Ownership of your funds is a key major theme & value proposition of public blockchains & cryptocurrencies. Therefore, it is critical to grasp how is is enabled & what are the risks involved. Cryptography enables ownership in cryptocurrencies.
For every account on blockchains, be it external user accounts or Smart contracts, a private key(64 hexadecimal in length) is generated. Subsequently, from this private key, algorithmically public key is generated. The public key serves as basis for the public address which you can share with others for sending you funds. You can also avail a text based name for the public address using ENS(Ethereum Name service).
If you are currently using any centralised exchange(Coinbase, WazirX, Coinswitch, Binance etc.) for investment, you can view the public address yourself. For example, in WazirX, navigate to the funds section & click on any coin you own. Then click on “Deposit” button, it will display the address of the centralised exchange holding your asset.The private key , though , owned by the centralised exchange itself & hence technically could withdraw your funds. There have been various instances involving fraud with centralised crypto exchanges in the past. Therefore, it is advisable & prudent to hold you own funds. you can achieve full independence & ownership with “Crypto Wallets” . Below is a primer on the topic.
Why Wallets?
Similar to how when you open a new bank account , you are assigned a unique account number & provided means to access the account through chequebooks, Net Banking credentials, Debit cards etc., In order to interact with blockchains , you need to first create an account. However, the account in crypto is essentially a key pair of private & public keys.
Visually you can imagine an account creation activity as shown below :-
When you interact with other accounts for transfer , it is the public address that you reference against that particular account. Your secret phrase or private key is crucial for accessing your funds. If the keys are lost or stolen, you will lose your funds. In banking , if you lose your debit card, you can easily avail a new one . However, there is no recourse for lost private key in crypto. You can imagine such a criteria is why majority of investors are using centralised exchanges instead.
Wallets give you access to your funds on public blockchains ( e.g. Ethereum). Wallets can be imagined as a type of Banking website or app . However, unlike banks, wallets do not have access to your funds, they are simply a pointer to your account on the blockchain & allows you to read you balance & perform transactions. Major public blockchains such as Bitcoin & Ethereum have its own wallets. Since Ethereum provides the most evolved eco-system of applications, we will primarily use Ethereum wallets as our example here.
Wallets also permit you to interact with various other applications such as DeFi, NFTs etc.
Centralised Exchanges & your funds
If you are currently using a centralised exchange, note that the centralised entity is here interacting with the blockchain on your behalf. you as individual user only exist in the DB of the centralised exchange. You can imagine it as below image for simplicity.
Every time you buy & sell assets, often only the balance gets redistributed in the DB of the exchange & exchange as a cumulative have balance account on the blockchain itself. Here you can view the top accounts on Ethereum.
In the above screen, the major accounts such as Binance,Kraken,Gemini ,Huobi, FTX are all centralised exchanges. You can imagine that the cumulative balance is redistributed in the DBs of such exchanges.
Accessing funds, trading & managing assets with centralised exchanges has its own benefits of ease of use. However, you are essentially trusting the exchange for securing your funds- similar to banks. However, most exchanges are not legislated unlike banks. In case of exchange attack , exchange closure or outright frauds, consumer protection & legal recourse is limited . Therefore, the centralised crypto exchanges are porting the disadvantages of centralised entities without the added safety of consumer protection. There have been countless cases of hack of centralised exchanges - proving that exchanges have poor track record in ensuring secutiry. In addition, at peak hours , in case of traffic load due to price crash or emerging opportunities, exchanges are know to go down frequently. In 2014, a tokyo based centralised exchange was drained for bitcoins worth over 400m+ ( today worth over 14B+).
Therefore to experience true financial independence , direct ownership with funds is preferred with the help of wallets.
Key Terms - Revision
Before moving forward, we will summarise few key terms for clarity.
Blockchain Account:- A blockchain account is you interact with others on the blockchain. Similar to a gmail account, it will various properties ( email id
Public address:- A public address is an identifier that can b shared with others for transactions.
Private Key :- Private key is mandatorily required for you to initiate any transaction on the blockchain. These must be stored very securely.
Secret Phrase :- A secret phrase is a random set of words which is used for generating your private key. Hence, Secret phrase must also be secured privately.
Types of Wallets
Wallets can be categorised in 4 types :-
Hardware Wallets:- Such wallets are sort of USB devices - customised for storing your private keys.All the data is kept on the hardware device itself & it can connect to the internet when required.
Web Wallets :- These are website or extensions. All the data is stored on the device itself -instead on the centralised server of the Web wallet provider.
Desktop Wallets:- Similar to Web wallets, all the data i.e. private key is stored on your local device.
Mobile Apps:- Mobile apps with similar functionality as Web & Desktop wallets.
The other way to categorise wallets are :-
Hot Wallets:- Hot wallets are sort of software or desktop based wallets which is connected to internet. Such wallets are easier to set-up & useful for recurrent use.
Cold Wallets :- Cold wallets are not connected to the internet such as Hardware wallets. If you have significant amount of assets as investment & recurring use cases are limited ( e.g. trading), cold wallets are advisable. Even a paper or diary with your private keys & your secret phrase written can function as Cold wallet.
It is important to emphasise that Wallets are holding your funds. The funds reside on the blockchain & relies on its immutable property for security. The wallet is how to interact with account on the blockchain itself.
How to set-up & use a wallet?
There are numerous wallets available in the market & as per categorisation defined above, you can select the appropriate one. We will use Metamask - a popular software wallet for creating our account on Ethereum Blockchain.
Navigate to https://metamask.io/ & click on download button.
Let’s go ahead with Chrome for our example & click on “Install Metamask” for Chrome.
You will be asked to add to Chrome the extension as shown in below screen.
Once you click on “Add to Chrome” , the below screen will appear apprising you of capabilities of extension. Click on “Add Extension” Button.
At this stage , you will be redirected to a new window & you can start now creating your account.
You will be asked to either “Import an existing Wallet” or “Create a new one”. Since we are starting a newbie, let’s click on “Create a Wallet” Button.
You will displayed below screen wherein Metamask requests for certain anonymised data for their internal use to improve the Product. You can click on “No Thanks” & still continue.
You will asked to set-up password at this stage. Set-one strong & robust password.
In the next screen, you will be displayed a tutorial of sort on importance of securing you secret phrase.
After you click on next, your secret recovery phrase is revealed. Since , i am creating a dummy account for this example & will not be using it further, i have attached the screen below. Otherwise, you need to be extremely cautious on how & where you store you secret phrase. Metamask cannot recover your secret phrase if its lot. This sort of trade-off is essential for complete ownership.
On next screen, you are asked to confirm your secret phrase in exact same order as in previous screen.
Once you confirm it, your account is set-up as shown below.
Even though you could not see, metamask behind the scenes generated your private key, public key & address. The details are stored on device locally.
On the Home screen, you can see that my balance is 0. in order to mover further & explore the world of Dapps, you will require ether as fuel.
One interesting point to note is the dropdown on top right corner which by default displays “Ethereum Mainnet”. Mainnet is the Live version of the blockchain, the one actually holding your funds.
The other networks such as - Ropsten, Kovan, Rinkeby are like test environments. It is often used by developers for testing their smart contracts or applications throughly before deploying it on mainnet.
As end user, you can interact with limited few applications on test networks for safety & for gaining experience.
Since you require ether for continuing further, you can buy it using CC/DC from centralised exchanges. However, often such transactions are expensive & local currency may not be enabled.
Alternately , you can either request someone to send some ether to your account.
You can also buy ether from exchange yourself & use the “Withdrawal” functionality with deposit on metamask account.
In either cases , you will require to provide your address. Click on “View account” for the sharing the same.
As seen below, your public address, derived from your secret phrase, is populated below in “Text” & “QR” form.
Since ethereum is public blockcain, each account & transactions is visible to everyone. To view your account, navigate here
As & when you perform transactions, the transactions will be visible below. you can also view your balance.
if you are interested in working in crypto space, you public blockchain account itself can server as “Proof of Knowledge” regarding cryptocurrencies & enable opportunities.
In the next article, we will cover basic transactions-preferably on Test networks instead of mainnet & highlight the risks involved that we must guard against.