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Bitcoin Wallets

Overview

A Bitcoin wallet is a software application or device that allows users to store, send, and receive Bitcoin. Despite the name, a wallet doesn't actually "store" Bitcoin. Bitcoin exists only on the blockchain. Instead, a wallet stores the private keys needed to access and control Bitcoin addresses.

Key Concepts

  • Private Key: Secret cryptographic key that proves ownership of Bitcoin
  • Public Key: Derived from private key, used to generate addresses
  • Address: Public identifier where Bitcoin can be received (like an account number)
  • UTXO: Unspent Transaction Output, the actual "coins" on the blockchain
  • Seed Phrase: Human-readable backup of private keys (12-24 words)

Types of Wallets

By Storage Location

Hot Wallets

  • Online: Connected to the internet
  • Examples: Mobile apps, web wallets, exchange wallets
  • Pros: Easy to use, quick access
  • Cons: More vulnerable to hacking

Cold Wallets

  • Offline: Not connected to the internet
  • Examples: Hardware wallets, paper wallets
  • Pros: More secure, less vulnerable to attacks
  • Cons: Less convenient for frequent transactions

By Control

Custodial Wallets

  • Third-party control: Exchange or service holds your keys
  • Examples: Coinbase, Binance wallets
  • Pros: Easy recovery, user-friendly
  • Cons: You don't control your keys ("not your keys, not your coins")

Non-Custodial Wallets

  • Self-custody: You control your private keys
  • Examples: Electrum, Bitcoin Core, hardware wallets
  • Pros: Full control, more secure
  • Cons: You're responsible for key management

By Technology

Full Node Wallets

  • Bitcoin Core: Downloads entire blockchain
  • Pros: Maximum privacy, validates all transactions
  • Cons: Requires significant storage and bandwidth

SPV (Simplified Payment Verification) Wallets

  • Light clients: Don't download full blockchain
  • Pros: Faster setup, less storage
  • Cons: Less privacy, relies on other nodes

Hardware Wallets

  • Physical devices: Ledger, Trezor, Coldcard
  • Pros: Excellent security, keys never leave device
  • Cons: Cost, requires physical device

How Wallets Work

Key Generation

  1. Random Generation: Private key is randomly generated (256 bits)
  2. Public Key Derivation: Public key derived using elliptic curve cryptography
  3. Address Creation: Address generated from public key using hash functions
  4. Address Types: P2PKH, P2SH, P2WPKH, P2TR (Taproot)

Transaction Process

  1. UTXO Selection: Wallet chooses which UTXOs to spend (coin selection)
  2. Transaction Creation: Builds transaction with inputs and outputs
  3. Signing: Signs transaction with private key(s)
  4. Broadcasting: Sends transaction to Bitcoin network
  5. Confirmation: Transaction included in a block

Address Management

  • HD Wallets: Hierarchical Deterministic wallets generate addresses from a single seed
  • Key Derivation: Uses BIP32/BIP44 standards with derivation paths
  • Address Reuse: Generally discouraged for privacy
  • Change Addresses: New addresses created for change outputs

Creating a Wallet

Software Wallet (Bitcoin Core)

# Install Bitcoin Core
# Download from bitcoin.org

# Start Bitcoin Core (will create wallet.dat)
bitcoind -daemon

# Create new wallet
bitcoin-cli createwallet "mywallet"

# Get new address
bitcoin-cli getnewaddress

# Get wallet info
bitcoin-cli getwalletinfo

Software Wallet (Electrum)

  1. Download: Get Electrum from electrum.org
  2. Install: Run installer for your platform
  3. Create Wallet:
    • Choose "Standard wallet"
    • Select "Create a new seed"
    • Save seed phrase securely
  4. Set Password: Choose encryption password
  5. Ready: Wallet is created and ready to use

Hardware Wallet

  1. Purchase: Buy hardware wallet (Ledger, Trezor, etc.)
  2. Initialize: Follow device instructions
  3. Generate Seed: Device generates 24-word seed phrase
  4. Backup Seed: Write down seed phrase (never digital!)
  5. Set PIN: Create PIN for device access
  6. Install Software: Install companion app (Ledger Live, etc.)
  7. Connect: Connect device and create Bitcoin account

Programmatic Wallet Creation

Wallet Security Best Practices

Private Key Management

  • Never share: Never share your private keys or seed phrase
  • Secure storage: Store seed phrases offline, physically secure
  • Multiple backups: Create multiple backups in different locations
  • No digital storage: Never store seed phrases on computers or cloud

Security Measures

  • Use hardware wallets: For significant amounts
  • Enable 2FA: Where possible (for custodial wallets)
  • Verify addresses: Always verify receiving addresses
  • Test transactions: Send small amounts first
  • Keep software updated: Update wallet software regularly

Backup Strategies

  • Seed phrase backup: Write down seed phrase, store securely
  • Multiple locations: Keep backups in different physical locations
  • Test recovery: Verify you can recover wallet from seed phrase
  • Encryption: Encrypt backups if storing digitally (but prefer physical)

Wallet Features

Basic Features

  • Send Bitcoin: Create and broadcast transactions
  • Receive Bitcoin: Generate addresses for receiving
  • View Balance: Check UTXO balance
  • Transaction History: View past transactions

Advanced Features

  • Multisig: Require multiple signatures
  • Coin Control: Manually select which UTXOs to spend
  • Fee Estimation: Calculate appropriate fee rates
  • RBF: Replace unconfirmed transactions
  • PSBT: Partially Signed Bitcoin Transactions