So instead of having just a bunch of keys, let’s try something a bit more clever.
What if we could instead come up with a way of deriving keys from a original seed value? That’s the idea behind HD Wallets, or Hierarchical Deterministic wallets.
So we start off with a randomly generated seed value.
Instead of having to back up every single key from now on, we could just deterministically generate a new key pair, so long as we know our original seed.
We can think of this seed as a master key.
We first generate our master key, and for each subsequent key we want to generate, we can just just take the hash of the master key with some counter or index number, and then we’ll arrive at our derived child key.
For example, if I want to generate my third child key, I would append 3 to my master key and hash the whole thing.
We can think of the master key as being a parent key, and any keys that are generated from it are its child keys.
And to make things more interesting, we can also use child keys as parent keys to generate even more child keys.
By generating keys in a known way instead of randomly, we greatly lessen the load on wallets having to keep track of all your keys — especially if you’re dealing with thousands of keys like exchanges do.
Of course, exchanges can use HD wallets to greatly reduce their load, but HD wallets are also useful elsewhere.
imagine an organization with a hierarchical structure.
Imagine that we have the president control our master key.
From the master key, we can generate child keys for each of the department heads.
And from the keys of the department heads, we can generate child keys again for each of the department employees.
Since keys are derived in a hierarchical fashion, someone controlling a parent key can derive a child key, and can thus spend from it.
In our hierarchical organization, if everyone in the org were to have an HD wallet as previously defined, then the department heads could spend from the wallets of employees in their department, since the employees keys were generated from the department head’s keys.
And the president would have the most power.
Everyone’s key originates in some way from the president’s master key, so the president would be able to spend from everyone’s wallet.