- A crypto wallet is a tool that allows a user to interact with a blockchain network.
- Wallets are usually referred to as “hot” if it is directly connected to the internet and “cold” if it is not.
- The main types of crypto wallets are software, hardware, and paper wallets, with software wallets being the most common due to convenience.
Each unique address on a blockchain network has a public key that acts as an identifier and account number where funds can be transferred and a private key that functions as a password that gives access to the assets held on that address.
Decentralized crypto wallets come in various forms including software, hardware and paper wallets, each falling under the classification of a hot or cold wallet. Software wallets are the most prevalent currently due to their convenience, while hardware wallets are more secure. Paper wallets, which consist of a public and private key printed on a piece of paper, were more popular in the early days of crypto, but are now considered obsolete and unreliable due to the evolution of the industry.
How Do Crypto Wallets Work?
To explain crypto wallets as means of storing cryptocurrency assets would be inaccurate because all they actually do is store the public and private keys of a cryptocurrency address and provide the software necessary to conduct transactions.
As long as a decentralized crypto wallet is designed to support a certain blockchain network, all a user needs to do is import the private key or recovery phrase into the wallet, and, like a key opening a safe, the assets held at that address are available to access.
On some networks, the public key will generate one or multiple alphabetical identifiers that can be used as the DeFi wallet’s address where funds can be transferred. It’s important to note that while it's okay to share a public key with someone to receive funds, you should never reveal your private key to anyone as it will give them complete access to the assets held in that DeFi wallet.
Hot vs. Cold Wallets
The terms “hot” and “cold” mentioned in the opening refer to how a crypto wallet operates.
Hot crypto wallets are connected to the Internet in some way and can send transactions. These types of wallets are easy to set up and allow funds to be quickly accessed, making them the preferred type of wallets for traders, gamers, and others who make frequent transactions.
On the flip side, a cold crypto wallet has no connection to the internet and instead uses a physical medium to store public/private keys offline in a more secure manner. Having a wallet connected to the internet exposes it to hacking, while cold wallets require a thief to gain access to the physical device if they are to have any hope of accessing the private keys it protects.
Holding cryptos on a cold wallet is often referred to as “cold storage” and is the preferred method of securing crypto assets for HODLers.
Types of Crypto Wallets
Aside from being classified as hot or cold storage, crypto wallets come in a variety of forms designed to suit the needs of their users:
- Software wallet - The most predominant and varying type and usually connected to the internet, making them “hot.” Common software wallets include web, desktop and mobile versions.
- Web wallet - Allow access to a blockchain through a browser interface without the need to install any software. Decentralized exchange wallets and other browser-based wallet providers fall into this category. Users typically create a username and password to access these wallets.
- Desktop wallet - Software that is downloaded and installed locally on a personal computer. Desktop wallets provide full control over private keys and the funds held in the wallet. These DeFi wallets can be encrypted so that a password is required each time that the application is opened. Private key information can be found in the “wallet.dat” file, which is stored locally when the wallet is generated, and it is important to make a backup of this file and store it somewhere safe, preferably offline.
- Mobile wallet - These function similar to desktop DeFi wallets but are designed to operate on smartphones and other smart devices. The widespread use of QR codes to represent addresses makes these a convenient way to send and receive cryptocurrencies and more suitable for conducting daily transactions and payments.
- Hardware wallet - A physical, electronic device that uses a random number generator to generate public and private keys. Keys are stored on the physical device, which is not connected to the internet and thus considered “cold.” These types of crypto wallets are considered more secure than other types, but they also tend to be less user-friendly and can sometimes include risks related to firmware implementation. Many web and desktop DeFi wallets now offer the ability to integrate and interact with hardware wallets.
- Paper wallet - A piece of paper containing a crypto address and private key printed out in the form of QR codes. These codes are used to execute cryptocurrency transactions, but they aren’t suited for transacting partial funds and can only be used for sending the full balance. It's important to understand the risks and nuances involved with using this type of crypto wallet before attempting in order to avoid losing funds.
Back Up Your Backups
Unlike the traditional financial system, where there are safeguards and chargebacks in place to protect users and their funds, that responsibility falls to the individual in the world of cryptocurrencies.
As such, it cannot be stressed enough that it is vital to back up and save all private keys, seed phrases, and data files in multiple secure locations or methods in order to prevent losing access to your funds.