Understanding the Derivation Path for Creating HD Wallets

In the world of cryptocurrencies, managing multiple addresses securely and efficiently is crucial. This is where Hierarchical Deterministic (HD) wallets come into play. HD wallets simplify the process of managing numerous keys through a structure that allows users to generate an entire tree of keys from a single master key, using what is known as a derivation path. This blog will guide you through the concept of a derivation path, how it plays a central role in the creation of HD wallets, and why it’s crucial for secure and efficient crypto management.

What is a Digital Wallet?

A digital wallet (also called an e-wallet) is a software-based system that securely stores user’s payment information and passwords for various payment methods and websites. It enables users to make transactions and payments without the need for physical cards or cash, typically via smartphones, computers, or other digital devices.

Deterministic vs. Non-Deterministic Wallets

Deterministic Wallets:

These wallets use a single seed to generate a series of private and public keys in a predictable manner. As long as you have the seed (or the mnemonic phrase), you can regenerate all associated keys and addresses. This ensures that the wallet is always recoverable, enhancing security and usability.

Non-Deterministic Wallets:

In contrast, non-deterministic wallets do not derive keys from a single seed. Instead, they may generate keys randomly each time, making it harder to track and recover addresses if the wallet is lost. This approach is less user-friendly and generally not recommended for secure crypto management.

Basic Deterministic vs. Hierarchical Deterministic (HD) Wallets

Basic Deterministic Wallets:

Generate all addresses from a single seed phrase but do not organize them hierarchically. They provide basic key derivation but lack advanced features like account structure or paths.

Hierarchical Deterministic (HD) Wallets:

These are advanced deterministic wallets that use a tree structure to organize addresses. The structure is often based on standards like BIP32 and BIP44, allowing for organized management of multiple accounts and currencies from a single seed phrase.

In most modern cryptocurrency applications, Hierarchical Deterministic (HD) Wallets are the standard due to their flexibility and ease of backup and recovery.

What is an HD Wallet?

An HD wallet (as defined by the BIP-32 standard) is a type of wallet that can generate a series of private and public keys from a single seed phrase, usually represented by a mnemonic (a list of words). From this seed, an HD wallet can derive multiple accounts, chains, and addresses while maintaining security and privacy. HD wallets enable users to control numerous addresses without needing to store separate private keys for each one.

For instance, if you’ve ever created a cryptocurrency wallet using a 12- or 24-word phrase, you’ve already encountered HD wallets. That phrase is the seed that will be used to generate all your addresses. The ability to recover your entire wallet using this phrase is one of the most significant advantages of HD wallets.

Why Use HD Wallets?

The structure of HD wallets offers several benefits, making them an essential tool for both cryptocurrency enthusiasts and developers. Here are the key reasons for using HD wallets:

Enhanced Security

• HD wallets offer a secure way to manage multiple private keys since the keys are derived from a single master seed. This means you only need to securely store this master seed to back up all your keys.
• Even if you generate thousands of addresses, you don’t need to keep track of each key individually. You can always regenerate them from the master seed.

Improved Privacy

• Users can generate a new address for each transaction, which helps maintain privacy as each address can only be linked to a single transaction.
• This feature is particularly useful for businesses or individuals who want to avoid linking all their transactions to a single address. It becomes much harder for external observers to track your financial history.

Convenience and Flexibility

• With a single mnemonic phrase, users can restore their entire wallet and access multiple accounts across various cryptocurrencies.
• You can even use the same seed phrase across different wallet applications, allowing for easy migration between different wallet software.

The Hierarchy of HD Wallets

To understand how an HD wallet works, it’s helpful to think of it as a tree of keys. The seed phrase is the root of this tree, and from this root, branches extend into different accounts, addresses, and private keys. Each address or key can be thought of as a child of the previous node, which is derived according to a specific structure called a derivation path.

What is a Mnemonic Phrase?

A mnemonic (or mnemonic phrase) in the context of cryptocurrency wallets is a human-readable string of words, typically 12, 18, or 24 words long, that serves as a backup for the private keys of a deterministic wallet. This phrase allows the user to regenerate all the addresses and private keys associated with the wallet in case it is lost or needs to be restored on another device.

How Mnemonic Phrases Work:

1. Seed Generation: The mnemonic phrase is generated from a seed, which is a large, randomly generated number. The seed is the core from which all private and public keys in a deterministic wallet are derived.
2. Word List: The words in the mnemonic phrase are selected from a predefined list of 2048 words, as specified in the BIP-39 standard. This ensures that the mnemonic phrase is both memorable and secure.
3. Restoration: If a user loses access to their wallet (e.g., due to device failure), they can enter the mnemonic phrase into another compatible wallet, and it will regenerate all of the wallet’s keys and addresses.

What is a Derivation Path?

A derivation path is a sequence that specifies how a private key is derived from the seed. Think of it as a map or address that points to a particular location within the HD wallet’s key structure. The derivation path determines which child key is being generated and how deep in the hierarchy the key is located.

The general format of a derivation path is:

m / purpose' / coin_type' / account' / change / address_index

How to Use Derivation Paths for Creating HD Wallets

Using derivation paths in HD wallets might seem complex at first, but with the right steps and tools, it becomes much simpler. Here’s a step-by-step guide on how to use derivation paths to generate addresses in an HD wallet:

Step 1: Start with a Seed Phrase

When you create an HD wallet, the wallet software will generate a seed phrase (usually 12 or 24 words). This phrase acts as the master key for your wallet. Keep it safe, as it can be used to recover all your addresses and funds. Example: praise you muffin lion enable neck grocery crumble super myself license ghost

Step 2: Select the Derivation Path

Depending on the type of address you want (e.g., Bitcoin, Ethereum) and the wallet software, select the appropriate derivation path. Here are some common examples:

• Bitcoin Legacy (BIP-44): m / 44′ / 0′ / 0′ / 0 / 0
• Bitcoin SegWit (BIP-49): m / 49′ / 0′ / 0′ / 0 / 0
• Bitcoin Native SegWit (BIP-84): m / 84′ / 0′ / 0′ / 0 / 0
• Ethereum (BIP-44): m / 44′ / 60′ / 0′ / 0 / 0

Different wallet applications might have slightly different derivation paths for specific use cases. Most wallet software will automatically use the standard path based on your chosen address type.

Step 3: Use Wallet Software for Address Generation

To generate addresses from your seed phrase and derivation path, use a compatible wallet software or tool that supports HD wallets. Popular options include:

• MetaMask (for Ethereum and EVM-compatible blockchains)
• Electrum (for Bitcoin)
• Trust Wallet or Ledger (for multi-coin support)
• Mycelium (for mobile Bitcoin wallets)

When you input your seed phrase into these tools, they will use the specified derivation path to generate a list of addresses.

Step 4: Generate Multiple Addresses

Using the derivation path, the wallet software will generate a tree of addresses. You can increment the address_index value to create multiple addresses. Example: For receiving Bitcoin, if you want to create multiple addresses under the same account, you would change the address_index value from 0 to 1, 2, etc. Path for second address: m / 44′ / 0′ / 0′ / 0 / 1

This is often managed automatically by wallet software, but knowing how it works is helpful if you need to recover addresses manually or switch wallets.

Step 5: Access and Manage Accounts

With the account parameter in the derivation path, you can create and manage multiple accounts under the same seed. For example, if 0′ is your personal account, you might use 1′ for a business account. Example paths:

• Personal Account: m / 44′ / 0′ / 0′ / 0 / 0
• Business Account: m / 44′ / 0′ / 1′ / 0 / 0

This allows you to organize different funds under a single wallet, using the same mnemonic phrase for access.

Step 6: Recover Funds with the Seed Phrase

If you ever lose access to your wallet software or device, you can recover all accounts and addresses by inputting your seed phrase into another compatible wallet. The new wallet will automatically recreate the derivation paths and generate the same sequence of addresses, allowing you to regain access to your funds.

Step 7: Backup and Store Securely

Always backup your seed phrase in a secure location, like a physical note stored in a safe. Avoid storing the phrase in digital form unless it is encrypted, as anyone with access to the seed can control all derived addresses and funds. Regularly review your wallet’s settings to ensure you are using the correct derivation path, especially when migrating between different wallet applications.

Summary

By following these steps, you can effectively use derivation paths to manage multiple cryptocurrencies and accounts from a single HD wallet. Understanding how the derivation path works gives you better control over your crypto assets, making it easier to recover, manage, and secure your funds. Whether you’re a developer working with HD wallet libraries or a user simply backing up a seed phrase, knowing the derivation path structure can help ensure that your assets stay secure and accessible.

With a single mnemonic phrase, users can enjoy the benefits of enhanced security, privacy, and ease of use. So next time you backup your mnemonic or set up a new wallet, you’ll have a deeper understanding of the path that connects you to your funds.

For any further queries, feel free to reach out to us at info@simplileap.com.

Harshith K Vasudev

Driven by a love for ongoing learning, I am delving into the realms of technology and web development. Even as I’m still building my foundation in these areas, I welcome challenges and enjoy exploring various programming languages and tools. At Simplileap, I enthusiastically take every opportunity to grow and gain insights under their mentorship. With a dedication to improving my skills and a passion for innovation, I’m focused on excelling in my career and making a meaningful impact in the industry.