New in crypto? Time to learn about wallets. Wallets are the most important tool you need to understand when entering the crypto world. In this article, you will learn what types of wallets exist and which one best suits your needs.
To start in crypto, the first thing you need is a wallet. And no, we don’t mean where you carry your ID. We are talking about a piece of software that you can download either on your mobile or on your computer. It is this one program that opens the doors to the world of cryptocurrencies, allowing you to interact with different blockchains.
When we hear the word wallet, we automatically understand the place where we keep our money. It is not incorrect to say this in the case of crypto wallets, but that is not exactly how it works. A cryptocurrency wallet is not a token storage device, as the tokens in a blockchain network are not stored anywhere; they are kept as records on the ledger or blockchain. A crypto wallet is a device that manages information, more precisely, cryptographic keys. And it is these keys that grant ownership of a coin, allowing you to write a new transaction on the ledger.
In short, it is much more accurate to say that a crypto wallet is an app that manages information about your cryptocurrencies. Now, what is that information? The most important one that you should know as a user, because you would have to navigate the deep oceans of crypto if you wanted to become a developer, are the keys. To speak in simple terms we will say that your crypto wallet has a key, and that key has two versions, private and public. The private key is a cryptographic key that allows you to sign transactions, therefore it is the one that secures your funds and grants you the ownership of your coins. And the public key, which is derived from the private key, is the one that allows you to receive transactions.
It becomes simple to think of your wallet as your home. The public key corresponds to the address where it is located (such as the street, number and floor), so you share it freely with those who want to visit you or send a package. And the private key is the metal key with which you open the door to your property; you don’t share it with anyone because whoever has it has access to your assets.
Types of crypto wallets
We can classify wallets into two main types based on one of their most important characteristics: the connection to the Internet. This is important because keeping your private keys disconnected from the Internet will increase the security of your coins by reducing the possibility of a remote attack. However, an Internet-connected wallet will be more effective for daily expenses and for money that you keep in regular flow.
The so-called hot wallets are those that are connected to the Internet, either because they work online or because they are installed on a device with an Internet connection. Within the hot wallets, we can make another subdivision according to another important feature: the custody of the keys. Thus, we find:
- Hot wallets held by third parties: cryptocurrency exchange services and other custody services, such as banks, offer their users online wallets. This means that in order to access the wallet, we have to log in to a website. The private keys of these wallets are stored and guarded by the same service provider (the exchange or bank), so users do not have access to them. These wallets are extremely easy to set up, just register as a user on the exchange and that’s it. One of their disadvantages is in the custody of the keys. The service provider is in charge of managing the keys, which means that it is the only one that can sign transactions. This, apart from eliminating the possibility of recovering your funds in another wallet service, places your funds under the responsibility of a third party. If the custodian loses access to the keys, gets hacked, goes bankrupt or actually turns out to be a scammer, you face the risk of losing your funds.
- Self-hosted hot wallets: there are many wallet services that allow you to download an app, either mobile or desktop, to manage your own wallet. There are many options, and you don’t need to pay anything to download them. The process to get them up and running is very simple but you must be rigorous.
The first thing is to make sure you are on the official site of the wallet provider and download the app. This is because there are scammers who impersonate wallet providers to steal your funds. Once installed, the process of creating your wallet begins. After the welcome, your seed phrase will be generated. This seed phrase is a translation provided to the user of your private key, i.e. it is what ensures that you can restore your funds in another app in case you lose access to the device on which it was previously installed. It is presented as a list of 12 to 24 words.
This is the moment when you take pen and paper and write down these words in order and with perfect spelling, and choose a safe place to save them. It is important that you do not take screenshots of them, do not write them down on google drive or iCloud, do not share them via any messaging service, etc. As this information is what allows access to your keys, you must keep it off the internet to prevent it from being compromised. After this, the app will ask you to confirm several of the words in the phrase to corroborate that you have written them correctly and that’s it, your wallet is ready to use.
The counterpart of hot wallets are cold wallets. This means wallets whose private keys have no contact with the Internet. Just like hot wallets, we could divide them depending on whether the keys are guarded by third parties or by the user himself, but the reality is that those guarded by third parties are simply the same services as hot wallets, but they use cold wallets to safeguard their users’ keys. That said, we can speak of cold wallets as those that provide the highest level of security possible within cryptocurrency wallets. Cold wallets are inherently self-custodial, so it is more relevant to divide them according to the physical medium they use:
- Hardware wallets: are physical devices that hold a security chip capable of storing the private keys of your wallet so that, even if you have the device connected to your computer, they never have contact with the internet. The setup process is the same as for the self-hosted hot wallets, the only addition is that you must connect the device to the computer or cell phone where you are configuring it. It is important that you only connect it to your devices, never to an unknown one. You do not need the hardware to receive transactions, but you do need it to confirm your sending.
- Paper wallets: are the most autonomous way to access a cold wallet. Although they are free, they are not recommended for novice users since you need to know which software is compatible in order to retrieve funds in an app.
The process starts with a private key generator. There are many available, so it is important to choose a reliable one with a solid reputation. It is advisable to perform the key generation process by disabling internet access to the computer in question. After that, you should print all the information of your wallet on paper. Similarly, use a trusted printer without wifi connection, which is not accessible by any external device. When finished, be sure to delete any files left in queue or as a backup on the computer before re-establishing the internet connection. That’s it!
With your public key you will be able to send funds to your paper wallet without any problem, and also check your balance in the block explorer. Your funds will be completely out of reach of any attacker. When you want to send them, you will need to retrieve your wallet in a software that allows you to interact with it, so you will need to find one that is compatible with the keys you have generated.
How to choose the best crypto wallet
There are many good and reliable wallet services on the internet, but what really determines which is the best cryptocurrency wallet you can choose is what you intend to do within the crypto world.
If you want to become a trader or an investor on a daily basis, a hot wallet exchange is what can best meet your needs. You have thousands of assets at your disposal and you can take advantage of the best opportunities by making trades that will take just a few seconds.
If your goal is to become a holder and you plan to maintain the position of what you have invested in cryptocurrencies in the long term, a cold wallet is the most recommended. You secure your funds and keep them out of reach of hackers, malware, and any other cyber threats.
It is common for these two profiles to overlap. If you are a trader, there will be more valuable holdings than others. For the investments you want to hold long-term, it is better to transfer them from the exchanges’ centralized portfolios to a self-hosted wallet. If you are a holder, you will eventually need access to a hot platform to acquire more assets or to take profits at a good time in the market.
Thus, it is rare that a user who has already gained a foothold in the world of cryptocurrencies does not have at least one account on an exchange, a self-hosted wallet, and a cold wallet, to balance the activities performed with the assets. Use the Blockpit cryptotax tool to track your entire portfolio. Start for free here.