Entering the world of cryptocurrencies? Meet your essential partner: the crypto wallet. Unlike a regular wallet, it's a smart software that safeguards and lets you handle digital assets easily.
This guide explores crypto wallets, their roles, types, and how they keep your digital valuables safe. Whether you're new or a crypto pro, understanding how crypto wallets work is crucial for confidently navigating the crypto market.
What is a Cryptocurrency Wallet?
A crypto wallet, in essence, is a software application that stores private and public keys. It also interacts with different blockchain technology, enabling users to send, receive, and monitor the balance of their cryptocurrency.
It’s a software tool that serves as a storage medium for various cryptocurrency assets, such as NFTs, tokens, and coins. Much like mobile banking applications in conventional financial systems, these wallets offer users a visual representation of their portfolio and account status.
How Does it Work?
In the real sense, crypto wallets don't exactly hold or store assets like a physical wallet would hold cash; what they really store are users’ public and private keys. These keys are lengthy strings of random characters that are used as a unique identifier in every transaction.
Public keys, also known as wallet addresses, function like bank account numbers and can be shared without issue. Private keys, however, are similar to bank account PIN numbers or passwords and must be kept confidential as they are required to sign transactions.
Crypto wallets use an internet connection to access the blockchain network for the specific cryptocurrency being used. The wallet can then read the public ledger and display the balances associated with the user's addresses.
In addition, the wallet retains the private keys necessary for users to conduct transactions. When transactions are initiated, the wallet verifies them using its private keys and sends them out to the blockchain network. The network processes the transaction and updates the balances in both the sender's and recipient's addresses accordingly.
Types of Cryptocurrency Wallet
Hot and Cold Wallets
Hot wallets and cold wallets are both methods of storing cryptocurrency. Hot wallets are software wallets that are typically connected to the internet, enabling real-time storage, transfer, receipt, and viewing of tokens. On the other hand, cold wallets are offline wallets that are disconnected from the internet, usually utilised for prolonged token storage.
Traders often prefer hot wallets because they are quick to establish and convenient for everyday transactions. Nevertheless, because they are constantly connected to the Internet, they are vulnerable to security breaches and unauthorised use.
A few examples of hot wallets are:
These are software packages that can be installed on a PC and allow users to store crypto assets. They are easy to set up and guarantee anonymity as there is no third-party involvement, although this also means users are responsible for their security. Precautionary measures to prevent attacks include regular security updates, backing up the PC, and using an up-to-date antivirus. Examples include Exodus, Bitcoin Core, Electrum, etc.
These are mobile applications that allow users to store and control their crypto assets on their smartphones. Mobile wallets are available on the Android and iOS Operating systems, and they are quite convenient as they use QR codes for transactions.
Examples are Coinomi and Mycelium.
These are web-based wallets, as the name suggests, and are accessed by Internet browsers via mobile or desktop devices, allowing users more flexibility. However, since private keys are stored online, web wallets are vulnerable to DDOS attacks.
On the opposite end of the equation are Cold wallets which are typically used by investors who hold on to their investments for long periods of time, as opposed to daily buying and selling by traders.
Due to a longer holding duration and usually a substantial amount of investment, users tend to be more conservative and opt for a secure, hack-resistant option. The following are common examples:
In this simple cold wallet solution, both private and public keys are written down on paper or printed as a QR code and stored in a safe place.
Although it safeguards crypto assets from hacks and thefts online, it also opens up the wallet and, consequently, the asset therein to new risks as the paper wallet can get lost, stolen, torn, or made illegible by getting wet.
These come in the form of a USB drive and have an added layer of security. Apart from storing the private key to the wallet offline, hardware wallets require users to enter a PIN to access their content.
This provides an extra layer of security, making sure that even in the event of a robbery, funds are still intact.
Custodial vs. Non-custodial Wallets
These are the types of wallets categorised based on control.
These are wallets managed by a third party, usually a centralised exchange. The custodian has the wallet’s private keys, hence total control of the wallet's operations. Since Custodial wallets are typically issued by centralised exchanges (CEXs), users can easily access features, services, and functionalities.
For example, CEXs make it easier to convert cryptocurrencies into fiat and vice versa; they also have perpetual trading options in addition to farms and staking pools.
However, amidst the glitz and glamour, users bear certain risks when using custodial wallets. Users bear the risk of censorship and blocked transactions as they are not in total control of their wallets.
Also, bankruptcy or fraud on the provider side could lead to losses, which may render the CEX insolvent.
Here, each user has their own private key and is therefore in complete control of their wallets. Non-custodial wallets are resistant to censorship and control by outside parties while providing users with direct and rapid access to their assets.
However, users are fully responsible for their own security and must fully understand the complexities behind how the wallet functions, as any potential errors are irreparable.
Picking the Right Wallet
Choosing the appropriate wallet for your needs is dependent on your lifestyle and wallet utility.
If you are a day trader who finds pleasure in scalping the market by utilising futures contracts on centralised exchanges, then you might choose a hot custodian wallet on a centralised exchange.
Conversely, if you are a more cautious investor who invests huge amounts of capital, a non-custodial cold wallet might be more suitable for your needs.
Remember to do your own research before settling for any type of crypto wallet.