Thread by @_benkaufman

1/ When using #Bitcoin, there are generally 3 components involved:

- Private keys

- Signing device

- Wallet software

The differences between these can be confusing, but knowing them is important in order to understand the best practices in self-custody (🧵thread).

2/ Your private keys, often represented as a list of 24 words, are the secret information you need to prove that you know in order to sign transactions.

Anyone holding your private keys can spend your coins, which is why you must handle them as securely as possible.

3/ The private keys are used to derive #Bitcoin addresses, which the user can receive funds to.

Then, they're used again to produce a digital signatures for these derived addresses, when the user wants to spend the coins received.

4/ The signature provides a proof that the person spending from the address is also the one who generated it in the first place, since only the private key (assumed to be kept secret by the user) can produce both.

In short, the private keys are secret data to prove ownership.

5/ Since producing a digital signature from the private keys cannot be done by hand, a second component is needed in order to make a #Bitcoin transaction - an electronic signing device which can take the transaction details and the private keys, and produce a signed transaction.

6/ The signing device can often be a regular computer or phone, but another popular option is having a dedicated hardware device (often called a hardware wallet) used specifically for the purpose of signing #Bitcoin transactions.

7/ The main reason such devices are common is that they let you to avoid entering the private keys on a computer connected to the internet, and instead keep them on a dedicated offline device. This significantly reduce the risk of getting the private keys exposed.

8/ It’s important to note the difference between the private keys and the signing device.

While the signing device is often used to also store (and generate) the private keys, these are two different components.

9/ The private keys can be used on any signing device, and are not tied to the one you’re using.

The device is merely used perform the cryptographic operations of signing, but your coins are not tied to it directly - they’re tied to your private keys.

10/ The signing device is the electronic device used to sign transactions - taking data in, cryptographically signing it using the private keys, and returning an output with the signed data.

The private keys are the secret information the device uses to produce the signature.

11/ The third component, the wallet software, is responsible for communication with the #Bitcoin network.

The wallet software is used to get the coins (UTXOs) owned by the private keys, compose transactions (later signed by the signing device), and broadcast them to the network.

12/ While this might be combined with the signing device in the same device/ software (i.e. a hot wallet - where the private key is entered on an online computer), it is often separated (as with hardware wallets) to ensure the private keys stay offline at all times.

13/ The wallet software must be connected to the internet (or to another communications channel with the #Bitcoin network) at least for some period of time to fetch data about coins belonging to the user, and to broadcast new transactions the user may create to the network.

14/ So to recap:

Private keys - a piece of information, often represented as a 24 words list, which can be used to derive #Bitcoin addresses and signatures to spend from said addresses.

15/ Signing device - a hardware device where the private keys are entered, and which can use those private keys to perform the actual derivation of addresses and signing of transactions mentioned above.

16/ Wallet software - a software which communicates with the #Bitcoin network to receive data about transactions made to said addresses, and to broadcast signed transactions spending from said addresses.

17/ These 3 components can, and often are, combined or abstracted to the user, but knowing their differences could be quite helpful in avoiding common mistakes and understanding best practices in #Bitcoin self-custody.

/end