What Is a Crypto Wallet? All You Need To Know
News about hacks, bankruptcies and lost seed phrases can initially make crypto wallets seem intimidating. But don’t worry; there is a self-custody fit for everyone. This comprehensive guide will walk you through everything you need to know about storing digital assets.
Graphic by Crystal Le
A crypto wallet is a software or hardware application that securely stores the private keys associated with your cryptocurrencies. You can use the wallet to send and receive crypto without seeing those cryptographic codes.
- There are many types of self-custody wallets — with varying security vulnerabilities.
- They are evolving to do more than just custody of digital assets. New smart contract tech is making them an essential puzzle piece to navigating Web3.
- Misconceptions: Some believe that crypto is stored in wallets. It is recorded on a public ledger stored on a blockchain.
- Key terms to know: Private key, public key, seed phrase, hot wallet, cold wallet
- Overall, understanding the different types of crypto wallets and how they work is crucial for the safe and secure management of digital assets.
Table of contents
- What is a crypto wallet
- Why use it
- How does it work?
- Types of wallets (Read more: Hot Wallets vs. Cold Wallets)
- Picking the best wallet
- Best place to buy wallets
- How to set up a wallet
- The security risks
- Best practices for security (Read more: What is the key phrase and do wallets need it?)
What is a crypto wallet?
A crypto wallet is a device that safely stores and manages your private keys — the cryptographic string of letters and numbers needed to approve transactions. Don’t think of it like a traditional wallet. It doesn’t cram your crypto in one place, next to the old receipts and expired coupons.
It is more like an intelligent key chain that manages keys needed to move funds from one locked box to another. Advances in user-interface technology make this possible without needing to see each key.
A crypto wallet usually provides a user-friendly platform that simplifies the transaction process. For instance, a crypto wallet may allow you to store cryptocurrencies from different blockchain networks. Each time the user initiates a transaction, the wallet communicates with the specific blockchain to execute the required action. The wallet sends a notification for you to confirm the transaction by signing a message.
New smart contract crypto wallets not only store your private keys but also provide access to decentralized applications (dapps) and the Web3 economy, allowing you to participate in the new digital landscape.
Using a cryptocurrency wallet grants individuals financial sovereignty and aligns them with the fundamental ethos behind cryptocurrencies. Bitcoin’s anonymous creator Satoshi Nakamoto designed the cryptocurrency to facilitate peer-to-peer transactions without the involvement of a third party.
Why use a crypto wallet?
With a personal crypto wallet, users become their own bank. They have the rare opportunity to securely store a portion of their wealth without relying on a third-party custodian such as a bank or centralized exchange.
The cryptocurrency industry is no stranger to exchanges losing billions of dollars to poor security practices or mismanagement of deposited funds. Using a crypto wallet protects an investor from such mishaps. It strips centralized platforms of their power to rehypothecate user funds and artificially inflate the value of certain assets.
Noteworthily, financial sovereignty comes with substantial personal responsibility. Investors that choose self-custody must learn the ropes to avoid losing their assets.
How does a crypto wallet work
A cryptocurrency wallet is a user’s passport to interface with the underlying blockchain. For first-time users, a cryptocurrency wallet typically generates a unique private key (similar to a secret bank pin) and a public key (similar to a bank account number) used for transactions.
A cryptocurrency wallet does not hold the actual coins or assets. Instead, it stores the private and public keys to the user’s address(es) on the blockchain. The wallet allows users to quickly sign a transaction with their private key to prove ownership of assets and transfer them from one address to another.
On the front end, a crypto wallet also provides tools for seamlessly managing cryptoassets. Users can generate new addresses, initiate transfers, track portfolio balances, and sometimes buy/sell cryptocurrencies using a fiat gateway.
Types of wallets
Cryptocurrency wallets come in different designs ranging from simple-to-use applications to sophisticated security solutions. Users must carefully consider the tradeoffs with each type and evaluate their needs before making a decision.
Mobile wallets typically exist as free-use applications available on Android or iOS devices. Users can install mobile wallets from their respective app stores and get started within minutes. Some popular mobile wallet options include Trust Wallet, Coinbase Wallet, Coinomi and Metamask Mobile.
Mobile wallets offer some of the best user experiences for crypto investors. Users can send and receive cryptocurrencies, shop online, and occasionally interact with decentralized applications.
Web wallets (exchange wallets)
A web wallet (also often called a Web3 wallet) exists as a browser extension. You can use it to exchange cryptocurrencies or connect with and perform transactions on dapps such as those used in decentralized finance (DeFi) and gaming applications.
Most web wallets are also free to use, with the best options supporting a connection to leading blockchains such as Ethereum, Polygon, Solana, BNB Chain, and others. Famous web wallet examples include Metamask, Coinbase Wallet, Phantom and Trust Wallet.
Desktop wallets are native applications for macOS, Linux, Windows, and other desktop-based operating systems. Most desktop wallets include the option to generate a private key file that users can securely store and use to recover funds if the device breaks down. Examples of desktop crypto wallets include Atomic Wallet, Exodus, Electrum, Coinomi and Bitcoin Core.
Hardware wallets are physical devices with customized chips for storing cryptographic keys. Most hardware wallets store private keys offline and require users to sign transactions in this mode. Next, the transaction data is transferred online via an encrypted connection onto the blockchain.
Ledger and Trezor are the most popular hardware wallet brands among crypto investors. New-age devices such as Casa and the Ngrave Zero also offer features that have grown their market appeal.
Cold storage wallets
Cold storage wallets is a term that denotes the practice of setting up a hardware wallet not intended for use in regular transactions. Cold storage wallets typically hold cryptoassets put away for the long term, with the offline storage of the private key eliminating the risk of losing funds to online attackers.
As the name suggests, a multi-signature wallet requires multiple cryptographic signatures to approve a transaction. It allows for distributed ownership and provides an additional safeguard against potential theft.
Atomic Wallet and Electrum (desktop wallets) offer a multi-signature feature for securing your cryptocurrencies. Casa and BitPay also provide mobile wallets with multi-signature support.
A paper wallet is a piece of paper with your private and public key addresses written on it. Users can transfer coins to the generated wallet address and securely store the paper. There is also the chance of retrieving the assets by restoring the private key on a mobile or desktop wallet and transferring the coins to a new address.
Paper wallets are generally considered an outdated way to store cryptocurrencies. However, they are handy for specific situations, such as gifting cryptocurrencies or setting up a temporary cold storage solution.
Ethereum Request for Comment 20 (ERC-20) is the standard for creating fungible tokens on the Ethereum blockchain. ERC-20-compatible wallets allow users to manage ether (ETH), the Ethereum network’s native currency, and ERC-20 tokens.
The majority of leading mobile and desktop wallets are ERC-20 compatible. However, the best ERC-20 wallets are Metamask, MyEtherWallet and Coinbase Wallet.
Read more: Hot Wallets vs. Cold Wallets
What to consider when picking a wallet
An investor’s choice of a crypto wallet depends on their specific needs. In this section, we narrow down what to consider when choosing a crypto wallet to three main points:
Bitcoin-only wallet or multi-currency wallet
A key consideration when picking a wallet is the number of cryptocurrencies in your portfolio. Bitcoin-only investors may not need a wallet that enables support for other assets, while individuals with a diversified portfolio will require one that supports a wide range of coins.
A bitcoin-only wallet may natively include advanced features such as message signing, mining pool synchronization, and lightning network compatibility. On the other hand, a robust multi-currency wallet will let you hold most of the leading altcoins, including tokens created on their underlying network.
Before installing or purchasing a wallet, prospective users can visit the developer or manufacturer’s website to find a list of supported assets. Picking a wallet that holds all assets in your portfolio eliminates the need to own multiple wallets, which may be challenging to manage.
Research wallet’s reputation
Researching a wallet’s reputation is crucial to learning about potential security risks and usability issues. A simple research method for mobile and desktop wallets is going through the app ratings and user reviews on the respective app stores.
Another approach is to join the wallet’s social media community on Reddit or Discord to read user feedback and complaints. Watch out for critical reviews and how the wallet company manages such feedback.
It is also helpful to read reviews published in independent online publications, albeit being wary of paid reviews and comments. The most reputable crypto wallets have independent reviews posted by thousands of online publications, lending credibility to their usability.
Understand what you will use the wallet for
Because different wallets serve specific use cases, understanding your needs simplifies choosing one. For instance, a mobile wallet is ideal if you hold a small amount of cryptocurrency for everyday payments.
Investors with substantial amounts in the DeFi and NFT niches find it more secure to invest in a hardware wallet for regular transactions. If the objective is to store away cryptocurrency, then a cold storage wallet provides the needed security. Meanwhile, a multi-signature wallet is ideal for business organizations to guarantee distributed ownership and advanced security.
Where is the best place to buy a wallet?
The manufacturer’s website is the best place to purchase a crypto wallet. The two most popular wallets, Ledger and Trezor, offer a direct purchase option for multiple devices on their website.
Buying crypto wallets from Amazon and other third-party eCommerce websites poses considerable security risks. Several verified reports have popped up of malicious sellers and third-party shipping agents tampering with the devices and siphoning funds from the wallets once the original buyer begins using them.
The same principle of security applies to mobile and desktop wallet applications. Users must download applications from official sources to mitigate risks related to crypto-malware.
How to set up a wallet?
Setting up a crypto wallet is one of the first experiences for new cryptocurrency investors. Although the user interface may differ, the entire setup process typically involves three steps, which are outlined below:
1. Initialize the wallet
Review the wallet packaging and content for hardware devices to ensure it is still tamper-proof. Next, turn on the hardware device or open the installed mobile or desktop wallet. Read and agree to the provided terms and carefully review any instructions for using the wallet. Choose the option to create a new wallet or restore an existing one if you already have a seed phrase.
2. Obtain and securely store your seed phrase
First-time users receive a prompt to create a new seed phrase. The wallet automatically generates a random 12- or 24-word phrase representing your newly generated private key. Some wallets also allow viewing your private key, which is ordinarily alphanumeric.
Write down the seed words and store them in a secure location, preferably offline. Some investors also use a steel plate to engrave their seed phrase, ensuring protection against fire outbreaks and other extreme hazards.
Most wallets prompt you to confirm the generated seed phrase by re-entering them or choosing them sequentially from a list. Either way, carefully review each word and ensure you have written them correctly before completing this step.
Finally, set a transaction PIN for your wallet. The transaction pin ensures only you can spend funds from your wallet. However, anyone can override the transaction PIN by obtaining your seed phrase. Set an easy-to-remember PIN and also store a backup away securely.
3. Choose cryptoassets and complete the setup
Multi-currency wallets allow users to select coins they want to send and receive. For hardware devices such as Ledger, users must install apps for the specific coins they wish to hold in the wallet. The coin selection marks the final step of the setup process, after which, users can generate addresses for receiving coins.
What are the security risks of using a wallet?
Crypto wallets are a popular way to store and use your coins, tokens and NFTs. However, like all digital devices, they are susceptible to security risks. Some of the most common security risks associated with wallets include the following:
Hack and theft
Cryptocurrency investors are often targets of both online and offline security attacks. Online attacks include phishing, brute force attacks, and smart contract-related risks. If an attacker gains access to your wallet, they can steal your crypto.
Although hardware wallets provide substantial security against online attacks, there are confirmed reports of physical assault on crypto investors with bad actors requiring them to sign a transaction to transfer assets.
Mobile and desktop wallets are highly susceptible to malware that could crash the application or transfer user assets to a malicious address. A common type of malware that infects a device’s clipboard could swap the victim’s copied address with that of a hacker, resulting in permanent loss. While regular upgrades make this risk avoidable, many investors have lost millions of dollars to crypto-malware.
Technical and human risks
Using a personal wallet means users risk losing funds to technical and human errors. Examples include a UI glitch, transferring funds to the wrong address or network, or signing malicious transactions.
How to make your wallet more secure
Wallets come in different shapes and sizes, but security is crucial when choosing a wallet. Users are responsible for protecting their crypto from theft, fire, or any other form of loss. Some wallets are more secure than others, so it’s essential to do your research before choosing one.
Storing your seed phrase
If you want to keep your seed phrase safe, it’s essential to store it in a secure place. You can store it on a piece of paper, in a cryptographically secure safe, or metal plate. Keep it hidden from others, and don’t tell anyone your seed phrase. Split the seed phrase in two for further protection and keep it separate.
Use an extra seed phrase
Some hardware wallets include the option for an extra seed phrase. This feature allows a user to add a 25th word to their seed phrase, so even if someone finds it, they need to guess another word that the user created. Creating a unique and hard-to-guess extra seed phrase makes your wallet more secure.
A multi-signature wallet provides additional security as transactions require multiple private keys to confirm. Determine an ideal multi-sig setup, namely 2-of-3, 3-of-5, or 5-of-7, where the initial figure represents the number of keys required to approve a transaction. Storing the private keys in several locations or with trusted third parties eliminates the risk of having a single point of failure.
Use more than one wallet
This strategy is beneficial to protect you from any number of the previously mentioned security risks. Manufacturers typically recommend having at least two wallets, one designated for regular transactions and another for long-term holdings. Creating a new wallet (also known as a burner wallet) for high-risk activities such as NFT mints is another way to avoid losing money.
Access from a secure computer
Many investors find it helpful to have a secure computer to connect to their hardware wallet or execute other crypto transactions. Overused computers can pick up malware, which may go unnoticed for a long time, particularly for devices with weak OS security. For obvious reasons, accessing your crypto wallet on a public computer or WiFi is also not advisable.
Where can I buy a hardware wallet?
You can buy a hardware wallet from websites of official brands including Ledger and Trezor. Ordering a device from unofficial sources such as Amazon or eBay introduces the risk of receiving a compromised hardware wallet. Buying from the official website also entitles users to customer support in case any issue arises post-purchase.
How much does a wallet cost?
Most mobile and desktop crypto wallets are free to use. However, hardware wallets can cost between $80-$500 depending on the specific brand and other features such as the number of supported coins, multi-signature compatibility, and operating system. It is advisable to compare prices across different brands before making a purchase decision.
How do I set up a bitcoin wallet with no ID?
There is no ID requirement for setting up a bitcoin wallet. Anyone can simply install a mobile or desk wallet on their device to receive transactions. The requirement for an ID is associated with using bitcoin exchanges where people buy BTC with cash. These platforms must comply with anti-money laundering and know-your-customer (AML/KYC) requirements as mandated by government regulations.
If you choose to order a hardware wallet from a vendor, you must usually provide a shipping address and some personal information. Still, an ID card is often not required to make the purchase.
Can law enforcement freeze/seize a wallet account?
Law enforcement can only freeze a personal crypto wallet if they obtain private keys. However, they may take other measures to make it difficult for the holder to spend the coins in the wallet.
A common approach is to publicly blacklist the address(es) and enforce laws that mandate centralized platforms to report any transactions received. Such restrictions make it difficult to convert the coins to fiat, although the holder can still freely send them on the blockchain to other addresses.
What happens If I forget my wallet password?
You can quickly recover your wallet using the seed phrase generated during the initial setup. The wallet password is mainly used for confirming transactions and does not hold the assets stored on your address.
What happens if I lose my wallet?
Cryptocurrency seed phrases work across multiple devices and applications. If you lose a physical hardware wallet or the software application on your device, you can easily restore your wallet using the seed phrase. Unless specified otherwise, the wallet provider cannot help you recover your seed phrase.
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