A Hardware Wallet - What Is It And How Does It Work?

Yesterday I wrote THIS post to compare Ledger and Trezor hardware wallets. In the comments I got a request to give a deeper explanation on this subject. Because I find hardware wallets extremely useful devices, I am happy to do so. I would advice everyone involved in crypto to invest in a hardware wallet, since it enables you to store your own keys in a secure and easy way. Storing your own keys is one of the key principles of Bitcoin!

Andreas Antonoupolus: Not your keys, not your Bitcoins!

What is a hardware wallet?

A hardware wallet is an external hardware device that enables you to create and store private keys. The device can be connected to an online device by USB and interact with the online environment without ever disclosing the private keys. This way your private keys will never be online (cold storage), while you are still be able to make transactions.

Why use a hardware wallet?

Cold storage is the most secure way to store cryptocurrencies, but it comes with two mayor problems. Firstly, to create your private keys really secure it should be done on an offline computer that has never been online and the software to generate random numbers (what a private key is) must not be infected. This is an extremely complicated and costly process if you want to do it the right way.

The 2nd problem is that you can’t spend your coins after you brought them in cold storage. You will have to bring your whole stack back in an online wallet first. Beside the effort it will cost, the coins you don't spend will be out of cold storage too, so can be stolen from that moment. Of course you can avoid this by creating many small cold storage wallets and take out only as much as you need, but this is still complicated and not really practical if you transact a lot.

A hardware wallet solves both of these problems. A random number generator is standard build in the device, so you can create private keys internal without the need to go through a complicated proces or making extra expenses. You can also make an unlimited amount of transactions without the need to switch between cold storage and hot storage. This means that a hardware wallet combines the advantages of deep cold storage and hot wallets in a user-friendly and easy way!

How does a hardware wallet work?

A hardware wallet is a device that creates and stores private keys. People often think that your coins will be stored on the device, but that is technically wrong. The coins are stored in a certain address in the blockchain, and the private key that is stored on the hardware wallet enables you to move them.

When you connect the device with a computer and open the web wallet you can interact by signing with the private key on your hardware wallet without exposing it to the online world. You simply browse through the web wallet interface and use your hardware wallet to confirm critical actions like logins, transactions or disclosure of private information.

Backup seed and pin

When you setup a hardware wallet, you will create a backup seed and a pin as well. Beware that you have to create both of them yourself, if this is done already it is probably an attempt to steal your keys by the reseller (ordering directly from the manufacturer is safer!). The pin and backup seeds have a different function:

The backup seed of a hardware wallet

The backup seed is an encryption of the private key that results in 24 english words. These words have to be written on the special card that is delivered together with the hardware wallet. When your device get stolen, lost or broken, you can order a new device and insert these words and your wallet will be back.

This means that you can acces your funds without the pin, so someone else who get his hands on your backup seeds too! Store your seeds extremely carefully, when you lose it you can’t acces your funds when something happens to your device, and when someone steels it he can take all your funds.

When you create a hidden wallet you actually add a 25th word to the existing combination and a brand new private key will appear. If someone steels your backup seeds but doesn't know your extra word (passphrase), he will not be able to steel your funds in your wallet. When theft of your seeds is possible, use of hidden wallets is advisable!

The pin of a hardware wallet

When you setup your device you will also create a pin. This pin is only applicable to the device you currently use, if you buy another device you need the seed to acces your existing wallet, the pin won't work.

The pin protect your funds in case your device get stolen and the attacker tries to open your wallet. The attacker can try to guess the pin only a few times, the Trezor will increase the waiting time between new attempts exponentially and the Ledger will block the device and require the backup seed to reset.

Additional functions
Because a hardware wallet enables you to sign with an unique key, also other possible applications popped up. You can use hardware wallets to protect accounts like Dropbox, Gmail ect. and use the password manager to create and store secure passwords. Because Bitcoin created online value the need for online security increased. I foresee that this technology will eventually be used to protect every online account around the world.

If you want to buy a hardware wallet, I advice you to order directly from the manufacturer. ORDER A LEDGER here or ORDER A TREZOR here.

Disclaimer
This is no financial advice, just my view on the market.

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