There are countless definitions of a crypto wallet. Essentially, this term refers to an app that enables cryptocurrency users to retrieve and store their digital assets. Generally, you can think of a crypto wallet as a convenient way to keep all your crypto assets in one place. Therefore, acquiring any cryptocurrency requires storing it in a wallet, which you can use to perform crypto transactions.
However, to understand the definition of this term is to merely scratch the surface. You must go deeper to learn more about how crypto wallets work and how you can use them to your advantage.
What is a Crypto Wallet and how does it work?
If you own a computer or smartphone, you likely have different apps running on these devices. A cryptocurrency wallet is one such app that you can install and use on both devices, although it’s not your only choice. You can also purchase a unique physical device that runs a wallet app if you prefer the experience of holding a physical wallet.
In the early days of cryptocurrency, wallets were exclusively used for individual cryptocurrencies. For example, owning Bitcoin meant having a BTC wallet, and owning Ethereum meant having an ETH wallet. Sending funds between disparate wallets was a nightmare, mainly since it often resulted in permanently losing access to your crypto if you sent them to the wrong wallet. However, wallets today can hold multiple cryptocurrencies.
How Does a Crypto Wallet Work?
If you own a crypto wallet and want to acquire cryptocurrency assets, you use a unique cryptographic address issued by the wallet and direct the sender to that address. It doesn’t matter whether you’re earning crypto as revenue, receiving it as a gift, or purchasing it on a cryptocurrency exchange like CEX.IO — the process is always the same.
When understanding what a crypto transaction looks like using your wallet, you might imagine files stored on a USB drive. However, this analogy is not 100% accurate because the information stored in your wallet only points to your assets’ location on the blockchain.
In other words, while your holdings live on the blockchain, you can only access them by using your wallet’s private key (more on this in a bit). Your wallet keys (private and public) prove that you are the owner of your digital funds and enable you to perform transactions. Therefore, losing your private key means you permanently lose access to your wallet and the funds contained within.
Two key pairs comprise a crypto wallet: public keys and private keys.
Image Source: crypto.com
On the one hand, a public key derives from the private key and acts as the address used to send crypto assets to the wallet. However, note that crypto wallets can have numerous public keys, allowing you to give out multiple different public addresses and use all of them to receive crypto to the same wallet.
On the other hand, the private key is the most critical part of a crypto wallet and is simultaneously the source of numerous headaches for new crypto users. This key is identical to a safety deposit box key in that any individual with access to this key can control the assets within that wallet.
The Various types of Crypto Wallets
The generally accepted consensus in the crypto community is that there are two main crypto wallet types: hot and cold wallets. However, you should note that there is another critical classification of crypto wallets: custodial and non-custodial. Here’s what you need to know.
What is a Hot Crypto Wallet?
The simplest way to differentiate between hot and cold wallets is to observe their internet connectivity. Cold wallets operate offline, while hot wallets are always connected to the internet. Consequently, hot wallets offer more accessibility to the funds stored inside them but are also more prone to hacker attacks. Desktop wallets, mobile wallets, and web-based wallets are examples of hot crypto wallets.
Hot wallets are always online, and the private keys to access these wallets are encrypted and stored on the wallet app. Consequently, keeping significant amounts of cryptocurrency in a hot wallet is considered a fundamentally poor security practice. However, you may mitigate some of the risks by using a wallet that features more robust encryption.
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What is a Cold Crypto Wallet?
Contrary to their hot counterparts, cold wallets are entirely offline. The trade-off in using these wallets brings increased security, but at the cost of much less convenience. Since you can use an engraved piece of metal or a mere piece of paper as a physical medium for cold storage, cold wallets typically include paper and hardware wallets.
You can write down or print your public and private keys on a piece of paper, representing a physical location that’s safer than keeping your crypto in a hot wallet. The reason is that remote hackers cannot access these keys in any way. However, if the piece of paper you used to store your wallet keys becomes lost or destroyed, the funds in your wallet will become permanently unrecoverable.
Hardware wallets are usually external devices like Bluetooth or USB devices that store your public and private keys. Since pushing a physical button on these devices is the only way to sign a transaction, these wallets provide increased security by preventing malicious hackers’ access.
Should you use a Cold or Hot Wallet?
The frequency of accessing your crypto assets, and their intended purpose, should dictate your decision. On the one hand, hot wallets are the better choice if you intend to trade your crypto assets daily since accessibility will be your primary concern. On the other hand, a cold wallet is the preferred option for those who value security over convenience and are looking to store a massive amount of cryptocurrency.
Custodial Vs. Non-Custodial Crypto Wallets
Custodial wallets are typically available on cryptocurrency exchanges (like CEX.IO), and most web-based wallets tend to belong in this category. Custodial crypto wallets are popular among experienced day traders and crypto newcomers, thanks to their ease of use and convenience.
When using such wallets, you no longer have complete control over your tokens, and the exchange is in charge of your private keys necessary to sign for transactions. Consequently, using a custodial wallet implies a high level of trust between the user and the service provider (exchange). The reason is that it is up to the exchange to implement robust security measures to prevent unauthorized access and token storage.
To that extent, CEX.IO has safely stored users’ crypto funds since 2013, earning a stellar reputation as a trusted and reliable crypto exchange. The platform uses biometric authentication like fingerprint verification and facial recognition, but also email confirmation and two-factor authentication to ensure users’ funds remain exclusively their own.
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What are Non-Custodial Wallets?
Since users store the private key to their wallets locally, non-custodial wallets give them complete control over their crypto assets.
Starting to use a non-custodial crypto wallet is somewhat more complex than a custodial one. You will typically need to write down and then safely store a list of 12 randomly generated words. This list is called a “mnemonic,” “seed,” or “recovery” phrase, which will be used to create all of your private and public keys. If you lose access to your device, this phrase will serve as a recovery mechanism or backup.
Note that any individual that gains access to your mnemonic phrase will have full access and control over your crypto. Additionally, if you lose this phrase, you also lose access to your funds, which underlines the importance of not storing a digital copy of it anywhere and keeping it in a highly secure location. Therefore, you should not take a picture of the phrase with your phone or print it out using a public printer!
Should you use a Custodial or Non-Custodial Wallet?
Like deciding between a hot and cold crypto wallet, choosing a custodial or non-custodial wallet comes down to what type of crypto user you intend to be.
On the one hand, you may want to consider a non-custodial wallet if you prefer total control over your crypto assets.
However, on the other hand, it makes more sense to use a custodial wallet like that of CEX.IO, if you are prone to losing or misplacing passwords and devices. In this case, a custodian or exchange typically has better backup options and security practices, making them popular among inexperienced crypto enthusiasts. Lastly, custodial wallet transaction fees can be affordable (sometimes even free), making them the perfect choice.
Disclaimer: For information purposes only. Not investment or financial advice. Seek professional advice. Digital assets involve risk. Do your own research.