In one of our earlier posts, we discussed different types of cryptocurrency wallets and how they differ from conventional wallets.
Now as the technology evolves and the Blockchain space grows, a new type of wallet known as the Hierarchical Deterministic Wallet or the HD wallet is gaining currency (unintended pun, or was it?).
Let’s have a look into how the HD wallets function and how are they better than traditional crypto wallets.
The Problem With Traditional Wallets
Traditional crypto wallets when created randomly generate a pair of public and private keys which enable them to sign outgoing transactions (private keys) and verify the sender of incoming transactions (public keys).
While this encrypted and privacy-friendly mechanism is a secure method of performing cryptocurrency transactions, these wallets are not suitable for managing enterprise-grade accounts that need more privacy and security features baked into the wallet
For example, take the case of a fundraising wallet (popularised by ICOs, STOs, and their many cousins). A project Founder has two options:
– Provide all users with the wallet address of a single master wallet
– Manually generate new public and private keys for each user to ensure the privacy of the Master wallet.
(Note: A master wallet, in crypto-parlance is the actual recipient of the funds accruing from several sources.)
The first scenario of giving out the public key of the Master wallet runs the risk of exposing it to brute-force hacking attempts.
On the other hand, generating multiple wallet addresses manually is a tedious process and adds to the cost of transferring funds from recipient wallets to the master wallets. Moreover, the private keys of these wallets must be backed up and mapped against their public keys in a private database, preferably off the grid.
A practical solution to this problem is the use of a deterministic algorithm that generates multiple wallet addresses, with distinct key-pairs. Only the owner of the Master wallet can create and track the recipient wallets created by it. These wallets are isolated, where, the knowledge of the keys to one wallet cannot be used to gain access to another recipient wallet, or to the master wallet itself.
That, is what HD wallets are.
How Does an HD Wallet Work?
Hierarchical Deterministic wallets are a secure and efficient way of storing and transacting in cryptocurrencies, where, using a single seed key, you can generate an unlimited number of wallet addresses.
A seed key, also known as the private key, is a 12 digit master key generally appended in the end by the counter and can be used to generate almost any number of addresses in a hierarchical form.
All you need to backup is the 12 digital key based on the Basic Improvement Proposal 32 and can then easily recover all the funds associated with the given master key.
Put simply, an HD wallet has one master key which can have ten different nodes with each node having ten different accounts storing ten different cryptocurrencies.
All the wallet addresses and the corresponding funds can then be accessed by applying the SHA 256 algorithm on the seed key, which would generate the tree of keys given the seed key is entered correctly.
It is important to note that the seed key isn’t the private key used to sign transactions. It is merely a key used to generate a tree.
Click here to understand the technical working of an HD wallet.
What are the Advantages of HD Wallets?
Easy to Use – You only to need to backup the seed key and can retrieve all addresses easily.
Improved security – Users would not have the location of where the funds are being stored.
Multi-currency support – allows users to store all their crypto holdings in one place.
Popular HD Wallets
Ever since the inception of HD wallets, a number of wallets have been released. Some of the popular HD wallets in the market include:
1. Ledger Nano S
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