In this series, we are covering the different solution platforms built for Bitcoin. In this post, we look at wallets.
Note: The post assumes that you are familiar with the concept of Bitcoin network, bitcoin transactions and the purpose of wallets. If you are just starting here, I recommend going over the earlier posts on Introduction to Bitcoin, Bitcoins payments ecosystem and Bitcoin platform ecosystem which precede this article.
Bitcoin wallets are more than a data file of users private keys. Wallets are the user interface to spend and receive bitcoins. Bitcoin transactions take place when users send payments using their wallets.
Bitcoin Core, the original wallet
The original Bitcoin release included Bitcoin-Qt a thick desktop client wallet interface and it was the first wallet available. This wallet runs on a full node that and relays transactions directly on the Bitcoin network. It offers high levels of security, privacy, and stability. However, it has fewer features. For example, only one wallet allowed per node, it takes a lot of space and memory, and is slow to download. Bitcoin wallet allows setting up Tor as a proxy providing anonymity over the network.
A mobile version of Bitcoin wallet is also available for Android and Blackberry devices. This wallet uses special payment verification or SPV which means it downloads and verifies against block headers. It does not support Tor as a proxy.
What Bitcoin Wallets Offer
A number of third party wallets solutions are available in the market providing new features such as mobile and web applications, enhanced security and cold storage, among others.
Multiple Platform Support
Bitcoin wallets today are available on a wide variety of platforms such as mobile, desktop, web and hardware wallets. Wallet providers usually offer cross-platform solutions.
Wallets are available as standalone solutions or hosted applications.
Standalone wallets such as desktop thick client wallets and mobile apps with storage give users full control of their wallets, however users are responsible for securing wallets from malware and taking backups. Hosted wallets are web applications, desktop apps or mobile applications where the wallet interface is a thin client while the data is hosted elsewhere. The wallet provider offers backup and security features. Hosted and shared control wallets offer lesser control as users are required to trust providers (these wallet can solutions require both provider and user to sign transactions and/or may make use of a centralized service/specific servers to verify transactions).
Hardware wallets are similar to hardware password token devices and provide a secure offline environment for private key generation and storage. A hardware wallet works with a wallet software during transactions, providing features such as private key generation, signing and transaction confirmation from user and storage. Hardware wallets are secure from virus and malware attacks to which desktop wallets are vulnerable.
Security
Bitcoin wallets usually offer additional security such as encryption, multi-signature transactions and spending limit rules to protect user data in insecure environments (such as an open wi-fi, theft or hacking). Multi-signature wallets require a transaction to be authorized by more than one party such as multiple designated users or in some cases, a trusted intermediary or the hosted wallet provider. This prevents unauthorized transactions if wallets are lost or stolen. Two factor authentication requires verification from more than one device to authorize a transaction. Web wallet transactions are usually secured over SSL encryption as well.
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| Multisig Example. Multi-signature set-up for a Coinkite wallet as illustrated on their website. The full range of multi-signature capabilities includes up to 15 signatories as described on their FAQ page. |
Some wallets allow user to specify rules such as spending limits on transactions. It is a good practice to backup wallets complete, using encrypted backups, and encrypting devices that wallets reside on, in addition to strong password protection.
Storage
Hot and cold wallet features allow users to secure bitcoins similar to the way cash wallets work - only limited, small sums are available for transaction at a point in time, while the balance is stored elsewhere (or offline). Wallet balances are secured by features such as vaults and offline cold storage, thus user private keys are secured from online hacking and used only when spending bitcoins. Cold storage or vaults offered by providers are are wallet backups saved in a secure environment such as a bank safety deposit box. Some wallets offer offline transaction signing where the transaction is signed in an offline device and relayed via an online wallet.
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| Hardbit, a bitcoin hardware cum offline cold storage wallet |
Transaction Speed
Wallet providers such as Coinbase create user accounts and allow instantaneous transfer between account holders through off the chain transactions. This means that transactions are maintained within the wallet provider's accounting and will be reflected on the blockchain as either a) a) a different transaction aggregated from multiple users and flowing through a provider wallet or b) updated in blockchain when the receiver spends bitcoins. Off-chain transactions are increasingly used to keep transactions fast and handle micro-payments. This is an example of diluting the peer to peer transactions and public ledger advantages of blockchain.
In addition to these common capabilities, there are wallet variations that offer enhanced privacy (or rather anonymity), through mixing services. These are more related to transaction anonymity and can expose users to money laundering, so care should be taken when using these services.
In the next post, we compare some of the popular Bitcoin wallets.
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