What is a Crypto Wallet?
Discover what exactly a crypto wallet is and why someone should have one.
Safe storage of cryptocurrency is extremely relevant in 2023. More and more users buy, sell and exchange crypto assets on a daily basis. Accordingly, multiple new crypto wallets appear each year, making it difficult to choose a worthwhile project.
There are several types of wallets which each have their own set of tasks and principles of work. This article will help you learn more about the variety of crypto wallets and their operational principles.
What does a crypto wallet do?
A cryptocurrency wallet is a piece of software, or application for storing, exchanging, sending, and receiving cryptocurrency or various digital assets. Such services are similar to online banking but in the blockchain sphere. Crypto wallets are available as physical USB-like devices like Ledger (cold wallets) and in an online format like Metamask (hot wallets).
Each cryptocurrency wallet can store many different assets if the developers have provided a connection to different blockchains. Some cryptocurrencies are designed for a single blockchain — for example, Bitcoin or Ethereum.
However, before choosing one or another crypto wallet, you should understand the the inner workings in more detail.
How do crypto wallets work?
A traditional Bitcoin wallet has three elements: a public key, a private key, and a SEED phrase.
- The public key is your coordinate (address) in the blockchain. Anyone can see it. It is used to make a deposit or exchange as a user identifier.
- The private key is a unique password. You will need to enter it when transferring or exchanging cryptocurrencies. A private key has a similar use-case to a credit card password.
- SEED-phrase is an auxiliary sequence of 12-24 randomly ordered words. It is used when you need to recover a private key, for example, if you have lost or forgotten it.
However, most hot wallets simplify the interaction for the user. Therefore, to work with crypto transactions, you only need to know the address of the asset and the SEED phrase to authorize or restore access to the wallet.
Hot & Cold Crypto Wallets
There are many cryptocurrency wallets, but the essential difference between them is whether they are “hot” or “cold”:
- A hot wallet is connected to the Internet and can be accessed at any time from a mobile or desktop device.
- A cold wallet is not connected to the Internet and allows you to keep your keys offline. Such a wallet can receive funds at any time, but only the owner can transact with them.
Hot wallets include all cloud-based online wallets, most mobile and software wallets, and exchange-based wallets — for example, Trust Wallet, Metamask, Binance, or Phantom.
Cold wallets are hardware wallets in the form of USB drives and similar storage devices.
A hardware wallet is considered the safest option for storing digital assets. They store personal keys on an external device such as a chip-secured USB. Some hardware wallets are web-compatible and support multiple currencies, which allows cryptocurrency storage and online payments.
The most common wallets are from the manufacturer Ledger, but there are also well-known wallets named Trezor and KeepKey among others.
Custodial and non-custodial crypto wallets
Cryptocurrency wallets are also divided into custodial and non-custodial, depending on the involvement of a third party in asset transactions.
A custodial wallet is a wallet in which personal data is stored by the operator (custodian). It has its own advantages – for example, in the case of a lost password, the user will still be able to restore access to their funds.
Many cryptocurrency exchanges (Coinbase, Binance, etc.) and brokerage services utilize custodial wallets. Such integration simplifies the work with other tools of these platforms and is beneficial for transactions.
Custodial wallets are optimal for speculative trading, as exchanges provide additional financial services such as interest-bearing deposits, futures, lunch pools (platforms that allow earning new tokens), etc.
A non-custodial wallet gives the user complete control over the keys and funds. Decentralized exchanges and special services create such wallets — for example, wallets like ZenGo and Nuri.
Non-custodial wallets can also be created in particular browser extensions (MetaMask). After a simple registration procedure, such extensions provide an address and a private key. A hardware wallet is also considered non-custodial. Accordingly, such solutions are suitable for long-term investments and asset storage because they provide a high level of security.
However, non-custodial wallets also have disadvantages. If the private key and the phrase to recover it are lost, funds will be irretrievably lost. Such wallets can also be affected by a hacker attack.
To receive funds to such a wallet, you need to give the sender a public key. To send cryptocurrency, you must enter a private key into a software wallet and create a transaction. The use of QR codes simplifies both these actions.
How to choose a wallet
When investing in crypto, you must choose at least one type of wallet to store them in. For example, institutional investors are more likely to use hardware wallets to store large amounts of cryptocurrency. It is safer but creates minor inconvenience.
Hot wallets are more popular among crypto-enthusiasts, but you always have to consider the security and the need to diversify assets to keep them protected.
Feel free to experiment with different wallets to see how you like them and to figure out how they work. Using smaller amounts of crypto (< $100) at first is great for experimenting and seeing how you like each user interface.
The choice of crypto wallet depends on your objectives, the number of assets you possess, and the purpose of use. If you want maximum reliability, then choose hardware options in the form of USB devices.
If speed and availability are essential to you, then look for options with a positive reputation on the market among “easy” hot wallets like Trust or Metamask.
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Information in the article does not, nor does it purport to, constitute any form of professional investment advice, recommendation, or independent analysis.