when finding 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 cryptocurrencies are stored until 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 wallets, 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 holds your keys for you. We recommend that 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 bit of a misnomer, and there's more than one type you can use to keep your crypto secure. From an active wallet to a cold wallet, from 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 needed 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 store your keys somehow 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.
What is a crypto wallet?
From the name alone, you would think that a crypto wallet is where you store your cryptocurrency, the same way you store your cash in your physical wallet. However, that is not how they work.
While the wallet in your pocket or bag holds your cash, cards, and a few small things, a cryptocurrency wallet holds the information you need to access your crypto. This is due to the way cryptography works.
Unlike physical cash, which comes in the form of easily transportable bills and coins, cryptocurrency exists solely on its respective blockchain: Bitcoin has a different blockchain than Ether, for example. We go into more detail about that in our blockchain explainer.
How do crypto wallets work?
When you send crypto, you access the blockchain and tell it that you moved a certain amount at a certain time. To do so, you need to prove that you own the crypto being sent, which is where your wallet and the information stored in 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 stands between owning cryptocurrency and not owning it. It also explains why there are so many stories of people buying Bitcoin or whatever, but can't get paid because they lost their public or private keys, or even both.
These would-be millionaires can do nothing but tear their hair out, as there is literally no way to access their digital fortunes without the keys. A wallet is pretty much the only way you can avoid this scenario.
What can a cryptocurrency wallet do?
In essence, a crypto wallet is nothing more than a place where you store your passwords. It's like a password manager for cryptocurrency. However, it is not surprising that people confuse wallets with a place where cryptocurrency is actually stored. First, the name is confusing, since we know what a wallet is; second, because crypto wallets have become much more than just password storage.
For example, many software wallets (and we'll talk more about wallet types in the next section) will also track which cryptocurrencies you own and how much of each you own. There are wallets that will also tell you how much your crypto is worth in real world money and help crypto users track it with charts and figures.
Some wallets are even connected to crypto exchanges, where you trade your fiat currency for digital, and are therefore also portals to increasing your treasury. As a result, wallets have become less of a place where you keep your passwords and more of a personal starting point for all things cryptocurrency.
Here is a short list of some of the things a crypto wallet can do:
- Store and manage your crypto keys
- Showcase your crypto and fiat value
- Track your crypto
- transfer cryptocurrency
- Bet your crypto
- Buying cryptocurrency (wallet exchange)
- Make crypto payments
Types of crypto wallets
As we mentioned earlier, there is more than one type of wallet. In fact, you can classify wallets in many 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 is a piece of paper where you have written your public and private keys. As with any paper, it has the advantage that it is not connected to the web and therefore cannot be hacked, a big problem for cryptocurrency investors. It's also easy to hide a piece of paper among your belongings.
The downside, however, is one we're all familiar with: nothing is as easy to lose as a piece of paper. Anyone who's ever turned their house upside down looking for a specific utility bill, a copy of a diploma, or even the scrawled phone number of a potential partner knows the sinking feeling that you'll never find that damn piece of paper. He now imagines that the paper holds the key to a million dollars.
2. Hardware wallets
A more secure option is to use a hardware wallet: a USB stick that contains your public and private keys.
Technically, any USB with a file containing your keys could work, although you're probably much better off buying one for the sole purpose of protecting your cryptographic information. Hardware wallets come in all shapes and sizes, and with a wide range of prices, so there are plenty of options.
Ledger is a popular type of hardware wallet.
However, in most cases, it is as simple as connecting your hardware wallet to your computer, making your transactions, and then โ this very important โ disconnecting your device again. Then all you need to do is store the USB stick in a safe place and you're good to go.
3. Software wallets (mobile and desktop wallets)
Of course, if you're doing a lot of trading, hardware wallets can get cumbersome, with all the constant connecting and disconnecting. This is where software wallets come into play. These are a very popular type of wallet because they can be used to trade anytime you want as long as you have a device available.
There are several subtypes, such as 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 are connected to the Internet. Not only do they keep your private keys safe, but they also track how much crypto you hold, the type of crypto, and even its real-world money value.
This is all very nice, but of course there is a downside. As with anything related to the internet, it can be hacked. With the amount of money involved in cryptocurrencies, hacking has become commonplace, so having information on the web can be scary. That being said, with all your information in the cloud, you won't have to worry about physical security.
Cold Wallets vs Hot Wallets
Hot or cold wallets refer to whether they are connected to the internet or not.
As you can guess from the previous section, there is another way to subdivide wallets, that is, based on whether they are connected to the Internet or not, better known as hot and cold. No matter how you slice and dice the 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 storage vs hot storage for more.
Both types of storage have their pros and cons. A hot wallet is more convenient for people who are looking to do a lot of crypto transactions, or who want to keep a close eye on their cryptocurrencies and their price fluctuations; Software wallets are almost exclusively active wallets. The downside is that since they are connected to the Internet, they are vulnerable to attack.
Cold wallets, usually some sort of hardware wallet, but paper ones count too, are more for the set and forget type of crypto fanatic. They are not connected to the web, so you have to actively access the internet to move your crypto around when you use them.
They are more secure, but make it less convenient for spot trading. They also come with fewer bells and whistles, no charts or charts here.
Custodial vs. Non-Custodial Portfolios
Finally, there is one last type of cryptocurrency wallet that we should discuss, namely custodial wallets. All of the examples we have looked at so far are non-custodial wallets, which means 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 blindly by the exchange. Generally speaking, when it comes to your money, you're better off holding on to your own keys or you could find yourself much poorer when things go wrong 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 more secure. Which one is best for you depends on your personal situation and how you plan to use your crypto.
What is your preferred type of wallet? How does it relate to your crypto strategy? Is there a type that you think deserves more mention? Let us know in the comments below, and as always, thanks for reading.
