By this age, you must have read or heard about Cryptocurrency wallets but do you really know what they mean? A wallet is a place where you can send & receive your coins & keys. Wallets are the platforms where users interact with the system to create their own bank for trading coins. However, there is a small problem in the way traditional cryptocurrency wallets work.
A cryptocurrency wallet works with a pair of private & public addresses. The wallet’s public address can be given out to other traders for receiving funds from them into the wallet, whereas the private key can be used for spending the coins stored in the wallet. Every time a transaction is needed to be executed, the key would need to be produced to ensure the tokens’ safety.
So, where is the problem? The need for repeatedly producing the keys comes at the expense of bearing additional overhead. Not only this, but the trader has to take a backup each & every time a new pair of addresses are created. This causes a lot of pain to a trader and makes the seamless trading process a complex and expensive job.
Initially, a trader might feel comfortable with it, but as time passes and the number of transactions & backup increases, it becomes a lot more complicated to handle the situation. Some of the E-Wallets use the same keys for all future transactions to avoid losing a backup, which is not at all a healthy practice as it may put financial privacy at risk. That’s the reason why HD Wallet was created. It takes away the pain of the traders to constantly generate the keys.
Understanding Hierarchical Deterministic Wallet
Now, you must be wondering, what exactly does ‘Hierarchical Deterministic Wallet’ (HD Wallet) really mean? No worries, we’ll explain it to you.
The concept of HD wallets was introduced in the cryptocurrency ecosystem in BIP 32 (Bitcoin Improvement Proposal 32), and it was further improved in BIP 44. The Bitcoin community brought the HD wallets into this world, but the wallet structure has extended the support for many coins.
HD Wallets are a modern version of the Cryptocurrency Wallets that generates a hierarchical structure of public & private addresses for its users. Technically speaking, it solved the problem of traditional wallets by attaining all the addresses from a single master seed (backup storage). All HD Wallets use a key of 12-word seed, and every time, this seed is magnified by a counter value, which makes it possible for the wallet to derive an uncountable number of new addresses.
If you don’t know what seed is, then allow us to explain. The wallets are able to create the backup because of seed. Each wallet has its own seed, and a seed usually contains 12 random strings of words. The seed is crucial because it helps to recover the funds stored in the wallet, hence, it must be stored with great care. The best way to secure them is multiple paper copies offline. Each seed has a well-defined standard for the secure storage of their private keys. BIP 32 and BIP 44 are examples of seed standards.
Another cool thing about HD Wallet is its hierarchical part. It means that each child key in the wallet can create its own keys giving the structure a look of hierarchy.
For a better understanding, the visualization of an HD wallet structure can be observed below:
Derivation paths signify the tree structure of the HD wallet to the first address nodes. In the case of Ethereum, the default is m/44’/60’/0’/0. Each digit in this path signifies a particular level in the tree shared above.
Let’s decode the path m/44’/60’/0’/0 –
- 44 – BIP 44 Purpose
- 60 – Ethereum’s coin type
- 0 – Account 0
- 0 – Chain 0
You can look at the Satoshilabs repository on GitHub to check the standard list of coin type codes. Satoshilabs is the company behind Trezor Hardware Wallet.
Earlier in this article, we referenced BIP 32 and BIP 44. Let’s decode what these two terms mean.
BIP 32 was the first seed standard that illustrates the general structure of the HD wallet and explains how to source private as well as public keys of the wallet from two things, i.e., binary master and set of indices:
m / index1 / index2 / … / indexn
BIP 44 illustrates the application of HD wallet based on BIP 43 and BIP 32 standards. It explains the structure of multi-coin wallet for P2PKH addresses as well as wallet discovery algorithms:
m / 44′ / coin_type’ / account’ / change / address
How HD Wallet Works
Now you must be wondering how HD Wallet performs such complicated calculations. Allow us to explain it to you.
Hierarchical key pairs start in HD wallet via the creation of the seed having 12 to 18-word sentences. From such seed, the master public key as well as private key pairs, are generated. The master key keeps on developing more key pairs, and such key pairs further create more keypairs. All such addresses are sourced from seed praise. Such a hierarchy can be understood with the help of the following diagram:
It should be remembered that the only purpose of the master key is wallet tree generation. HD Wallets use SHA-256 Hash Algorithm to produce such a complicated structure without making any error. By this, you’ll no longer be creating any new addresses, nor will you need to wait for the security keys to be generated. You’ll only need to take care of the backup being provided to you. Even then, if you lose the backup due to any reason, the user can fully restore the data due to its ability to direct all the hierarchy keys using BIP 32. This transfer protocol will enable the parent keys to create the missing child keys in the hierarchy.
You can also create a new wallet using the same parent key. For example, it can prove to be very beneficial for the users if they want to recover their wallets due to a corrupt drive. In this case, an HD Wallet will allow you to get all the addresses & keys back using the same parent key.
Advantages and Disadvantages of Using HD Wallets
As usual, you also have the question of why ledger or other crypto wallet providers use HD wallets? Well, there are several reasons for crypto traders to use HD wallets because of the plethora of advantages it brings. At the same time, there are some downsides to using this upgraded cryptocurrency wallet mechanism. Let’s have a look at the pros and cons.
- There is no need to backup all the generated keys.
- The privacy is strongly secured through a hierarchical structure mechanism.
- Multiple unique coins can be stored within the same HD wallet.
- Unlimited public addresses can be produced to restrict the re-use of addresses
- The addresses stay safe even after the trader has lost the backup of the private key.
- It might become difficult to backup the key pairs of the lost or stolen wallet if hard-to-memorize seed praises have been selected.
- The child keys can be securely handed out without risking the parent key. The master public keys can also be handed out without risking the master private key. However, both these actions cannot be done at the same time.
Top Wallet Providers Using HD Wallets
All the leading hardware wallet providers are using HD wallets mechanism to serve their users with the best experience. Let’s have a look at these wallet providers.
Ledger Nano X
Ledger Nano X is a popular hardware wallet provider that uses the HD wallet mechanism. This wallet is rich with features like-
- Robust security
- Support for more than 1100 cryptocurrencies
- Compatibility with 50+ wallets
- Comfortable design
Trezor is an extensively used hardware wallet trusted by millions of crypto traders all across the globe. Some top features of Trezor include:
- Enables two-factor authentication (2FA)
- The wallet is 100% cold storage
- Each crypto transaction is signed uniquely.
- Accessible via desktop and mobile
- Relatively low-cost hardware wallet
KeepKey is a premium hardware wallet and one of the safest options available in the market for storing your digital assets. Some of the great features of KeepKey are as follows:
- Supports a wide range of cryptocurrencies
- Compatible with multiple operating systems like Windows, Linux, and Mac
- Attractive and appealing design
Electrum is one of the oldest Bitcoin and desktop wallets available in the market, responsible for taking care of almost 10% of all Bitcoin transactions. Some other features worth the notice are:
- Hardware wallet integration
- Well-established and popular
- Simple to use
- Cold Storage
- Excellent customer support
Hierarchical Deterministic Wallet has emerged as a trusted and reliable option amid crypto traders. This concept has helped the traders to streamline and expand their trading options without any extra overheads or need for creating the backup. More and more HD wallet providers are emerging in the market to fill the gap that was left by traditional cryptocurrency wallets.