The Truth About Cryptocurrency “Wallets”

The term “wallet” is easy to remember. We all have a wallet, it carries our credit cards, debit cards, dollar bills, ect. When we hear the term “wallet” in cryptocurrency, we automatically assume it’s the same as our physical wallet, we think, “oh ok, this is the thing that holds our crypto, nfts, ect”. However, the reality is actually much different.

You see, your cryptocurrency wallet is actually just the combination of your seed phrase and private keys. There is no “digital wallet” (like a bank account for example) that holds your funds. In fact, an individual cannot actually store their own crypto. Now, before you freak out, let me explain.

When you create a 12-24 word seed phrase and send crypto to your “wallet”, your crypto is actually stored on the blockchain. What’s that? Well, in nerd talk, the blockchain is a “decentralized, immutable, digital ledger”. Decentralized meaning there is no central authority that governs it. Immutable, meaning it can’t be changed, transactions are final and permanent. Digital ledger, meaning transactions and financial accounts are recorded digitally. The blockchain is also public. So, everything that happens on the blockchain is decentralized, unchangeable, and public. Ok, but what does this have to do with “wallets”?

Well, the fact of the matter is, your crypto is not in a “wallet”. Your crypto is stored on the blockchain. If you wanted to access any of the crypto that is publicly stored on the blockchain, you would need the 12-24 word seed phrase that protects it.

So, your “crypto wallet” doesn’t actually exist. While your seed phrase allows you to access the crypto stored on the blockchain. Your private key can be thought of as your “digital signature” that allows you to approve spending or transferring your funds. One seed phrase can grant access to multiple private keys / public addresses.

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Crypto stored on the blockchain has no name attached to it, no home address, and no social security number. Whoever has the seed phrase, can move the crypto by signing transactions with the private key. This is an important concept to understand, not only from a security perspective but a legal one as well.

When it comes to security, a hacker does not need to physically come and steal your “wallet”. All he needs to do is find your seed phrase. This is why it’s important to store your seed phrase physically, rather than digitally. A digitally stored seed phrase could be more easily found by a hacker than one that is, for example, carved into metal and stored in a safe. Too often do people neglect their seed phrase security, and one day find their wallets drained with no idea how it happened.

From a legal standpoint, how is it that we can classify whether someone “owns” crypto? The crypto is on the blockchain, it’s not in any one person’s possession at any given time. If I have 12-24 words memorized in my head, is that considered ownership? What if I lose or forget my seed phrase. Do I still have to pay taxes on money I can no longer access? Do I have to pay taxes because I have words memorized in my head? These are interesting questions that should be asked, especially with lawmakers seemingly looking to crack down on cryptocurrency over the next few years (See Elizabeth Warren’s “Digital Asset Anti-Money Laundering Act”).

While the term “Wallet” was originally created to aid in the adoption of cryptocurrency among the masses. It has reached a point where the ignorance of what a crypto “wallet” actually is, can lead to confusion around proper security measures, or uneducated legislation attempting to treat cryptocurrency the same way we treat traditional finance.

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Ben DuBard

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