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What Is A Cryptocurrency Wallet, Why You Need Them & Different Types Of Cryptocurrency Wallets Explained

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Whether you have decided to trade or invest in cryptocurrencies, you must understand the fundamentals of crypto wallets, what they are, and the importance they hold in the crypto world. Using the right wallet for transacting and storing crypto keys is crucial, as it goes a long way in saving traders and investors from frauds and online thefts.

Before diving into the world of cryptocurrencies, it is crucial to get yourself familiar with the basics first.  Before you can begin transacting cryptocurrencies, one of the initial things you will have to establish is a cryptocurrency wallet, where you can securely store all your purchased coins. Several kinds of wallets are offered by various crypto exchanges and platforms, which are discussed in this post. However, before getting to that, here is a brief explanation of what a crypto wallet is and why you need one to store your cryptocurrencies.

What Is A Cryptocurrency Wallet?

A crypto wallet can be described as a tool used to store your cryptocurrencies. Since cryptocurrency exists in the digital form, a crypto wallet stores information such as the private and public keys used to carry out transactions on the blockchain.

Typically, cryptocurrency wallets are automatically created when one opens an account on a cryptocurrency exchange. Alternately, there are hardware wallets may be used to store crypto for flexibility and additional security.

Why Do You Need A Cryptocurrency Wallet?

Trading in cryptocurrency requires a trader or an investor to open a cryptocurrency wallet. All cryptocurrency keys are stored in a digital wallet, much like fiat currency is stored in a physical wallet. However, digital wallets do not store actual currency but information about crypto in the form of public and private keys. Also, it is crucial to note that digital wallets can store multiple cryptocurrency keys.

To trade on the blockchain, one needs to have a cryptographic address generated by the wallet. This address points to the crypto coin's location on the blockchain, to which the other party can send cryptocurrency.

In essence, the wallet is necessary to buy, store and transact cryptocurrency on any crypto exchange.

What Are The Different Types Of Cryptocurrency Wallets?

Dealing with cryptocurrency requires one to have enough knowledge and understanding of the various methods of storing and trading crypto. The first step towards conducting any trade on the blockchain is to choose the right crypto wallet. That depends on the goal and how one decides to invest.

Cryptocurrency wallets can be categorized based on the method and the location of storage.

Hot and Cold Wallets

  • A hot wallet requires one to be connected to the internet, making it the most convenient but highly vulnerable to cyber-attacks.
  • On the other hand, a cold wallet offers a storage facility in offline mode and does not require a connection to the internet resulting in a more secure wallet. Hence, a fraudster would need to be in physical possession of the cold wallet and the security codes to access the private keys.

Software Wallets

Software wallets are a type of hot wallet offering the convenience of online accessibility at all times. Depending on the features, software wallets can serve the needs of different users while still offering robust performance and security.

There are three types of software wallets, namely:

  1. Desktop wallets,
  2. Mobile wallets
  3. Online wallets.

·       Desktop Wallet

A desktop wallet is software that can be downloaded and installed locally on the computer. The cryptocurrency keys are stored on the computer as a file called 'wallet.dat.' Another layer of security can be added by encrypting the desktop wallet, thus, requiring a password each time the private keys need to be accessed. The 'wallet.dat' file can also be backed up to a secure external disk and stored away in case of loss or system failures.

                    Benefits:

  • All private keys are stored locally in the user's computer and not with any third party.
  • Networks like TOR (The Onion Router) can help mask a user's location, adding to the overall security.
  • It is an excellent option for cold storage for private keys if the computer is strictly disconnected from the internet.

Disadvantages:

  • Leaving the computer unattended makes it vulnerable to theft.
  • Not having a robust security solution installed can make the PC vulnerable to malware or ransomware attacks.
  • There is the risk of losing the private keys if the computer crashes and the data is unrecoverable, and a backup has not been created.

·       Mobile Wallet

Mobile wallets in the form of smartphone applications have made it highly convenient for traders on the go. Most of these wallets allow the use of QR codes to send and receive crypto, and, as such, conducting daily transactions becomes quick and straightforward.

Benefits:

  • It is a quick and easy way to send and receive payments on the go.
  • Offers additional features absent in other wallet types, such as QR code scanning.
  • Adds a level of safety as it is carried on the person.

Disadvantages:

  • Smartphones are vulnerable devices open to keyloggers and malware.

·       Online/Web Wallet

Exchange wallets and browser-based wallets are referred to as web wallets. They are online wallets accessed via a browser interface without requiring any additional software to be downloaded. Exchanges have recently started offering coin holders the option to have complete or partial control of their keys, making web wallets an attractive option for more significant holdings.

Benefits:

  • The wallet, hosted by the exchange, makes it the fastest way to complete transactions.
  • It is perfect for maintaining small amounts of cryptocurrencies.
  • Some exchanges offer options of holding and transacting between multiple types of cryptocurrencies.

Disadvantages:

  • The wallet, as well as the exchange, is vulnerable to cyber-attacks as it is always online.
  • The main drawback is that the wallet is not with the owner but with a third party.
  • Even if a strong authentication protects one's wallet, the exchange itself could be compromised.

Hardware Wallet

Hardware wallets are meant to be disconnected from the internet and are, therefore, a type of cold wallet. They need to be connected to the internet only while making a transaction. They are considered to be one of the most secure ways of keeping cryptocurrency keys safe.

A hardware wallet works by generating a random number for the private keys stored within the device itself. When users intend to transfer the keys to the device for secure keeping, they only need to move them from the hot wallet to the hardware wallet's public address. Some platforms provide direct transfer from the hardware wallet, requiring no need for a hot wallet to be used at all.

Suppose a hardware wallet device is lost, damaged, or stolen. In that case, the entire crypto can be recovered to a new hardware device using the seed phrase, also called a recovery phrase created during the initial setup.

          Benefits:

  • The major benefit of a hardware wallet is that it remains disconnected from the internet except when a transaction is to be made.
  • It keeps the digital assets safe even when connected to an insecure computer.
  • It is the most secure way to store large amounts of cryptocurrency keys.
  • One can store all kinds of crypto, and the device can work with different blockchains.

Disadvantages:

  • Due to their complex nature, hardware wallets can be inconvenient, especially for someone new to them.
  • While hot wallets are free, hardware wallets can cost money.
  • Hardware wallets can be a bit cumbersome, considering that they have to be carried around and plugged into a computer to be used.

Paper Wallet

Like hardware wallets, paper wallets are a type of cold wallet because they are disconnected from the internet. Paper wallets were considered the default medium for storing cryptocurrency keys until hardware wallets came along.

Paper wallets are merely the private keys and the corresponding QR codes printed on sheets of paper which could then be kept in a safe or secure place until needed for the next transaction. That would then require the codes to be scanned by a hot wallet to complete the transaction.

          Benefits:

  • As a cold wallet, it is considered a secure way of storing private keys.
  • A paper wallet is safe from cyber threats like malware or ransomware.

Disadvantages:

  • Since it is a physical document, there is the possibility of it being stolen.
  • If a good quality paper is not used or if the printing ink is of low quality, the longevity of the document is at stake. The paper can get damaged, rendering the codes unusable.
  • Too much effort is required to use paper wallets for day-to-day transactions.

 

Final Words

While there are software wallets, hardware wallets, hot wallets, and cold wallets, there is no 'best' wallet out there. Yes, one is right to consider that hardware wallets are the most secure of the lot, but it may not a viable option for someone who does not have a significant amount of cryptocurrency to own. A hot wallet is best for quick and hassle-free transactions, but it is not recommended for storing large amounts of crypto.

Therefore, it boils down to use case scenarios where the user needs to decide which kind of crypto wallet is best suited based on the amount, type, and frequency of transactions to be carried out. A user's best bet would be to strike a balance between security and convenience; after all, it is wiser to sacrifice a bit of comfort to secure one's digital assets.

 

References

  1. Binance Academy. 18 Jun 2019. Crypto Wallet Types Explained

https://academy.binance.com/en/articles/crypto-wallet-types-explained

  1. Bankrate, Cryptocurrency wallet

https://www.bankrate.com/glossary/c/cryptocurrency-wallet/

  1. Jake Frankenfield. 30 Jun 2020. Bitcoin Wallet

https://www.investopedia.com/terms/b/bitcoin-wallet.asp

  1. Radar Relay. 27 Feb 2019. Hardware Wallets Explained

https://medium.com/radartech/hardware-wallets-explained-da8bd93ce801

  1. Toshendra Kumar Sharma. Types Of Crypto Wallets Explained

https://www.blockchain-council.org/blockchain/types-of-crypto-wallets-explained/

  1. Alex Lielacher. 17 Mar 2021. Hot Wallets vs Cold Wallets: What's the Difference?

https://coinmarketcap.com/alexandria/article/hot-wallets-vs-cold-wallets-whats-the-difference

  1. All Cryptocurrency Wallet Types, Explained

https://hobowithalaptop.com/crypto-wallets