Hierarchical Deterministic Wallet Meaning

Nov 23, 2023 | Updated Nov 23, 2023

A hierarchical deterministic wallet is a special kind of wallet that uses a random number to create virtually infinite cryptocurrency key pairs.

What is a Hierarchical Deterministic Wallet?

Public blockchains basically allow anyone to view all the transactions and balances you’ve made on the blockchain. A hierarchical deterministic (HD) wallet ensures that no one can know your exact balance by creating multiple addresses.

But before HD wallets, non-deterministic wallets ruled the cryptocurrency world. They used to produce unrelated key pairs for every crypto account. For instance, the public key and the private key were unrelated despite being for the same wallet or account. What’s worse, the derived key pairs can’t be retraced to an original random phrase. This forced users to back up every key pair separately. For one or two wallets, backing up four keys is reasonable (but not convenient), but imagine when you’re managing 100 accounts? That makes for 200 unrelated keys for you to track, which is quite impractical. A hierarchical deterministic wallet solves this challenge.

A hierarchical deterministic (HD) wallet describes a wallet that generates all its keys from a single recovery phrase in a tree-like pattern. This recovery phrase can be used to recreate the entire wallet, even if the wallet is lost or damaged. HD wallets have become popular for their convenience.

What are the HD Crypto Wallet Improvements?

Bitcoin Improvement Proposal 32 (BIP-32) introduced a hierarchical tree-like structure for crypto wallets while the BIP-39 standard provided the means to generate deterministic wallets. This enabled a random number – known as entropy – to derive virtually infinite key pairs. As a result, users can back up multiple accounts using a single secret code.

Technically, the entropy serves as the root of this tree-like structure. The entropy is translated to derive the secret recovery phrase, which then generates all the private keys and corresponding public addresses. The owner of the HD wallet can use the recovery phrase to recover their wallet if it is stolen, lost, or damaged. Hence, they are only required to back up this phrase as opposed to backing up individual key pairs. However, losing the secret recovery phrase means that the owner could lose access to their wallet and funds forever.

HD wallets use the entropy to generate the Extended Key Pair, a single key pair that governs all the addresses in the wallet. It consists of:

Extended Private Key (xpriv): Generates all the private keys for corresponding addresses. Every time a new account is created, the xpriv produces a new private key.
Extended Public Key (xpub): Serves as a key for creating new public keys without involving the private keys, ensuring that the public address changes with every transaction. This improves users’ privacy and security.

To conceal your account balance from the public, both the xpub and xpriv should be stored in private.