What is a Cryptocurrency Wallet and How Does It Work

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What is a Cryptocurrency Wallet?

A cryptocurrency wallet is a name given to a software program that stores a random pair of cryptographic keys. The keys, also known as private and public keys, are used to send and receive cryptocurrencies from one person to another. If you want to make a transaction using Bitcoin or any other altcoin, you need to own a digital wallet.

Actually, the name wallet is a little bit misleading because the coins are not stored in a physical wallet, as cryptocurrencies do not exist in a physical form. All that exists are records of transactions stored on the blockchain. Different from traditional pocket wallets, the digital wallet communicates with the blockchain of the specific cryptocurrency. This allows you to monitor your balance, send money or conduct other operations.

How Does It Work?

To make sure you have a full understanding, let’s have a look at the following example where I explain the role of the wallet address, as well as the private and public keys. I used real-life scenarios so you could easily understand.

What is a Wallet Address?

First, I will start with the wallet address because it is a simple and easy concept to explain. For you to understand what a wallet address is, imagine a sequence of letters and/or numbers that is used to uniquely identify the wallet. Yes, you could compare it with a bank account number.

Just like in the real world, if a person wants to transfer you some altcoins, all they need is your wallet address. As we all know, there is no harm in sharing this particular information with somebody else. Actually, the number is needed if someone has to transfer any funds to you.

There is no limit to the number of wallet addresses you can create and also the wallet address is unique as I mentioned at the beginning. So, no need to worry that someone else might receive your funds. Only if the sender mistyped the wallet address. Ups.

How Do Private and Public Keys Relate to a Wallet Address?

Essentially, each digital wallet contains a unique collection of key pairs, each consisting of a private key and a public key.

Cryptographic Hash Function
Cryptographic Hash Function

To give a real case example, think about the process of transferring money to a friend’s bank account. In order to initiate the transaction, first, you will have to enter a password or a pin code. Nobody else knows the private word or number, not even the bank, otherwise, whoever knows it could transfer the money from your account. A private key does the exact same thing. It gives you access to the wallet to spend, withdraw, or transfer your cryptocurrency.

An important thing to remember is to store the private key in a secure location. If you lose it, you will not be able to authenticate that you are the owner of the wallet. There are many famous but sad stories where individuals forgot their private keys. For example, James Howells began mining Bitcoin on a personal computer in 2009. By 2013, he had mined 7,500 Bitcoin which is worth $389,586,000 million today. Unfortunately, he threw away the hard drive on which he stored the private keys of the Bitcoins.

What about the public key? The public key is used to receive tokens and it is created from the private key through a complicated mathematical algorithm called the HASH function. The algorithm encrypts the private key and returns a fixed-size string of bytes. It adds an extra layer of security and ensures that your wallet cannot be hacked.

Where is the Cryptocurrency Stored?

Because cryptocurrencies are not physical money, they are digitally stored on the blockchain. The blockchain is essentially a digital ledger that stores every single transaction that has ever occurred in the system.

The software within the digital wallet is connected directly to the blockchain. That means you can submit transactions to the ledger. To better understand this relationship, think about going to the supermarket and paying for groceries with a credit card. You enter the pin code to verify that you own the funds that need to be transferred, but there is no physical exchange of money between you and the store. And this is the same as a cryptocurrency wallet.

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6 replies on “What is a Cryptocurrency Wallet and How Does It Work”

OMG, u’ve just ans what I wanna know exactly.
BUT one more question, How can I use my offline generated private key to send btc to someone?

Excellent explanation. Thank you for your efforts. I have a question. Given that the wallet algorithm generate keys “randomly”, and the algorithm do not check exisiting wallet keys, how they ensure that same keys are not used more than once?

Wow, I understand crypto currency now, thanks! This is probably the simplest explanation of the concept I’ve ever seen.

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