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Overview of Wallets

In the context of blockchains, a wallet is a tool (hardware or software) that allows you to interact with a blockchain using public and private keys.
illustration of wallet with bitcoin icon in front of phone and icons of lock and credit card
© RMIT 2022

There are just a few things we need to do to prepare to mint an NFT. Before you can mint (or buy and sell) NFTs, you will need a wallet. In the context of blockchains, a wallet is a tool (hardware or software) that allows you to interact with a blockchain using public and private keys.

How does a wallet work?

Unlike a traditional physical wallet that actually holds currency (notes and coins), a blockchain wallet does not hold tokens. Rather, you use it to perform transactions with tokens on a blockchain. Transactions could involve not only buying goods or services but also buying, selling or even swapping tokens (including NFTs) on an exchange, borrowing or lending tokens, and so on. This article will refer to a blockchain wallet simply as a ‘wallet’.

To begin to understand the nature of a blockchain wallet and how one works, a helpful analogy is how a bank account works. Suppose we look at bank accounts before electronic banking became the norm (though the analogy can be carried over to electronic banking as well). A bank account is identified by a number – and so the address generated by a public key in a blockchain is similar to a bank account number in that it can be shared with others to receive funds. Balances of funds in a bank account are recorded in a ledger which is maintained by the bank. In a similar way, a blockchain serves as a ledger to record transactions and maintain balances of tokens associated with addresses.

graphic demonstrating the likenesses between a traditional bank account and a crypto wallet explained in the text

However a bank account can incorporate other functions as well. The bank can store a record of an individual’s signature, which can then be used in cheques to authorise transfers of funds to others. The bank can issue a ‘passbook’ to the account holder to provide a record of the balance of funds in an account. A wallet performs all the functions of a cheque and a passbook. It stores the public and private key associated with an account on the blockchain. This allows the private key to be used to authorise transactions, like a signature on a cheque, or a password on an e-banking account. It provides a record of the balance of tokens in an address, like a bank statement.

Unlike most bank accounts, a wallet is capable of maintaining balances of multiple tokens at the same time. So, a single wallet can be used to transact in ETH, UNI, DAI and so on, all of which meet standards for compatibility with the Ethereum blockchain. This is a very useful feature for holding and trading tokens of all sorts, from cryptocurrencies to NFTS to governance tokens on a DAO. In other words, a wallet is the primary way of interacting with a blockchain for a number of different applications, including buying, holding and selling NFTs.

Hot and cold wallets

There are primarily two types of wallets: hot wallets that are connected to the internet and cold wallets that are not.

By virtue of being connected to the internet, hot wallets are convenient for performing transactions. However, as hot wallets are exposed to the internet, they can be more prone to attacks and security can be an issue. Hot wallets may be stored online on a server or downloaded as an extension to a web browser (like Chrome) on a desktop or mobile device.

A cold wallet is not linked to the internet and can be used to store private and public keys. Cold wallets often take the familiar physical form of a USB key, or thumb drive as they are less formally known. Since cold wallets are kept offline except when they are needed, they need to be specifically reconnected to the internet to complete a transaction. While this means that they are less convenient, and even cumbersome for performing transactions, their physical separation from the internet, means that they are more secure. There are a number of alternative hardware and software solutions available for cold storage.

It is quite common for a user to own both hot and cold wallets. The former accesses tokens that are required for transactions, and the latter acts as a storage device for tokens that are not immediately required. As such, hot wallets may bear some resemblance to a traditional physical wallet where you carry currency to perform transactions, while a cold wallet is more like a safety deposit box or a vault. Ethereum (Layer 1 and Layer 2) is by far the most common platform for NFT applications and there exist a number of different wallets available for connecting to the Ethereum network. Examples include Metamask, Trust Wallet, MyEtherWallet, and so on. The most widely used wallet on the Ethereum chain is Metamask, which works as a browser extension. Having access to a wallet and gaining some familiarity with its usage is a prerequisite for entering the world of NFTs.

Gas fees and wallets

While we are talking about wallets and performing transactions on Ethereum, we should spend a moment to think about ‘gas fees’. ‘Gas’ refers to the price required to complete a transaction or execute a contract on an Ethereum blockchain. Gas is paid in ETH, the native currency of Ethereum, but is more commonly denominated in the smaller unit of Gwei. 1 ETH = 1bn Gwei. While the standard transaction fee is around 21000 Gwei, gas fees can vary wildly with the traffic and the volume of transactions on the Ethereum network. A bit like the (sometimes controversial) surge pricing on UBER, the more demand there is for transactions at a given moment, the higher the gas fees.

In the context of NFTS, minting, buying, selling and swapping on Ethereum all attract gas fees and they can become very expensive very quickly. In order to reduce the gas fee exposure, some NFT platforms operate on what is referred to “Layer 2” of Ethereum (eg Immutable X), in which transactions are often batched and the gas cost shared between many transactors. Other blockchain networks have developed, in competition to Ethereum, that use less costly validation protocols to reduce transaction costs to users (eg the ‘Flow’ blockchain from Dapper Labs).

Now it’s your turn

Hot, cold or both? Which type of wallet do you think will suit your needs better? Why? Share your thoughts (but not your private key) in the comments.

© RMIT 2022
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