Programmer Stefan Thomas is one of the unluckiest people in cryptocurrency history.

Although Thomas claims he has 7,002 Bitcoins (BTC) sitting in a hardware crypto wallet, he can't access the digital funds. Why? Thomas doesn't remember his essential backup password (called a "seed phrase"). Without this crucial information, there's no way for anyone to recover Thomas's cryptocurrency fortune.

While decentralized cryptocurrencies open new financial possibilities, Thomas's circumstances highlight the security risks of self-custody. People who hold digital assets can't fall back on a bank or fintech company if they make a user mistake, like sending coins to the wrong wallet address. Most significantly, if users lose or forget their seed phrase, there's little hope of ever recovering their cryptocurrency.

Seed phrases are crucial to crypto security, but forgetting them can have expensive consequences. Anyone  purchasing virtual currencies should learn what these passcodes are, why they’re important, and how to store them safely.  

What is a Seed Phrase?

Sometimes called a "mnemonic phrase" or a "recovery phrase," a seed phrase is a list of 12–24 words that grant crypto wallet owners access to their digital assets.

Think of a seed phrase as the master password for a cryptocurrency wallet. Whoever knows the seed phrase for a wallet address can send, trade, and sell coins or tokens in the associated digital account.

Traders also use seed phrases to restore their cryptocurrency wallets. Suppose someone breaks their smartphone that they used to access their MetaMask wallet. To reclaim their assets, they can redownload the MetaMask software app on a new mobile device, select "Import Existing Wallet," and enter the seed phrase to restore access to their cryptocurrency.

Private Key Versus Seed Phrase: How Does a Seed Phrase Work? 

Although each seed phrase may appear to be a collection of random words, it's actually a carefully-constructed list linked to a crypto wallet's “private key.” The private key is another form of a wallet's master password, but instead of 12–24 recovery words, it's a 256-bit list of letters and numbers.

When a trader sets up a new wallet, they receive an automatically generated private key and corresponding seed phrase from a list of 2,048 possible words. Crypto developers created the seed phrase to make it easier for humans to remember this critical password. After all, it's simpler to recall and record words like "egg," "airport," and "gentle" than a long string of code. Thanks to the widely accepted "BIP-39 standard" wordlist, cryptocurrency wallets automatically decipher the words in a user's seed phrase to reveal the private key.

Where Do You Find Your Seed Phrase?

Cryptocurrency wallets typically reveal the seed phrase during the set-up process and instruct the user to write the words down on paper. For additional security, people may need to reenter their recovery phrase to double-check they recorded it correctly before entering their wallet. When a trader opens an existing wallet account, they can also find the seed phrase in their wallet's "Settings" or "Security" tabs.

Seed Phrase Storage: How to Keep Your Seed Phrase Safe

Every trader has different preferences for storing their seed phrase, but many in the cryptocurrency community don't recommend keeping these words on electronic devices (such as USB drives) or in the cloud. No matter how well-encrypted a file is, there's always a risk of hacks, glitches, and cyberattacks. For example, cryptocurrency trader Bo Shen lost $42 million in digital assets after information about his seed phrase leaked online.

Rather than storing a seed phrase on the internet, it's best practice to write these words on paper and lock them in a secure place. For example, some traders lock a written copy of their seed phrase in a fireproof safe or a safety deposit box. Others choose to use special sheets made of durable materials (like steel) they can carve their crypto seed phrases into. These steel seed sheets are beneficial because they're resistant to decay and unpredictable environmental damage like floods and fires.

No matter how a trader stores their seed phrase, it's essential they keep it a secret. Anyone who knows the list of words can control the wallet's cryptocurrency, so it’s vital to be extra cautious about where the mnemonic phrase is stored and who (if anyone) it’s shared with. 

How to Use a Seed Phrase for Crypto Recovery

If a trader breaks the device containing their software wallet or loses a hardware wallet device, they still own the assets inside—if they have their seed phrase.

Interestingly, crypto wallets don't hold cryptocurrencies like a physical wallet holds dollars. Cryptocurrencies exist on decentralized computer networks known as "blockchains," so they aren't "destroyed" when someone breaks a wallet. Instead, a crypto wallet gives users access to digital assets at a particular "blockchain address," but it doesn't store these virtual currencies in a digital account. A wallet's seed phrase identifies its address on the blockchain network, so users can regain control over their assets even if their wallet is destroyed.

To recover the cryptocurrency in a lost or broken wallet, the trader must first redownload their wallet app or buy a new hardware device. For example, if someone using a Ledger hardware wallet for their assets broke the device, they would need to buy another Ledger to set up a new account. Similarly, if a trader using the Trust Wallet app broke their tablet that contained the software, they would have to redownload Trust Wallet on a new device.

When setting up a wallet, the program asks whether the user wants to open a "new wallet" or “recover a pre-existing wallet." Click the second option and enter the previous wallet's seed phrase in the provided blank spaces. The wallet will automatically regenerate the cryptocurrency in the account if the words are correct and in the proper order. 

Is a Seed Phrase the Same as a PIN? 

Many crypto wallets have users create a password or personal identification number (PIN) when setting up a new account. Traders must use their password or PIN to enter their wallets, but these security measures aren't a part of the wallet's private key like the seed phrase is. 

While a wallet's password or PIN is a great first line of defense, this information is less essential than a wallet's seed phrase. If someone lost their wallet's PIN, they could still restore their cryptocurrency with the seed phrase—but they can't use a PIN to recover lost assets on a new device.

What are Optional Crypto Wallet Passphrases?

Some crypto wallets, such as Trezor and Ledger hardware devices, offer optional "passphrase extensions" as a bonus feature. This extension is often called the "25th word" because a wallet won't open unless users put this term at the end of their seed phrase.

Unlike the actual seed phrase, the optional passphrase isn't a part of the device's private key. Anyone who opts to create a passphrase extension enters a word, sentence, or set of symbols to tack onto their wallet's seed phrase—the wallet doesn't automatically generate this extension. However, wallets with optional passphrases recognize the terms associated with a particular seed phrase so that a person can use the master passcode to unlock new wallet accounts. In other words, with passphrase extensions, users have the freedom to create dozens of wallets with the same seed phrase to spread their assets between multiple accounts.

Some traders memorize their one-word passphrase for extra security. If cryptocurrency holders don't record their optional passphrase on paper or in an electronic device, it won't matter if a criminal takes possession over their seed phrase. The passphrase-protected wallet will only open if someone knows the 25th word. While optional passphrases offer traders exceptional security, they're another passcode to either misplace or misremember. People who use these passphrase extensions must treat them with the same vigilance as their seed phrase.

Learn More About Safety in Cryptocurrency with dYdX 

It's impossible to overstate the importance of safety when storing and sending cryptocurrencies. Unlike bank withdrawals or fintech transfers, there are no do-overs in Web3. dYdX wants everyone exploring digital assets to be up-to-date on the best ways to safeguard their cryptocurrency. To learn more about cryptocurrency, explore the dozens of beginner-friendly guides on Academy and check out dYdX's blog to find out more about our product. And don’t forget: dYdX offers eligible traders a safe decentralized trading platform for cryptocurrency derivatives, specifically perpetual swaps.

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