Cryptocurrency wallets: learn about the different types and why they matter23 min readReading Time: 9 minutes
Cash, particularly cash used daily, is typically stored in wallets, debit cards, and, more recently, e-wallets such as Apple Pay and Google Pay. The universe of digital currencies works the same way. To store Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC), or any other crypto asset, you need to use cryptocurrency wallets.
In this article, we’ll explain how wallets work, how to secure them, why they’re important, and how to choose one.
What is a cryptocurrency wallet?
When one person transfers cryptocurrencies to another, these assets are stored on the blockchain. Blockchain is the famous decentralized database that was born with Bitcoin (BTC) in late 2008.
Wallets are the software and physical devices that give users access to the digital assets stored in that system. In addition, they also allow the sending of digital currencies without the need for intermediaries.
In practice, wallets are similar to bank accounts, but with one big difference: it is the owner of the wallet who is responsible for the ownership and security of his assets, not the bank.
How does it work?
At first glance, the functioning of a cryptocurrency wallet seems complex. However, when comparing the technology to more popular services such as bank transfer and email sending, it becomes easier to understand. See below:
After a wallet is created, a “seed” is immediately generated. This seed is a string of 12 to 24 words, which works like a system recovery password. Keep it safe and don’t show it to anyone.
Right after the seed is created, the wallet releases a private key, a public key, and an address. The private key is like your bank account password. You should not pass it on to anyone, as it is through it that you have access to cryptocurrencies.
The public key, on the other hand, is like your bank account. Your cryptocurrencies are stored in it, and can only be released with the private key. Since it’s public, anyone can see it, but no one can move funds into it.
Finally, the address is like your bank account number. It is this address, derived from the public key, that must be informed in cryptocurrency transfers. It’s an alphanumeric string like this one: 1G2bAat5x1HUXrCPQbtMDqcw7o5MNn5owX.
It is also possible to make an analogy with sending emails:
To send a message to someone, you need to log into your email service – like Gmail or Yahoo, for example -, enter your password, write the message, and put the recipient’s address, right?
In the case of cryptocurrencies, the private key is the email password. The public one, in turn, is the email account (Gmail, Yahoo, etc). Lastly, the cryptocurrency wallet address is the email address – firstname.lastname@example.org.
This whole mechanism of keys and addresses is based on cryptography, a technique that consists of the exchange of protected messages between two or more parties.
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Types of wallets
There are several types of wallets on the market, with different formats. In general, however, the available models can be divided into two large groups: hot wallets and cold wallets.
See the differences between them below.
Hot wallets are those wallets connected to the Internet. They are more practical than cold wallets but tend to be more vulnerable to virtual attacks. There are versions for mobile, web, and desktop.
These are cryptocurrency wallets that can be downloaded from mobile app stores such as Google Play and the Apple Store. For those who want to shop at establishments that accept Bitcoin and altcoins, they are very practical.
Despite being practical, these wallets are more vulnerable to malicious programs, as they are online. Keeping all cryptocurrencies in a mobile wallet can also be risky in cases of cell phone theft.
Web hot wallets are those that can be accessed by the browser itself. The user only needs to enter the wallet page and enter data such as login and password to move their cryptocurrencies.
Like mobile wallets, they are practical. However, as they are always connected to the internet, they are also more susceptible to hacker attacks.
Desktop wallets are programs that can be downloaded and installed on your computer’s hard drive. Unlike what happens with web and mobile wallets, in this type of wallet, user information is stored on the PC, not on the internet.
Overall, they are more secure than mobile and web cryptocurrency wallets. However, the user needs to be careful and keep the equipment away from malware, viruses, and others.
Cryptocurrency cold wallets are those that are not connected to the world wide web. Because they are off the web, they are generally safer. There are two main types.
Hardware wallets are physical devices where you can store cryptocurrencies. They are small and very similar to thumb drives.
Because they are not connected to the Internet, they are more secure than hot wallets. On the other hand, they are not practical at all, especially for those who need to use cryptocurrencies daily.
The main hardware wallets on the market are from the Ledger and Trezor brands.
It’s a piece of paper printed with private and public keys. There are programs, such as BitAddress, where you can generate a paper wallet.
Because they are physical, they are more secure than hot wallets. However, they also pose risks, both virtual and physical.
The person’s computer may, for example, be infected with a virus at the time of wallet creation. Or, the ink used in printing can wear out over time, causing the information to be erased.
What is the difference between a wallet and an exchange?
One of the maxims widespread in the universe of cryptocurrencies, especially among older investors, is the following: “Exchange is not a wallet”. And the statement is true.
A wallet is a piece of software or a device where you can store information that gives access to cryptocurrencies stored on the blockchain. That is, it is where the private and public keys are, as well as the addresses.
An exchange, on the other hand, is a platform that allows cryptocurrency trading, not a wallet. It is possible to leave the cryptocurrencies in them, of course, but in that case, your public and private keys are in the possession of the brokerage. Therefore, it is responsible for the custody of its assets.
Leave cryptocurrencies in a wallet or exchange?
Many cryptocurrency investors wonder whether it is better to leave cryptocurrencies in wallets or exchanges. Both possibilities have positive and negative sides.
The downside of leaving it in brokerages is that they, because they move a lot of cryptocurrencies, are targeted by hackers. In the world, there are several cases of exchanges that lost investor assets.
In October 2021, the Coinbase brokerage, one of the largest in the world, revealed that hackers stole cryptocurrencies from at least 6,000 customers. According to the company, unauthorized third parties exploited a flaw in the company’s account recovery process to gain access to victims’ accounts and transfer funds.
However, because they are targeted by cybercriminals, exchanges tend to invest heavily in security.
Furthermore, even though the cryptocurrency market is not regulated, most brokerages tend to comply with the legislation. Therefore, if a problem occurs, such as fraud or bankruptcy, the user can go to court. In the case of possible problems with wallets, it would be a little more complicated to ask for legal aid.
The positive side of using wallets is the possibility of becoming your own bank. The user is, therefore, responsible for taking care of his cryptocurrencies and calculating the transfer fees. You also don’t have to pay the fees usually charged by brokers. It has even more security, as long as you take the necessary precautions against viruses and malicious programs.
Although the autonomy generated by the use of wallets is seen by some as positive, others see it as a problem. That’s because not everyone has the time or desire to understand the details of the cryptocurrency market. In that case, holding coins on exchanges might make more sense.
Which cryptocurrency wallet to choose
Choosing the type of cryptocurrency wallet will depend on the objective.
- Day by day – If the idea is to use your cryptocurrencies daily to buy coffee at a bakery or pay bills, for example, the ideal is to keep them in mobile wallets. They are practical and work almost like wallets used to store paper money.
- Long term – If you have a large asset in cryptocurrencies, and plan to hold the assets for a long time, a good option is to put them in hardware wallets, as they are more secure. To further protect crypto assets, one possibility would be to store the device in a vault.
- Custody – Finally, if you do not want to be responsible for the custody and care of your assets, it is worth leaving the cryptocurrencies in the brokerages. In this case, it is important to analyze whether the exchange is serious and not a scam.
How to do a risk analysis of a cryptocurrency portfolio
Before choosing a cryptocurrency wallet, you need to do a lot of research on it. The points below must be taken into account.
- Reputation – It is important to verify that the wallet and the people behind it are serious. Social networks, news sites, and opinions published in app stores are great sources. It is also interesting to chat with other users.
- Types of Cryptocurrencies Supported – Some wallets support a few cryptocurrencies, while others support many. If you intend to have different types of assets, opt for those wallets that accept your portfolio currencies.
- Ease of use – Some cryptocurrency wallets have better usability than others. Review the opinions of other users regarding this aspect. A good alternative is also to test several of them and see which one you prefer.
- Security – Before choosing a wallet, it is worth entering the website of each one and analyzing what security measures are offered. Is there two-factor authentication? Is there biometrics? The more security levels, the better.
Importance of making a cryptocurrency wallet
A cryptocurrency wallet is important because it gives the user the possibility to become their “own” bank and have autonomy over their finances.
By using cryptography, the wallet also protects assets in cryptocurrency. However, the user also needs to do his homework and beware of attacks by hackers and malicious programs.
Advantages and disadvantages of wallets
Each type of cryptocurrency wallet has its advantages and disadvantages.
Practicality is the main advantage of hot wallets. A smartphone wallet, for example, makes life easier for anyone who wants to use cryptocurrencies for day-to-day payments. The disadvantage of this group lies in the fact that they are connected to the Internet, which makes them more vulnerable to virtual attacks.
Cold wallets are safer because they are not online. A hardware wallet, which is very similar to a pen drive, is the most recommended for those who need to store large amounts of digital assets for a long time. The disadvantage of this group is the lack of practicality.
How to protect your cryptocurrency wallet?
Users who choose to manage their funds in wallets need to be careful about security. Below are some tips. The recommendations apply, however, to wallets that support other cryptocurrencies as well.
- Protection – You need to keep your seed under lock and key. That’s because if someone has access to it, they will have access to your funds. Therefore, it is ideal to put it in a safe place (it is not worth taking a screenshot and leaving the file in the cell phone gallery). But be careful not to keep it too well and forget where you put it.
If you can no longer find the seed, unfortunately, you won’t have access to your funds. There is no password recovery service in the cryptocurrency market. It is estimated that 20% of the 18.8 million BTC mined are lost due to loss of credentials. In dollars, the value is something around US$ 216 billion.
- Distribution – Do not leave large amounts of cryptocurrencies in just one wallet. If you wouldn’t leave $1,000 in your pocket, maybe you should give your Bitcoin wallet the same consideration.
- Backup – Make backups of the wallet frequently. In this way, it is possible to protect against possible failures, whether human or virtual. The wallets have different procedures, but in general, they offer a backup option within the platform itself.
- Update – It is ideal to keep your cryptocurrency wallet with the latest version of the software. These updates usually fix possible problems, “upgrading” security processes.
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