What is a Crypto Wallet and How Does it Work?
Ever heard of the phrase ‘hot and cold wallets’, or ‘custodial or non custodial wallets’?
Or have you ever overheard someone say that they keep their ‘Bitcoin in a wallet’? – And you wondered, what are they talking about?
Well, this isn’t a leather wallet that you carry around with you that holds physical ‘fiat’ currency.
A crypto wallet stores the users’ private and public keys whilst giving access to a user-friendly interface to manage your crypto assets.
The wallet enables you to view your crypto balance on the blockchain. This doesn’t mean that your crypto is actually stored in that specific wallet, as you can import your private keys into another wallet and view the same balances.
So, what are private and public keys?
A key is made up of random numbers and letters. Every public key is paired with one corresponding private key.
The public key is the address that is used in the public domain. You use this address when sending and receiving crypto. Sharing your public key with someone else doesn’t mean they can access your wallet.
On the other hand, your private key is your secret password/passphrase to gain access to your wallet. This should never be given out to anyone – And we mean no one!
Think of it like an email account; your email address is public to everyone, and you can send and receive emails. This is like your public key. Your password to enter your email account is private and never given to anyone. This is your private key.
Top Tip – Never keep your private key passphrase on a digital device. Write it down on paper, or engrave it in metal and store it in a safe and secure place.
WHY SHOULD YOU USE A CRYPTO WALLET?
In order to hold and transact with different cryptocurrencies, you will need a crypto wallet. This may be an exchange type of wallet or a non custodial wallet.
It’s advisable to hold large amounts of your crypto holdings in a non custodial wallet, unless you’re frequently trading, then it would be more beneficial to use an exchange.
Many crypto holders generally have a number of wallets for their specified outcome. For example, crypto holders may prefer specific wallets for day trading, long-term holding, transacting with DeFi protocols, and minting NFTs.
DIFFERENT TYPES OF CRYPTO WALLETS
You may have heard of hot and cold wallets before. These are the main types of crypto wallets. A hot wallet is a web-based crypto wallet that you can access via your desktop or mobile device.
A cold wallet is a physical device that looks similar to a USB stick or a small hard drive kept offline.
Hot wallets are connected to the internet, making them easier to access and use, but compared to cold wallets they are easier for hackers to gain access to.
Hot wallet examples:
- Desktop wallets
- Mobile wallets
- Web-based wallets
The hot wallet vulnerabilities arise from your private keys being stored and encrypted by the app itself, which is also connected to the internet.
There is potential for your computer or device to be compromised by malware programs, phishing emails, and malicious links. These are able to break into your system and ultimately gain access to your wallet.
It is advised to refrain from keeping a large amount of your crypto holding in a hot wallet. As well as to be vigilant and attentive when carrying out transactions and clicking on certain links.
Some hot wallets include MetaMask, Trustwallet, Phantom wallet, Exodus, Coinbase wallet, and plenty of web-based crypto exchanges.
As mentioned earlier a cold wallet is kept entirely offline. Although they’re not as user-friendly compared to hot wallets, they do offer far more protection and security for your crypto holdings.
Cold wallet examples:
- Hardware wallets
- Paper wallets
WHAT IS A HARDWARE WALLET?
A hardware wallet is often a small, portable USB or Bluetooth device, which allows you to safely access your crypto assets anywhere in the world.
To perform transactions, you will be prompted to press a physical button on the hardware wallet; this is nearly impossible for any malicious hackers to control.
You can interact with many blockchains using hardware wallets, which means you can store many different cryptocurrencies like Bitcoin, Ethereum, and Altcoins.
WHAT IS A PAPER WALLET?
A paper wallet is where you securely keep your private and public keys on a piece of paper or engraved in metal.
There is no way for hackers to gain access to your wallet through this method.
However, if you lose your paper wallet your fund will be irrecoverable. Also, if the wallet is not stored securely and someone finds it, then they have complete access to your assets.
HOT WALLET VS COLD WALLET: WHICH IS BETTER?
As you can see both wallets clearly have their benefits and weaknesses, so in order for you to utilize the most appropriate wallet, this comes down to how you’re going to use your crypto assets.
For long-term investment, it would be best to store your crypto assets on a cold wallet, preferably a hardware wallet like a Trezor Model T or a Ledger Nano.
For day trading or swing trading then accessibility will be your greatest need, therefore a hot wallet will be crucial to have.
Also, if you plan on playing around with some dApps or minting NFTs, then a hot wallet with a small number of funds would be the best method.
CUSTODIAL AND NON CUSTODIAL WALLETS
Crypto wallets can be further broken down into custodial and non custodial wallets.
These types of wallets can be either hot or cold wallets too.
Custodial wallets are where you don’t physically own the private keys to your wallet. These tend to be hot wallets on crypto exchanges.
These types of wallets are widely known for being accessible, convenient, user friendly, and you’re able to talk to customer support to resolve any issues you may face.
Crypto exchanges and custodial wallet service providers take in-depth security measures that include 2 Factor Authentication, biometric authentication, facial and video recognition, and email confirmation.
Most custodial wallets require you to set up these security steps in order to perform transactions.
The custodial wallet service providers also take further measures to securely store your crypto funds, such as sending a portion of their entire holdings to their cold wallet storage. From here, we can easily understand why it’s beneficial to keep large amounts in a cold wallet.
There’s a saying with regards to custodial wallets. ‘Not your keys, not your coins.’ This refers to the fact that you don’t own the private keys to the wallet, therefore you don’t own the crypto holdings inside the wallet either.
NON CUSTODIAL WALLETS
Non custodial wallets allow you full control of your crypto assets. This means you are solely responsible for your private keys to the wallet.
When you create a non custodial wallet, you will be asked to physically write down 12 words that act as passphrases to access your wallet. It is highly recommended to store these in a safe and secure location. This is essentially your password to gain access to your wallet. It is used as a backup or recovery mechanism in case you ever lose access to your device or delete the app itself.
Non custodial wallets can be hot or cold wallets, for example:
MetaMask is a non custodial hot wallet, as you own the private keys and it’s a web-based wallet.
Whereas a Trezor Model T is a non custodial, cold hardware wallet, as you also own the private keys but the wallet is kept completely offline.
CUSTODIAL VS NON CUSTODIAL WALLETS: WHICH IS BETTER?
Again, this is subjective to how you’re going to use your crypto assets as both types have their pros and cons.
However, one important factor to consider is how well you trust yourself with having sole responsibility for your private keys.
If you’re prone to losing things and aren’t well organized, then maybe a non custodial wallet isn’t for you.
In theory, a non custodial wallet is superior as you own your private keys and full ownership over your assets.
WHICH CRYPTO WALLET SHOULD I CHOOSE?
First, identify what your needs are. Are you a day trader? Long-term HODLer? Using dApps? Minting NFTs?
Once you successfully realize your needs, choosing a crypto wallet that works for you will be easy.
You can then delve further into specific wallets and weigh up certain factors, such as:
- Supported coins & tokens
- Company reputation
- Security features
- Access based on user location
The final choice remains yours but here are a few crypto wallets that we recommend:
Hot, non custodial wallets
- Trust Wallet
Hot, custodial wallets
Cold, non custodial wallets
- Trezor Model T
- Trezor Model One
- Ledger Nano X
- Ledger Nano S