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How Does a Bitcoin Wallet Work

A 3D render of a macro view of a circuit board with a digital bitcoin projecting above it on a dark background

Recent years have witnessed sharp growth in cryptocurrencies, driven by the overwhelming acceptance of digital currencies the world over, especially Bitcoin. This digital currency is generated through an encryption technique and is transferred in a system that is not governed by any central currency authority, such as a nation’s central bank. Although its value has surged from pennies to over $7,000 in the few years since its introduction, concerns regarding its safety remain. Read on to know more about how Bitcoin wallets are actually safer than credit and debit card transactions that form an integral part of our lives these days.

Benefits of Bitcoin

This cryptocurrency is fast emerging as a legitimate mode of payment, with an increasing number of service providers accepting it as payment. Factors contributing to the popularity of Bitcoin include the ease and convenience of using this currency, besides the safety associated with the anonymity of transactions. In fact, Bitcoin transactions do not have the risk of exposing users to cyber theft or online fraud, as is the case with debit and credit transactions.

Bitcoin transactions do not call the users to provide and/or link their private information, thus reducing the possibility of fraud. To understand more about these benefits, we need to find out how bitcoins are used and how a bitcoin wallet works.

Understanding Bitcoin Wallets

Just like the traditional currencies that we keep safely in a wallet, Bitcoins are stored in software programmes called digital wallets. This wallet does not hold physical currency, but has the private keys that allow users to transact in the cryptocurrency. Each Bitcoin wallet comes with at least two keys, one public and one private. While the public key allows the Bitcoin user to send a sum of Bitcoins directly to another Bitcoin user, the private key allows access to the currency stores in the wallet only to the wallet owner. Bitcoin wallets come in many forms: desktop, mobile, web and hardware.

All the Bitcoin transactions are included in a shared public ledger or blockchain. The backbone of the Bitcoin network, the blockchain, allows various Bitcoin wallets to calculate their spendable balance and verify new transactions by ensuring that the digital currency being spent is actually owned by the spender. This is done with the use of cryptography.

To be able to transact in Bitcoins, the user first needs to install the wallet software on their computer or mobile phone, and then control it as the owner, with access to the private key. The security of these wallets is dependent on the security of the computer on which the software is installed. If a computer is compromised, the private key could also be at risk.

Now, once the wallet software is downloaded, it is synchronised with the Bitcoin network by downloading the blockchain, which leads to quick implementation of transactions. The users will need to know the public key (for receiving) and the recipient’s public key (for sending).

Can the Bitcoin Wallet be Misused?

Unfortunately, the answer to this question is Yes. However, to prevent misuse, all Bitcoin wallets include a secret piece of data or a private key, used to sign transactions. This key provides proof that the order to transact has come from the owner of the wallet. This signature prevents the alteration of a transaction by anybody other than the wallet owner. All transactions are broadcast between users and generally confirmed within minutes.

So, anybody wishing to use Bitcoins needs to first set up a Bitcoin wallet, which stores the relevant information, such as the private key to access Bitcoin addresses and carry out transactions.

Web or Online wallets allow users to carry out transactions from anywhere since the wallet is stored online rather than on a physical device, while mobile wallets can be used to make payments in physical stores via features like Touch to Pay or NFC scanning or a QR code. Hardware wallets hold private keys electronically and facilitate payments, but are still not very popular.

To conclude, Bitcoins are quite convenient but need to be kept safe to prevent misuse. This is possible by choosing a strong password, using encryption or opting for the cold storage option, storing your Bitcoin wallet offline.

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If you liked this educational article please consult our Risk Disclosure Notice before starting to trade. Trading leveraged products involves a high level of risk. You may lose more than your invested capital.

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