the associated wallet reviews are meant to provide a general overview of bitcoin wallet technology and help users to pick the wallet most suitable to their security needs.

The exchanges - custodian wallets

It is often said that you do not truly have possession of your bitcoin if it is not stored in a client-side wallet. This is true, insofar as it goes. When storing bitcoin at an exchange you are entrusting them to manage security on your behalf. Exchanges generally pool bitcoin together in their own wallets, either on or offline, and keep records of which bitcoin is owned by whom. Passwords grant access to your account, from where you can instruct the exchange on what to do with your coin.

In the event of a security breach, hackers gain access to all or some of the coin owned by the exchange's clients. In the case of the Bitstamp hack in January 2015, approximately 10% of client funds, those stored in so-called "hot" or online, wallets were compromised. In the catastrophic February 2014 meltdown of Mt. Gox, hackers had made off with $600 million in client bitcoin.

In truth, for the non-technologically minded among us it is most likely safer to store bitcoins in a secure exchange like coinbase than in a client-side wallet. Client side theft, though much less spectacular, can theoretically be more likely depending on the individual user, as there has been a proliferation of malware designed to exploit security lapses on personal computers to steal bitcoin.

Responsible exchanges invest heavily in securing coin, and the top exchanges have reserve strategies in place to ensure that, in the event of a breach, they are able to honor lost client bitcoin. Some exchanges even offer insurance of funds and enterprise-level wallet security options. Partnering up with such an exchange might be the best option for users that simply do not want to think about security, that want a full-service solution providing security and ease of access to funds. If this describes you, please visit our exchange review page and find yourself an exchange highly-rated in the security and gravitas aspects.

Client-side wallets

When using client-side wallets, private key and password information is generated using an assortment of different methods on the clients computer. The encrypted wallet is passed back server side, and can only be accessed with the password information stored locally with the client. This means that theoretically, in the event of a server-side security breach, hackers would only gain access to encrypted - and thus worthless from their perspective, information.

This also means that the client is solely responsible for the security of his passwords. If a client computer is breached and a thief gains a user's password, they are able to unlock the wallet and transfer bitcoin where they would like. (This is a very simplified explanation. There are a number of security parameters offered by wallets to protect against client-side breach).

Additionally, If the password is lost the wallet has limited ability to allow a user access. Indeed, many a bitcoin are locked forever in client-side wallets, the owners of which lost their passwords.

To protect against lost passwords - or against a catastrophic wallet collapse, users must back up private key information in a secure location, preferably offline. Let's take a look at how this is generally done, using wallet as an example. Users are able to backup the private key associated with a particular wallet in encrypted or unencrypted formats. The encrypted wallet is accessible only with the password. In the case of a catastrophic collapse, the encrypted wallet can be imported to other wallet providers, most notably multibit , and vice versa. It goes without saying that the encrypted wallet and the password should be stored in entirely different locations!

There is an additional option to export the unencrypted private key to a paper wallet. Funds can continue to be contributed to the public address associated with the paper wallet, but to access your funds you will need to import your paper wallet to most any wallet service, simply following their directions for inputting the private key code or scanning the QR code. While securing a paper wallet is much simpler than ensuring digital security, if a paper wallet is stolen, the thief has easy access to your coin.

When handled properly, a paper wallet constitutes a great cold storage mechanism for individual bitcoin users. Paper wallets are safe from malware and keystroking hacks, and funds can continue to be deposited into the associated public wallet without the paper's private key ever coming into contact with the internet jungle.

Now, more than one address can be created within a particular wallet. This makes for a much less convenient backing up process, as each address has its own associated private key. It means a backup must be done after each new address is created. This segways us nicely into a discussion on HD wallets.

Hierarchical deterministic wallets

HD wallets contain a "seed" which is a single master private key connected algorithmically to its corresponding public key. A mnemonic password, a series of 12 or 24 random words representing the seed, is securely kept by the user. Now, by running the public address associated with the key through a hash function (automatically done through the wallet service), any number of linked additional addresses may be created that maintain a one way association with the private key. So each private key can have any number of associated addresses.

HD wallets never require backups - all that is required is the 12 word mnemonic to access the seed and authorize transactions with any of the associated wallets. Additionally, the mnemonics are universally recognized across wallets most HD wallets, including multibit, electrum, coinkite, and armory, among others. This means that, with just your pneumonic password, you can restore your wallet on any of these services.

Not only does this provide greater convenience for backing up online wallets, it is extremely useful for personal offline "cold" storage solutions.

For more information on the different types of wallets, check out our pages on cold storage, multisig and hardware wallets.  If you would like to see comprehensive listings of all wallets on the market, check out our bitcoin wallet page.

Bitcoin Price (USD): 853.48