What is a Cryptocurrency Wallet?
- The public key acts as a public address, much like a bank account number, where cryptocurrencies are sent;
- The private key unlocks the wallet and should be known only to the user.
How Does a Crypto Wallet Work?
Crypto wallets do not physically hold coins and tokens, but they store both keys to provide digital signatures, authorizing each transaction. They provide a means to access the coins and tokens that are stored on the blockchain.
To transfer crypto to another wallet, the sender enters the recipient’s public address, chooses how much to send, and initiates the transaction. They need to have enough funds available in the wallet to cover the amount plus the fee for processing the transaction, known as the gas fee.
The recipient can then use their private key to access the wallet where the crypto is deposited.
Types of Crypto Wallets
There are several different types of wallets for users to choose from, depending on how they intend to use and store their crypto.
- Software wallets – digital wallets in the form of software applications that run on computers or mobile devices.
- Desktop wallets – installed on a laptop or PC, for example, Electrum for bitcoin (BTC), which supports multiple cryptocurrencies.
- Mobile wallets – mobile apps designed for smartphones and tablets, such as Trust Wallet or Coinbase Wallet, providing easy access to coins and tokens on the go.
- Web wallets – online wallets that are accessed through web browsers. Although they are convenient, they should be used with caution as they carry a higher risk of security vulnerabilities.
- Hardware wallets – physical devices designed to store cryptocurrencies securely offline, such as Ledger or Trezor. Storing coins and tokens offline provides extra protection from online threats.
- Paper wallets – a paper record of private keys and public addresses. While this reduces the risk of hacking, it requires careful handling to prevent physical loss or damage.
- Online wallets – wallets offered by cryptocurrency exchanges or online platforms that manage the private key on the user’s behalf.
Multi-signature (multisig) wallets require two or more private key signatures to authorize transactions. This can prevent an individual from losing access if they lose one key. They can also prevent the misuse of funds in an organization, as each authorized individual has one key, and a majority of keys are required to authorize transactions.
Any of the wallet types can have a multisig version.
Custodial vs. Non-Custodial Wallets
Some crypto wallets are non-custodial – meaning that the user is responsible for their private key and retains full control of the wallet’s contents.
While custodial wallets are easier to use and manage than non-custodial wallets, especially for beginners, they also transfer control to a third party. This has given rise to the phrase “not your keys, not your crypto,” – referring to instances when custodial wallet providers have failed, and account holders have lost their cryptocurrency holdings.
|Custodial Wallet||Non-custodial Wallet|
|Types||Online wallets on exchanges and platforms||Software wallets, hardware wallets|
|Who Holds the Private Key?||The wallet provider||The user|
|Control||Limited control, reliant on the provider’s services||Full control over the wallet’s contents|
|Ease of Use||Easier for beginners; managed by the provider||Requires more responsibility from the user|
|Security measures||Two-factor authentication, biometrics, email confirmations||The user’s choice of security measures|
|Recovery||If the user loses their account credentials, they may not be able to recover their funds||The user can always recover their funds by using their seed phrase|
|Risk||Third-party control; risk of provider failure||The user bears responsibility for security breaches|
|Backup||Limited control over backup options||The seed phrase serves as a backup for access|
Hot Wallets vs. Cold Wallets
Crypto wallets can be referred to as “hot” or “cold,” depending on whether they are connected to the Internet.
- Hot wallets are connected to the Internet and more accessible, while cold wallets are offline and, therefore, more secure.
Hot wallets include web-based, mobile, or desktop wallets. They store and encrypt the private key online, which can pose a security risk as hackers can exploit computer network vulnerabilities. Keeping large amounts of cryptocurrency in a hot wallet is potentially risky, although strong encryption can help mitigate the risk.
- Cold wallets include hardware wallets or paper wallets. Although these are less convenient than hot wallets, they protect the private key from malicious actors.
An NFT wallet is able to store non-fungible tokens (NFTs). Developers are increasingly launching wallets that can support crypto coins and tokens as well as NFTs in one place.
When choosing an NFT wallet, users need to consider their level of experience, the wallet’s compatibility with NFT marketplaces, the types of tokens they plan to store, and the strength of the wallet’s security.
While most NFT wallets support Ethereum-based tokens, users who want to mint and trade NFTs on other blockchains need to use a wallet that offers cross-chain compatibility.
Why Use a Crypto Wallet
Crypto wallets store private keys, which are used to access and manage cryptocurrencies. They facilitate the sending and receiving of cryptocurrencies between accounts and users by generating unique addresses for each transaction. These addresses act as the source for outgoing funds and the destination for incoming funds.
It is possible to buy, sell and store cryptocurrencies on exchanges and centralized finance platforms without ever creating a crypto wallet. However, exchange accounts are most suitable for holding small amounts of cryptocurrency for trading.
For larger amounts of crypto, it is more secure to withdraw it to a hot or cold crypto wallet. This gives the user complete control over their coins and tokens, reducing the threat of losing funds to a malicious attack or exchange failure.
Beyond basic transfer and storage features, many wallets provide functionality that allows users to track their cryptocurrency holdings and monitor market prices.
A cryptocurrency wallet facilitates a trader or investor’s participation in the cryptocurrency ecosystem. It holds the keys that provide a secure, convenient way for users to send and receive coins and tokens, hold them as investments, and engage with decentralized applications.
There are several different types of wallets available that offer users different levels of security, convenience, and control over their assets.
Whether it is a software wallet for easy access or a hardware wallet for enhanced security, understanding the role and functions of a crypto wallet is crucial for any cryptocurrency user.