Bitcoin wallets are software programs that you use to store Bitcoin. Exchanges allow you to turn “real money” like US dollars into Bitcoin. Additionally, exchanges provide a wallet-but that wallet is not always fully under your control.
Bitcoin is not something we recommend you invest in. It’s important to know this stuff if you plan to invest in Bitcoin, or even if you’re just interested in how it works.
We discussed before that a Bitcoin wallet is a software program where you store Bitcoins. This is true, but it is oversimplified. Coins are never really kept anywhere. A Bitcoin wallet can only be understood if you first understand what Bitcoin is and how it works.
A Bitcoin wallet actually contains one or more private keys that can be used to sign transactions. Private keys are the mathematical proof that you own a specific amount of bitcoins. Consider these private keys as secret codes that can be used to spend your bitcoin. Blockchains are public records of all bitcoin transactions.
It is very important to have these private keys. Your Bitcoin could be spent if someone steals your private keys — such as if they have malware running on your computer. Your private keys could be used to send Bitcoin to their own Bitcoin address, for example. In that case, your Bitcoin would be stored in their wallet and secured by their private keys, to which you would not have access. Therefore, it’s very important to store your Bitcoin wallet securely and its private keys.
A bitcoin exchange is a website or service that lets you exchange fiat currencies, such as US dollars and Euros, for bitcoins. Furthermore, these websites allow you to convert Bitcoin back to US dollars or your fiat currency of choice. A bitcoin exchange buys and sells bitcoins according to the current market rate.
When exchanges did not exist and people wanted to buy bitcoins using dollars, they had to find someone who had Bitcoins, agree on an exchange rate, pay them, and then have them send those bitcoins to their wallets. To sell Bitcoin, you would have to find someone who would buy it from you. Exchanges simplify this process by providing a single place where you can buy or sell Bitcoin with your bank account at the market rate.
Private keys for the wallet are controlled by the exchange
It’s important to realize that when you store your bitcoin in a wallet controlled by an exchange. That exchange holds your private keys. To put it another way, it’s like the exchange storing your Bitcoins within their own wallet and giving you access through your account. Bitcoin is not held in your own wallet, which you would otherwise control, as you would with a traditional Bitcoin wallet.
If you store your Bitcoin with the exchange, you’re putting your trust in that organization. For example, you may lose your Bitcoin if the exchange was hacked, an employee stole your private keys, or if the exchange’s owners took the money and fled. So always be sure to go with a secured exchange for crypto trading.