What Is a Crypto Wallet?
Referring to crypto storage as a “wallet” isn’t quite accurate, given that cryptocurrency exists on a blockchain. A crypto wallet is really where you store and secure your proof of ownership — using pairs of public and private keys that give you, and only you, access to your crypto.
Similar to other forms of investing — where you need a bank or brokerage account and passwords to execute transactions — you need a wallet in order to buy, sell, transact, and keep your crypto secure.
You can use a physical device (sometimes called a cold wallet), or software that’s on your computer, phone, or in the cloud (called a hot wallet). Keep reading to learn about the different types of wallets and how to use them to optimize both the trading and security of your crypto.
Why Do You Need a Crypto Wallet?
To understand why you need a crypto wallet, it might be helpful to compare crypto transactions to more traditional financial transactions using a fiat currency (e.g. dollars, euro, yen, etc.).
Traditional banking
When you deposit, withdraw, or invest ordinary money, the financial institution is at the center of every transaction. Although you can access your funds through a private account and passwords or PIN numbers, the financial institution manages, records, and finalizes all your transactions.
Cryptocurrency transactions
Crypto transactions are different because cryptocurrency is not only digital, it’s decentralized and lives on a distributed network known as a blockchain. There is no middleman or central authority like a bank, brokerage, or stock exchange involved. (That’s why these systems are often called “trustless,” because you don’t need to trust a third party; transactions are conducted independently.)
the blockchain. That’s what a crypto wallet enables you to do, and why you need a crypto wallet. The wallet is where you store your public-private key pairs that give you access to your crypto on the blockchain and execute different transactions.
Recommended: Crypto 101: A Beginner’s Guide
How Does a Crypto Wallet Work?
A crypto wallet is pretty simple. The wallet software generates pairs of keys, one public and one private, which allow you to send and receive and otherwise manage your crypto.
A public key can be shared publicly to allow others to send cryptocurrencies to a wallet. In fact, a wallet address is basically a hashed version of a public key — shortened and compressed. A private key is a cryptographic string of numbers and letters which is mathematically related to a public key.
Private and public keys come in pairs because the public key is derived from the private one.
These days most wallets will accommodate many types of cryptocurrency, but not all of them do, so you have to check before buying or sending crypto.
4 Different Types of Crypto Wallets
Most people divide crypto wallets into two categories — hot and cold. Here, we’ll add two more: the paper wallet and the custodial wallet.
1. Cold Wallets
A cold wallet is simply a hardware device, like a thumb drive, where you can store your private keys. A cold wallet is not connected to the internet. You can attach it to your computer using a cable or via bluetooth (although some people believe a bluetooth can be a vector for an attack).
Hardware wallets are less vulnerable to viruses or hackers, and crypto thefts from cold wallets are rare. These devices typically cost between $100 to $200. Ledger and Trezor are both well-known hardware wallet manufacturers.
2. Hot Wallets
The term “hot” refers to the fact that the private keys are held online at all times. While this makes your private keys more accessible when you want to make a transaction, the fact that you must access your wallet using an internet connection may also make it potentially vulnerable. Hot wallets can include desktop and mobile wallets.
Web wallets are online services that you can interact with from almost any device, similar to the way you would access your email. These can be more vulnerable to hacks and cyber theft.
Recommended: Cold Wallets vs. Hot Wallets
3. Paper Wallets
Paper wallets are an outmoded type of crypto storage that’s basically a crude type of cold wallet. A paper wallet involves printing out the private keys on a piece of paper using a key generator program.
While it’s relatively easy to store the private key to your crypto this way, trying to spend or trade some or all of that crypto can be complicated. Most crypto exchanges don’t support paper wallets.
Also, given how easy it is to lose a paper wallet or accidentally destroy it, this is generally not considered a smart way to safeguard your crypto. A paper wallet is vulnerable to theft — and to simple human error in recording the keys accurately. Remember: If you lose your private keys, forget them, misplace them, or if the keys are stolen, you can’t access your crypto and will lose your assets.
4. Custodial Wallets
Some investing apps and platforms, like crypto exchanges, allow you to buy, sell, and store your crypto using an embedded or hosted wallet, meaning the wallet is held on the platform. These wallets are “custodial,” in that the service or exchange actually holds the private keys to your crypto and therefore ultimately controls your assets.
The advantages of a custodial wallet is that it allows you to execute transactions seamlessly from the service or exchange you’re using. The downside is that you don’t have full control over your assets, and there have been some instances where an exchange was hacked.
In general, it’s best to not store large amounts of crypto in online exchanges. You can move it into the exchange when you want to send or sell it, but otherwise keep it in cold storage.
Which Type of Crypto Wallet Is Best?
Even if you have a web wallet or custodial wallet on an exchange, best practices are to invest in a cold wallet as well, especially to store large amounts of crypto. But you have to consider the tradeoff between accessibility and security.
Using a hot wallet that’s connected to the internet, or a custodial wallet that’s linked to your online trading account, can give you easier access to your keys, which translates to less hassle when you want to send or receive crypto.
Storing your crypto using a cold wallet is less vulnerable to hacks, but a little more difficult when you want to trade.
Public & Private Keys: What You Need to Know
Public addresses and private keys are used to view your assets, send, and receive crypto.
A crypto wallet has many public addresses. Anyone can deposit or send cryptocurrency to a public address, but a corresponding private key is required to take the funds.
Your public wallet address is what you give to someone when you want them to send you cryptocurrency.
However, the address is simply a string of numbers and letters, so unless someone knows it belongs to you, your holdings and transactions are anonymous. This transparency combined with anonymity is part of what appeals to many people about cryptocurrencies.
Your private address should never be published or given out to anyone – like your email password. The private key is what’s used to sign off on transactions, and if someone has access to both your public and private keys they now have control over your assets.
There are dozens of online exchanges where you can purchase and sell cryptocurrencies. Many of these allow you to directly link your bank account so you can easily transfer between U.S. dollars and crypto.
You can also directly transact with individuals using wallet applications or paper wallets. QR codes are commonly used as a quick way to sell or send cryptos, or you can send out your full public address.
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Other Uses for Crypto Wallets
Although the primary use for cryptocurrency wallets is to store and transact with cryptocurrencies, there are also other uses for this technology. Tokens or digital information stored in a blockchain that represent anything from goods in a supply chain to a plane ticket can also be stored in and accessed via a digital wallet.
Blockchains can also store personal information such as your identity, tax history, medical information, voting information, and more. In the future we may find ourselves using blockchain-based wallets in many facets of our lives.
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Photo credit: iStock/Elena Perova
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