What is a wallet and why do I need a private key?

If you are dealing with the crypto world, you will quickly come across terms such as private key, public key, and wallet. If you are new to the crypto scene, these expressions can be overwhelming at first. However, understanding these concepts is fundamental for using Web3 applications correctly.

That’s why  this article will deal with the mentioned terms and explain them.

What is a Private Key?

Basically, a private key is nothing more than a random number. In cryptography, the private key is used to both encrypt and decrypt data. A private key is always associated with a public key, which is mathematically derived from the private key. However, it is not possible to deduce the private key from the public key. The use of public and private keys is also known as asymmetric cryptography.

Use of a Private Key

But what is a private key needed for?

Private and public keys are the cornerstones of blockchain technology, enabling the creation of digital signatures that authorize access to the values stored within the blockchain. The person who possesses the corresponding private key to an encrypted transaction is allowed to "spend" it. That's why it's crucial to keep your private key secret. If it falls into the wrong hands, the associated values can be irretrievably lost or stolen.

The public key works differently. Although it is derived from the private key, it can be easily shared with others. The public key is used as the receiving address for transactions.

‍ The connection between Wallet and Private Key

Since this key pair can be difficult to manage in practice, wallets have been developed. Wallets can be understood as a form of digital bank account in the crypto world. They generate and manage the keys for their respective users, while also facilitating the viewing of account balances and statuses on the blockchain, as well as enabling the creation of transactions. Wallets are differentiated into non-custodial and custodial wallets. With a non-custodial wallet, the user has full access to their own keys. For custodial wallet, an entity, such as a crypto exchange (e.g. Kraken, Coinbase, or Binance), takes over the management of the keys. 

Well-known examples for a wallet include MetaMask or Unstoppable. Wallets are essential to use Web3 applications in practice.

Hot Wallet vs. Cold Wallet

Wallets can also be categorized into two categories: Hot Wallets and Cold Wallets. 

Cold Wallets: Fortresses of Security

Cold wallets, hardware or paper-based, prioritize security by operating offline. Ideal for long-term storage, they act as an impregnable vault against online threats.

Examples: Ledger Nano S, Trezor, Paper Wallets

Hot Wallets: Embracing Digital Convenience

Hot wallets, on the other hand, are online entities—software solutions catering to everyday transactions and active trading. While convenient, their constant connectivity exposes them to potential cyber threats.

Examples: Coinbase, Electrum, MyEtherWallet

Users of Tokenize.it also require a wallet, which functions as a storage location for the self-created tokens that represent the company shares of the startup. Our application automatically connects to the user’s wallet and allows for an easy-to-use platform for overview and management of their company tokens. Since we use tokens on the ERC-20 standard of the Ethereum blockchain, a wallet that can manage this type of token is necessary. We recommend to use a Cold Wallet to enhance security (eg. Ledger).