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Learning outcomes:
By the end of this article you will understand:
- What a crypto wallet is and how one works
- The concept of custody and what’s meant by a Recovery Seed
- The difference between hot & cold storage
- The different wallet formats – paper, browser, mobile and hardware
What is a crypto wallet?
A cryptocurrency wallet is an interface for sending, receiving, and managing your crypto assets. There are different crypto wallet designs, balancing control, security, and convenience.
We’ll look at those three criteria to help you understand which type of crypto wallet is best for your needs.
Crypto wallets & control of funds
Cryptocurrency is secured by cryptography rather than the authority of a central bank.
To send crypto, you need a pair of keys – a long character string mixing numbers and text. One key is private, acting like a password to unlock funds, and should be known only to you. The other key is public and provides details of where the funds are going; their location on the blockchain.
Public keys are commonly known as Bitcoin addresses. Like a street address, anyone with an internet connection can look up a Bitcoin address and see what unspent funds it holds. There is no personal information associated with it.
A private key allows anyone to move the crypto funds it secures, so keeping your private keys safe is critical. There is no fail-safe with crypto ownership; if you lose your private keys, you lose access to your crypto forever.
This aspect of being in full control of your digital money is considered a feature as opposed to a bug. But, that level of personal responsibility doesn’t suit everyone, so crypto wallets are differentiated by who have control of private keys. This is described as custody.
Non-Custodial crypto wallets
A non-custodial crypto wallet stores private keys, giving the user full control and responsibility.
For ease, private keys for all funds are combined into one piece of information called a Recovery Seed, which is a collection of 12-24 unique words.
A Recovery Seed gives access to all funds secured by a non-custodial wallet if it’s lost or stolen, so it’s essential to protect your Seed.
Custodial crypto wallets
A custodial crypto wallet puts private keys in the custody of a third party but gives you access via traditional account credentials, like a username and password.
You can recover those credentials in the usual way (such as password retrieval), taking away the responsibility of protecting your keys. But you must trust a third party not to be hacked or simply go bust. Removing those trusted relationships was one of Satoshi Nakamoto’s main objectives when creating Bitcoin, the first cryptocurrency.
If you already use a cryptocurrency exchange to buy and sell crypto, your account will automatically include a custodial wallet via desktop, mobile or app. Any crypto you buy will be stored there, with the exchange managing your private keys, until you decide to withdraw the funds to a non-custodial wallet.
Non-custodial wallets put all the responsibility for security on you, but their design differs in how that security is balanced with convenience. These two factors – convenience and security – account for the additional crypto wallet criteria.
Hot vs cold wallets
Being connected to the internet (hot) presents the biggest threat to any crypto wallet, but without an internet connection (cold), you cannot trade or transact.
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Hot wallets –Connected to the internet by default for maximum convenience. Your exchange wallet is a type of hot wallet.
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Cold wallets – Offline by default and only connect to the internet when transacting, maximising security. We’ll introduce the main type of cold wallet below.
To accommodate the preferences for control, convenience and security, different wallet designs have emerged that are either software (soft) or hardware (hard).
Types of soft wallets
Mobile wallets – The most common type of soft wallet is an app on your phone. Mobile crypto wallets can be custodial or non-custodial.
Browser wallets – If you regularly interact with digital applications (dApps) for trading crypto/NFTs, Defi or gaming, you must approve transactions frequently. Browser wallets like MetaMask run as extensions in your browser, giving you the convenience of connecting to a dApp and approving transactions at the click of a button.
By their nature, both browser and mobile wallets are connected to the internet by default, so fall under the hot wallet category. Hot wallets are more convenient but less secure.
Types of hard wallets
Hardware wallet devices –The most common type of hard wallet is a small physical device that connects to a laptop via a USB or QR code. Hardware wallets work with a desktop application to let you view of your portfolio without being connected to your device and exposing private keys.
When you need to sign transactions, you connect the device and make necessary approvals. The Recovery Seed is stored offline.
There are numerous competing cryptocurrency hardware wallet brands differentiated by their usability and security features.
Paper wallets – The most basic form of a hard wallet is a piece of paper with private/public key pairs written as text strings and printed as QR codes.
Paper wallets are simple to use and store and were popular before hardware wallets were available. Paper wallets are free, which might seem attractive, but they require an intermediary system to transact. Moreover, some sites that allow you to generate paper wallets have proved to be insecure.
Summarising crypto wallet types
To summarise the differences between crypto wallets, here are the distinctions between their characteristics in a table along with some pros and cons.
|
Wallet Type |
Custody Type |
Soft/Hard |
Hot/Cold |
Example |
Cost |
Usage |
|
Mobile |
Can be either custodial or non-custodial |
Soft |
Hot |
MetaMask |
Free |
Frequent, small transactions |
|
Desktop |
Custodial |
Soft |
Hot |
Exchange |
Free |
Trading |
|
Browser |
Non-custodial |
Soft |
Hot |
MetaMask |
Free |
Trading, Defi |
|
Hardware |
Non-custodial |
Hard |
Cold |
Ledger, Trezor |
£50-250 |
Longterm storage |
|
Paper |
Non-custodial |
Hard |
Cold |
Bitaddress |
Free |
Intermediate storage |
A recap of crypto wallets: What is a cryptocurrency wallet?
A cryptocurrency wallet is an interface for sending, receiving and managing your crypto assets. There are different crypto wallet designs, which balance control, security and convenience to varying degrees.
Crypto wallets & control of keys
To send crypto, you need a pair of keys – long character strings mixing numbers and text. One key is private: it acts like a password to unlock funds and should be known only to you. The other is public: it provides details of where the funds are going; their location on the blockchain.
There are wallets that manage private keys for you – custodial wallets – and those where you manage the keys – non-custodial – with a Recovery Seed (12-24 unique words).
Security & convenience
Different crypto wallet designs have different levels of security and convenience. Being offline gives maximum security but is less convenient and vice versa.
-
Hot wallets –Connected to the internet by default for maximum convenience. Your exchange wallet is a type of hot wallet.
-
Cold wallets – Offline by default and only connect to the internet when transacting, maximising security.
Hard & soft wallets
Crypto wallets are also differentiated between physical hardware devices (hard) and those that are software-based (soft).