Wallets and Security Flashcards

A company wants to secure its corporate cryptocurrency treasury by requiring transaction approval from at least 3 out of 5 executives. This approach is designed to prevent a single point of failure and unauthorized fund transfers. Which type of wallet best meets this requirement?

Answer: A multi-signature (multisig) wallet

A multi-signature (multisig) wallet is specifically designed for this purpose. It requires a predefined number 'M' of signatures from a total number 'N' of possible signers (an M-of-N setup) to authorize a transaction. This distributes control and enhances security, making it ideal for corporate governance.

An investor decides to store the majority of their cryptocurrency holdings for the long term and wants to maximize security against online threats like malware and hacking. Which of the following storage solutions is most appropriate for this goal?

Answer: A hardware wallet kept in a secure physical location

A hardware wallet is a form of cold storage, meaning it keeps the user's private keys offline and isolated from internet-connected devices. This makes it the most secure option for long-term holdings as it is nearly immune to remote attacks, hacking, and malware that affect 'hot wallets' (mobile, web, and desktop wallets).

What is the primary function of a mnemonic phrase (or seed phrase) provided by a non-custodial wallet?

Answer: To generate and restore all private keys associated with the wallet.

A mnemonic phrase, often based on the BIP-39 standard, is a human-readable representation of the master seed. This seed is used to deterministically generate all the private keys, and consequently public keys and addresses, within a Hierarchical Deterministic (HD) wallet. Its main purpose is to serve as a master backup for recovering the entire wallet if the device is lost or destroyed.

A user is setting up a new hardware wallet and is prompted to write down a 24-word recovery phrase. Which of the following is the LEAST secure method for storing this phrase?

Answer: Storing it in a password manager application synced across devices.

Storing the recovery phrase in any digital, internet-connected format, such as a password manager, email draft, or cloud storage, is highly insecure. It exposes the phrase to malware, hacking, phishing attacks, and data breaches. The best practice is to keep the seed phrase completely offline and physically secure.

Hierarchical Deterministic (HD) wallets, defined by standards like BIP-32 and BIP-44, offer a significant advantage for managing multiple cryptocurrency accounts and addresses. What is this key advantage?

Answer: They can generate a nearly infinite tree of key pairs from a single master seed.

The core feature of HD wallets is their ability to derive a tree-like structure of child keys (and their corresponding addresses) from a single master seed, also known as the recovery phrase. This allows users to manage numerous accounts and generate fresh addresses for every transaction to enhance privacy, all while only needing to back up the single initial seed.

When comparing custodial and non-custodial wallets, what is the most critical distinction regarding the user's assets?

Answer: Non-custodial wallets give the user sole control and responsibility for their private keys.

The fundamental difference lies in who controls the private keys. With a non-custodial wallet, the user has exclusive possession and control of their private keys and, therefore, their funds. In a custodial wallet (like one on a centralized exchange), a third party holds the keys on behalf of the user, meaning the user is trusting the custodian to secure their assets.