What is a cryptocurrency wallet, and why is it important?
Cryptocurrency wallets are vital resources for navigating the world of digital assets. They serve as secure vaults, protecting users’ private keys that provide them access to and authority over their cryptocurrency holdings. These keys allow users to communicate, receive and manage their digital assets in a manner similar to that of passwords.
A user’s cryptocurrency remains locked and unusable on the blockchain without a wallet. Wallets offer a safe entry point or gateway, enabling users to safeguard their digital assets and participate in the decentralized economy.
The evolution of digital wallets
Cryptocurrency wallets have evolved over the years from Bitcoin Core to hardware wallets and the integration of crypto wallets with decentralized finance (DeFi) and non-fungible tokens (NFTs).
Bitcoin Core
The first cryptocurrency wallet, Bitcoin Core (also known as Bitcoin-Qt), was released shortly after the first Bitcoin (BTC) was mined in early January 2009 as a place to store, manage and transact with novel cryptocurrency.
The wallet arrived out of necessity. After all, a fundamental aspect of Bitcoin mining is the block reward, which is recorded in the coinbase transaction (the first transaction within the new block) and should be directed to the miner’s BTC wallet address.
The above image shows the address of the first-ever Bitcoin Core wallet, which received funds for mining the Bitcoin Genesis Block and likely belonged to Satoshi Nakamoto himself.
Interestingly enough, due to a bug in the early version of Bitcoin, the first-ever cryptocurrency to be sent to a wallet (50 BTC, the mining reward in 2009) was rendered unspendable. Nevertheless, this marked the first-ever blockchain transaction requiring a valid crypto wallet address to be carried out.
Ever since, cryptocurrency wallets and the blockchain have been inseparable. After all, what’s money without pockets?
Bitcoin Core was unique because it didn’t resemble the mobile crypto wallets that are common today. It functions as both a non-custodial cryptocurrency wallet and a kind of validator software.
As a wallet, Bitcoin Core allows users to securely store their Bitcoin by generating and managing private keys. These randomly generated strings of characters serve as a cryptographic secret, giving the holder access to the cryptocurrency associated with it.
It also stores public keys derived from private keys using a one-way cryptographic function. The public key is then hashed to create the wallet address, the publicly visible identifier where others can send cryptocurrency. Aside from storing these keys, Bitcoin Core provides an interface for sending and receiving Bitcoin transactions.
In its capacity as validator software, Bitcoin Core operates as a full node, downloading and storing the entire Bitcoin blockchain to independently verify all transactions and blocks. It validates transactions against consensus rules, checks the validity of new blocks through proof-of-work (PoW) and propagates validated data to other nodes, thus supporting network decentralization.
This unified interface allowed users to manage their Bitcoin funds while simultaneously contributing to the network’s health and security.
Paper wallets and brain wallets
Early crypto wallets, such as Bitcoin Core, were exclusively non-custodial. This meant they gave users full control over their private keys. However, since there was no centralized storage point for these private keys, they needed to be stored by the user. During this era, terms such as “paper wallet” and “brain wallet” emerged.
These are not actual types of wallets like software or hardware wallets. Instead, they are techniques for securely storing the private keys that control access to your cryptocurrency.
A paper wallet is a physical method of storing cryptocurrency. It involves generating and then printing or transcribing private keys onto a piece of paper, which is then kept in a secure location, such as a safe.
Conversely, a brain wallet involves an individual memorizing their private key. Before standardized mnemonic phrases, some users created and memorized their own passphrases or passwords to generate and retrieve private keys using specific software tools. Of course, it’s unlikely that someone would go to the lengths of remembering a 256-bit integer representation of their private key.
On the one hand, paper and brain wallets seem like safe storage options. However, if you lost the piece of paper associated with your private key or simply forgot it, you could not recover your funds. This is what sparked the transition from paper wallets to digital wallets.
Web wallets and custodial services
Cryptocurrency wallets were initially designed to be non-custodial, as we’ve explored. However, custodial crypto wallets soon emerged, offering ease of use and account recovery to attract users familiar with traditional banking.
From its inception as a Bitcoin exchange in 2010, Mt. Gox offered integrated wallet services to its users. This means that when users created accounts on Mt. Gox, they were provided with Bitcoin wallet addresses to deposit and withdraw Bitcoin. These wallets were custodial, meaning Mt. Gox controlled the private keys on behalf of its users, and users interacted with their balances through the exchange’s interface.
Indeed, without the weight of carrying a full Bitcoin node, and with the added functionality of being integrated into an exchange, these kinds of crypto wallets were more accessible and user-friendly, playing a key part in the historical development of wallet recovery methods, too.
In March 2011, Mt. Gox was sold to Mark Karpeles, who took over its operations and transformed it into the largest Bitcoin exchange by trading volume. At its peak, Mt. Gox handled over 70% of all Bitcoin transactions worldwide.
Blockchain.info (now blockchain.com) was founded as a custodial wallet the same year. Today, the wallet exchange operates in over 140 countries and has millions of users worldwide.
Importantly, custodial services were not a panacea during this period, which led to various issues. In June 2011, Mt. Gox was hacked, and Bitcoin worth millions of dollars were stolen. In February 2014, the exchange suspended trading, closed its website and filed for bankruptcy protection after discovering that approximately 850,000 BTC (worth around $450 million at the time) were missing.
The loss was attributed to a combination of theft and technical vulnerabilities, reminiscent of early challenges in wallet security and solutions.
Desktop wallets and non-custodial improvements
Parallel to the custodial development of Bitcoin wallets and the meeting of key milestones in cryptocurrency wallet development, a part of the crypto community was moving in the opposite direction, and a demand arose for greater security of user funds. This is when the cold wallet saw its genesis.
Armory was released in 2011 to cater to this need. One of the first advanced Bitcoin multisignature wallets, known for its strong security features, it introduced cold storage, allowing users to store their private keys offline and requiring multiple signatures for transactions, respectively. The introduction and adoption of multisignature wallets was key for users who needed higher security for their Bitcoin holdings.
Electrum emerged as one of the first Bitcoin wallets that did not require users to download the entire Bitcoin blockchain. Instead, it relied on a network of servers to handle the blockchain for users. These innovations in cryptocurrency wallet technology meant that wallets could finally be “lightweight.”
Moreover, in 2013, Bitcoin Improvement Proposal-39 (BIP-39) set out a method for generating a mnemonic phrase from a private key, which is a group of easy-to-remember words. This phrase can be used to create a deterministic wallet, which means the same phrase will always generate the same private keys.
These developments drastically improved the user experience when interacting with non-custodial software wallets. Such mnemonic phrases are now commonplace throughout the industry.
Mobile wallets
The community dichotomy regarding the “perfect crypto wallet” continued throughout the 2010s, somewhat unified by ongoing advancements in wallet encryption over time.
However, a common theme with the rise of smartphone usage was the consensus on the need for a better mobile experience. Mycelium, which launched in 2013 for Android users, offered strong security features and supported cold crypto storage.
Similarly, Breadwallet, another non-custodial mobile wallet, was launched in 2015 for iOS users and later rebranded to BRD. It is known for its simplicity and intuitive user interface, making it accessible for beginners.
Sparking the evolution of wallet security features, the Mt. Gox fiasco led to many mobile wallets focusing on security from the start. For example, Mycelium supported the Tor network, which helped to anonymize the user’s internet traffic and enhance privacy.
It also used hierarchical deterministic (HD) wallets by default, making it harder to track transactions and link them to a single user. Equally, Breadwallet used client-side encryption and integrated with the device’s secure crypto storage systems.
Moving over to custodial mobile wallets, Binance made sure to implement multi-tier and multi-cluster system architecture from its inception. Aspects such as cold storage for the majority of user funds, and robust incident response mechanisms also came as standard.
Founded in 2017, it quickly became one of the largest exchanges in the world by offering a wide range of cryptocurrencies and advanced trading features. Binance was initially designed with a custodial wallet in tandem but acquired Trust Wallet (a non-custodial mobile wallet) in 2018 to cater to a broader audience.
Hardware wallets
The history of hardware wallets in cryptocurrency started early on in the development of Web3. Indeed, offline, cold wallets catered to a growing segment of the crypto community back in 2014 with the inception of Ledger.
The company offers products such as the Ledger Nano S Plus and Ledger Nano X, which utilize a secure element chip (similar to those used in passports and credit cards) to store private keys. This chip is designed to be tamper-resistant, providing a high level of security against physical attacks.
The integration of crypto wallets with DeFi and NFTs
The creation of the first Turing-complete blockchain, Ethereum, by Vitalik Buterin in 2015 provided the foundational technology for DeFi. Ethereum’s smart contract functionality enabled developers to build decentralized applications (DApps) on its blockchain for the first time.
Decentralized lending and borrowing platforms such as Aave, Compound and MakerDAO arrived shortly after, with decentralized exchanges (DEXs) like Uniswap, SushiSwap and Balancer emerging later in the decade. Insurance platforms also became possible during this period, offering coverage for smart contract failures, hacks and other risks associated with DeFi activities. This wave of new products created a demand for new types of wallets.
MetaMask was up to the challenge and provided a non-custodial, NFT-compatible wallet developed by Consensys in 2016. What made it unique is that it offered a browser extension that provided quick compatibility with a range of new DApps. MetaMask became essential for interacting with the DeFi ecosystem, facilitating activities such as lending, borrowing and trading directly from the browser.
NFT-targeted wallets such as Enjin Wallet, which launched in January 2018, began to emerge. These wallets feature advanced security measures and a user-friendly interface, as well as a built-in marketplace for trading NFTs, making them popular choices for managing digital collectibles and game assets.
Smart contract-focused wallets like Argent introduced features such as social recovery, daily transfer limits and integration with various DeFi protocols, eliminating the need for traditional seed phrases and providing a user-friendly experience.
Meanwhile, Gnosis Safe leveraged multisignature security, customizable policies for transaction approvals and DApp integration, ensuring robust protection and flexibility for users managing significant assets. Overall, the integration of crypto wallets with DeFi platforms and NFT support certainly significantly broadened the functionality and appeal of non-custodial wallets.
The future of crypto wallets
Biometric authentication
Moving on from the history of hot and cold wallets, future crypto wallets are likely to incorporate biometric authentication methods, such as fingerprint scanning, facial recognition and iris scanning.
In light of ever-present cybersecurity concerns, these methods may provide an additional layer of security by ensuring that only the authorized user can access the wallet.
Biometric authentication simplifies the user experience by eliminating the need to remember complex passwords or PINs, making it easier and faster for users to access their funds.
Quantum-resistant wallets
As quantum computing technology advances, it poses a potential threat to the cryptographic algorithms that underpin current crypto wallets. Quantum computers could potentially break these algorithms, compromising the security of digital assets.
The threat is being taken seriously, too. Projects like Bitcoin Post-Quantum and Iota are actively developing or planning to implement quantum-resistant solutions. Major blockchain platforms like Ethereum and Cardano are also researching and preparing to integrate quantum-resistant cryptography to protect against future quantum attacks.
Wallet developers will also need to implement transition plans to migrate existing wallets to quantum-resistant solutions, ensuring the continued security of users’ assets.
Further integration with traditional finance
The future will see the rise of hybrid wallets that integrate both crypto and traditional financial services. These wallets will allow users to manage their digital and fiat assets in one place, providing a seamless experience for all types of financial transactions.
Future wallets that integrate with traditional finance will also incorporate compliance features to meet legal requirements, making it easier for users to navigate regulatory landscapes.
For example, with the European Union’s Markets in Crypto-Assets Regulation coming into force, future wallets will be tasked with integrating robust Know Your Customer processes to verify user identities and ensure compliance with Anti-Money Laundering and Counter-Terrorist Financing regulations.
Written by Bradley Peak