When figuring out how to buy Bitcoin or some other cryptocurrency, you may have wondered how to keep your new purchase safe. This is where wallets come in: digital spaces where cryptocurrency is stored until it’s needed. Join us as we help you figure out what a crypto wallet is and how it works.
Key Takeaways: Crypto Wallets Explained
- In no way does a crypto wallet store your crypto; a wallet only stores your keys. It’s more like a password manager than a wallet, really.
- There are several types of wallet, each with its own type of storage. Which one is best for you depends on how often you trade and your own security situation.
- There are also so-called custodial wallets, where an exchange keeps your keys for you. We recommend you stay away from this type of wallet and keep your own private keys, well, private with non-custodial wallets.
As you’ll see, the term “wallet” is a misnomer, and there’s more than one type you can use to keep your crypto safe. From a hot wallet to cold wallet, software to hardware, let’s delve into the world of cryptocurrency wallets. You can also look at our guide to the best crypto wallet options.
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A crypto wallet stores the public and private keys necessary to access your crypto; it does not store the crypto itself.
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Yes, unless you have an eidetic memory, you need to somehow store your keys or you won’t be able to access your crypto.
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A hardware wallet is a small device, usually a USB key of some kind, that stores a user’s private keys.
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What Is a Crypto Wallet?
From the name alone, you’d think that a crypto wallet is where you store your cryptocurrencies, much the same way you store your cash in your physical wallet. That’s not how they work, though.
Whereas the wallet in your pocket or bag holds your cash, cards and some odds and ends, a cryptocurrency wallet holds the information you need to access your crypto. This is due to the way crypto works.
Unlike physical cash, which comes in the form of easily carried notes and coins, cryptocurrency exists purely on its respective blockchain — Bitcoin has a different blockchain than Ether does, for example. We go into more detail about that in our blockchain explainer.
How Do Crypto Wallets Work?
When you send crypto, you’re accessing the blockchain and telling it that you moved a certain amount at a particular time. To do so, you need to prove that you own the crypto that’s being sent, which is where your wallet and the information stored on it comes in.
To access your crypto, you need your keys. There are two: Your public key is the address where your crypto is stored (think of it like a bank account number) while your private key is the password you need to access that account.
These two keys are all that stand between owning crypto and not owning it. It also explains why there are so many stories of people buying Bitcoin or whatever but not being able to cash in because they lost either their public or private keys — or even both.
These would-be millionaires can’t do anything but tear their hair out, as there’s literally no way to access their digital fortunes without the keys. A wallet is pretty much the only way you can prevent this scenario.
What Can a Cryptocurrency Wallet Do?
In essence, a crypto wallet is no more than a place where you store your passwords. It’s kind of like a password manager for cryptocurrency. However, it’s no wonder people mistake wallets for a place where crypto is actually stored. First, the name is confusing, since we know what a wallet is; second, because crypto wallets have become a lot more than just password storage.
For example, a lot of software wallets (and we’ll talk more about the types of wallets in the next section) will also track what cryptocurrencies you own and how much you have of each. There are wallets that’ll also tell you how much your crypto is worth in real-world money, and help crypto users track it with graphs and figures.
Some wallets are even attached to crypto exchanges, where you exchange your fiat currency for the digital kind, and are thus also portals to increasing your hoard. As a result, wallets have become less a place where you keep passwords and more of a personal starting point for everything crypto.
Here is a short list of some of the things a crypto wallet can do:
- Store and manage the keys to your crypto
- Display your crypto and its fiat value
- Track your crypto
- Transfer crypto
- Stake your crypto
- Purchase crypto (exchange wallets)
- Make crypto payments
Types of Crypto Wallets
As we alluded to earlier, there’s more than one type of wallet. In fact, you can classify wallets in all kinds of different ways. For our purposes — and to keep your head from spinning — we’ve decided on three main types.
1. Paper Wallets
The first type is the most basic, jokingly called a paper wallet. It’s a piece of paper where you’ve written down your public and private keys. As with anything paper, it has an advantage in that it’s not connected to the web and thus can’t be hacked — a big problem for crypto investors. It’s also easy to hide a piece of paper among your belongings.
The downside, though, is one we’re all familiar with: Nothing is as easy to lose as a piece of paper. Anybody who has ever turned their house upside down looking for a specific utility bill, diploma copy or even the scribbled phone number of a potential partner knows the sinking feeling that you’ll never find that damned scrap of paper. Now imagine that paper holds the key to a million bucks.
2. Hardware Wallets
A safer option is to use a hardware wallet: a USB stick that holds your public and private keys.
Technically, any USB with a file that holds your keys could do, though you’re likely much better off buying one for the sole purpose of securing your crypto information. Hardware wallets come in all shapes and sizes, and with a wide range of prices, so there are plenty of options.
Ledger is one popular type of hardware wallet.
In most cases, though, it’s as simple as plugging your hardware wallet into your computer, making your transactions and then — this is very important — unplugging your device again. Then all you need to do is keep the USB stick in a safe place and you’re golden.
3. Software Wallets (Mobile & Desktop Wallets)
Of course, if you’re making a lot of trades, hardware wallets can become cumbersome, with all the constant plugging and unplugging. This is where software wallets come into play. These are a very popular type of wallet because they can be used to make trades anytime you want as long as you have a device available.
There are several subtypes, like desktop wallets for your laptop, mobile wallets for your phone and even web wallets, which work in your browser. What they all have in common is that they’re connected to the internet. They not only keep your private keys safe, but also track how much crypto you own, the type of crypto and even what it’s worth in real-world money.
Guarda is one example of a popular software wallet.
All that is very nice, but of course there’s a downside. As with all things internet-related, you can be hacked. With the kind of money involved in crypto, hacking has become commonplace, so having information out there on the web can be scary. That said, with all your information in the cloud, you won’t have to worry about physical security.
Cold Wallets vs Hot Wallets
Hot vs cold wallets refer to whether it is connected to the internet or not.
As you can guess from the preceding section, there’s another way to subdivide wallets, namely by whether they’re internet connected or not — better known as hot and cold. No matter how you slice and dice wallet types, each of them can only offer one of these two types of storage. Cloud storage has a similar system, check out our comparison of cold vs hot storage for more.
Both types of storage have their pros and cons. A hot wallet is more convenient for people looking to make a lot of crypto transactions, or who want to keep a close eye on their crypto and its price fluctuations; software wallets are almost exclusively hot wallets. The downside is that, since they’re connected to the internet, they’re vulnerable to hacks.
Cold wallets — usually some kind of hardware wallet, but paper ones count too — are more for the set-it-and-forget-it type of crypto fan. They’re not connected to the web, so you need to actively access the internet to move your crypto around when you use them.
They’re safer, but make it less convenient for spot trading. They also come with fewer bells and whistles, no graphs or charts here.
Custodial Wallets vs Non-Custodial Wallets
Finally, there’s one last type of cryptocurrency wallet we should discuss, namely custodial wallets. All the examples we’ve gone over so far are non-custodial wallets, meaning that only the owner has access to the keys contained in the wallet.
Custodial wallets are different: The entity running the wallet for the owner has the keys, or at least shares them. This is a common arrangement with exchanges and allows them to more easily execute trades on your behalf.
However, as we saw with the FTX scandal, it also leaves you open to being robbed blind by the exchange. Generally speaking, when it comes down to your money, it’s best that you hold on to your own keys or you might find yourself a lot poorer when things go south for the exchange.
Final Thoughts: Crypto Wallets
Crypto wallets are the only good way to keep track of the keys that control your crypto and, unless you have a photographic memory, you should use one. Generally speaking, software wallets offer greater convenience, while hardware wallets are safer. Which is best for you depends on your personal situation and how you plan to use your crypto.
What’s your preferred type of wallet? How does it tie into your crypto strategy? Is there a type you feel deserves more mention? Let us know in the comments below and, as always, thank you for reading.
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Originally posted on February 3, 2023 @ 11:07 am
