Crypto wallet - how it works, how to use, and what to choose from

Crypto wallets are a crucial part of blockchain technology, you need to understand their types, levels of security, and how they function on the basis level.

Crypto wallets, cryptocurrency storage, hot wallet, cold wallet, how to store crypto

Written by

Alex Crypto
Published on

February 10, 2023

For every owner of the cryptocurrency or NFT tokens, the issue of storing their assets is relevant. Therefore, it is important to understand what ways to store crypto assets exist.

A wallet is a tool with which the owner interacts with his or her assets. A wallet can be either a program or a physical device. It is needed to store, accumulate, control, and spend digital currency.

It is important to understand the fundamental difference between an ordinary wallet, in which we store our paper money, and a cryptocurrency wallet. A cryptocurrency wallet does not store assets. A digital token, cryptocurrency, and NFT are all records in a blockchain. And a wallet, through certain mechanisms, allows you to access these records and change them at the owner's will.

One of the functions of a wallet is to generate the data needed for transactions. That data is the keys, private and public.

Private and public keys 

Private and Public Keys 

The security of assets in a wallet is inextricably linked to the existence of public and private keys. These keys create the important elements of a wallet: an address and a digital signature that allow transactions to take place.

During wallet registration, the private key is generated first. The public key is generated from the private key.

Knowing the private key, you can easily identify the public key. It is not possible to find a private key from a public key. The private key is the key that gives access to the assets in the wallet. Therefore, it is worth emphasizing that the private key must never be shared with anyone. It is tantamount to losing your money.

A public key allows you to create an address - an identifier that is something like a bank account number. By giving their address, the user allows another person to uniquely identify that address and send cryptocurrency there. A public key can be transferred to third parties, it is a payment reference from which the intended recipient will receive funds in his wallet.

An example of a public key: 1DSsgJdB2AnWaFNgSbv4MZC2m71116JafG.

The private key forms a digital signature, which is proof that the wallet owner has validated the transaction. There are different formats for creating a private key.

An example of a private key in one of them: L2hjTJNhjpUTd25MArh8UqmnTXEVx7J7Faui3cUXCPpyQMUEkJ54.

Instead of using a private key as a wallet security tool, another method was developed. It is based on using words instead of a complex combination of numbers and letters. This combination is called a "seed phrase." You can also meet the names: mnemonic phrase, recovery phrase, or just seed.

Nowadays, users rarely have access to private keys. Most cryptocurrency wallets today support seed phrases. A seed phrase is a sequence of 12, 18, or 24 words. An example of a seed phrase: alpha afford bundle fit fatigue vast upper youth wood vacuum toddler skirt.

The phrase is generated when the wallet is created and stays unchanged for the lifetime of the wallet. The seed is only available to the wallet's owner; the developer of the application or any other services does not have access to it. It's worth mentioning that the seed phrase must not be disclosed to anyone under any conditions. When creating a wallet, it must be stored in a safe place. The medium, on which a copy of the seed phrase is fixed, must not be connected to the Internet. A flash drive, a piece of paper, or engraving on metal are a few common ways to store the seed phrase. If the phrase is lost, there is no way to recover it. The question may arise whether it is possible to pick up a seed phrase, for example, with the help of special software. In short, no. Experts assert that with modern technical possibilities, the selection of a seed phrase of twelve words takes time, commensurate with infinity.

What does the availability of this phrase mean? One scenario is that a phone with an installed wallet app with assets has been lost. When you install the app on a new phone, all you have to do is enter your seed phrase, and all the assets will be pulled into the wallet on the new device.

Types of crypto wallets 

Types of Crypto Wallets 

Cryptocurrency wallets can be classified in several ways. The method will depend on the characteristic by which the classification is made. These are custodial and non-custodial, hot and cold, and heavy and light wallets.

Custodial wallets 

The private key is stored on the side of the service that provides the wallet, the custodian. The simplest example of a custodial wallet is storing funds on a crypto exchange.

Examples of exchange's custodial wallets:

  1. Binance
  2. KuCoin
  3. Bitmex
  4. Cypto.com
  5. WhiteBit 

Advantages of storing on custodial wallets

  • Facilitated access. Pressing a few buttons on the right, the secure device will allow you to manage your cryptocurrency assets.
  • A forgotten private key or mnemonic phrase is not a loss of funds. You can start the recovery process at any time. It will take some time, plus it's a step back from the classic anonymity, but it's better than losing everything completely.
  • Cancellation of some transactions and refunds are possible. Even though all transactions within the blockchain are irreversible, some mechanisms allow you to return funds. Without the help of an intermediary, however, there is little hope for this, but some services provide their users with some compensation in case they make a mistake.
  • Low commission and high transaction speed.

Disadvantages of the custodial storage

  • The custodian controls the funds when using managed wallets.
  • If the wallet provider goes down, access to the funds will be lost.
  • The authorities may restrict the activities of the custodian, and the servers may be withdrawn. The custodian is often centralized and subject to government regulation.
  • There is no way to use the private key to access your funds from other wallets.
  • Losses of the platform where the funds are stored, such as those caused by hackers, can have a direct impact on users.
  • Slow withdrawals, manual approval, or other interventions may be required.
  • Inability to access funds during technical work.

How to protect the custodial wallet?

  1. Set PIN.
  2. Set daily withdrawal limits - this will help save some of the funds if you regain control of your wallet in time.
  3. Store only those funds in custodial wallets that are actively involved in transactions.
  4. Install multisignature (multisig). Enter two-factor authentication.

Multi-signature is one of the most effective ways to protect the wallet. A simple example of how this technology works is that a safe is locked with two locks and requires two keys to open it. If different people have the keys, then none of them will be able to open the safe without a second key. This function is useful for account management, for example, in a financial institution. One of the varieties of multisig is two-factor authentication. The action (login to the wallet, confirmation of the transaction) will be approved only if it is confirmed on different devices.

Non-custodial wallet 

The private key is kept by the owner of the wallet. That is, the service that provided the non-custodial wallet does not have access to the private key.

The main advantage of a non-custodial wallet is that the owner has full control over the assets. There are disadvantages, too. If you lose your private key or seed phrase, you will lose your funds. A non-custodial wallet can also be hacked by hackers.

Examples of non-custodial wallets:

  1. Trust Wallet 
  2. Metamask  
  3. 1INCH wallet
  4. MyEtherWallet
  5. Argent

Hot wallets 

A hot wallet is constantly online. A "hot wallet" is any wallet that is installed on a device in the form of a computer program, browser extension, phone app, or Telegram bot. Because they are always connected to the Internet, these wallets have the advantage of being faster to use without having to connect or further configure anything. However, that's also their weakness: they're always online, which means they can be hacked.

PROS

  • Ease of setup and use.
  • Free
  • Easy integration with cryptocurrency exchanges.
  • Speed - to make a transaction, you just need to connect to the Internet.
  • Multicurrency. Most often, hot wallets have a much larger list of supported assets than cold wallets.

CONS

  • Vulnerability to cyberattacks.
  • The custodial hot wallet can be blocked by the provider.

Most popular hot wallets:

  1. Metamask 
  2. Trust Wallet 
  3. MyEtherWallet 

Cold wallets  

They are considered the safest because they are not connected to the internet all the time. They are only connected to the network for transactions. A cold wallet is not comfortable for frequent transactions, but a device for long-term storage of crypto assets is the best option.

The most common type of cold wallet, a "hardware wallet," is a physical device, often, but not necessarily, made in USB drive format.

A hardware wallet is a physical device with software that is capable of generating public and private keys.

The most famous brands of cold wallets:

  1. Ledger
  2. Trezor 
  3. SafePal
  4. CoolWallet 

Cold wallets can include paper wallets. This is a piece of paper on which a private key or seed phrase is printed, or better yet, handwritten. Such a sheet cannot be photographed, or a digital copy of it can be stored on a computer or cloud storage. It is advisable to write down the information by hand rather than print it out on a printer. An experienced hacker can intercept digital information from any network, thus nullifying the crypto-asset owner's attempt to protect it. Paper is the most vulnerable physical property in terms of storage. Therefore, the sheet can be laminated. Instead of a paper sheet, a metal plate with typesetting or engraving is sometimes used.

PROS

  • High level of protection.
  • Possibility to recover lost wallet data.

CONS

  • The estimated cost of a hardware wallet is $40-$200.
  • There may be issues with the hardware wallet software.

Heavy wallets

A heavy wallet is the official wallet program of a particular network. Heavy wallets are found in Bitcoin, Dogecoin, etc. When you install it on your computer, the entire blockchain is downloaded along with the program itself. The program then updates the data when it connects to the network. Private keys are stored on the user's device.

Examples of heavy wallets:

  1. Bitcoin Core 
  2. Ethereum Mist 

PROS

  • Reliability is provided by open source. In addition, such wallets are continuously tested to find vulnerabilities, which allows you to anticipate and promptly eliminate security gaps.
  • Almost complete confidentiality.
  • The place where the private key is stored in the user's device.
  • Staking and mining are available.

CONS

  • Monocurrency - one wallet is used to store one asset.
  • Using a wallet requires a huge amount of hard disk space. The Bitcoin Core wallet takes up about 400 GB. The amount of data is constantly growing.

Light wallets

These are the same as heavy wallets, but without downloading the entire blockchain. They need to connect to the network regularly to update and upload their data.

Examples of light wallets:

  1. Exodus 
  2. Armory 

Which type of wallet to choose?

Which Type of Wallet to Choose

There is no definite answer, it all depends on the needs of the user, the approach to risk management, and the way the cryptocurrency is used. Holders and active traders have different requirements. The multi-signature function is required if the wallet is managed by an organization and the transfer must be confirmed by several people.

Using a hardware wallet is a reliable way, but first, it will be correct to test its work on a small amount to study the peculiarities of the wallet. A cold wallet can be seen as a bank account, a long-term vault.

A "hot wallet" is something like a regular wallet for going to the store. With some services, there is no choice, you have to use the wallet option offered by the service itself.

All of the characteristics discussed above describe wallets in terms of their technical capabilities. To choose a particular purse, a user wants to understand the capabilities of a purse and why one is better than another. Therefore, let's consider wallets from a practical point of view.

Convenience 

Usability: how easy it is to install a wallet, how many coins it supports, how convenient it is to buy cryptocurrency from an application; the availability and responsiveness of technical support services; and whether a wallet meets the maximum user needs.

Metamask: is sometimes referred to as the "default" wallet. In November 2021, the wallet had a monthly audience of 21 million users. Almost every question a user might have has already been answered. Information on installing, and solving various problems can be found on any convenient service: YouTube, Telegram channels, various sites, and in different languages. The wallet supports about 40 networks, allowing you to store cryptocurrencies, make transactions, and earn through stacking. Metamask is a means of identification on many Web 3.0 sites. The wallet is a repository for more than just cryptocurrency. It can store NFT, and Ethereum Name Services domain names. The wallet is non-custodial, KYC verification is not required.

The wallet has apps and extensions for Android, iOS, Chrome, Firefox, Brave, and Edge.

Trust wallet:  is a smartphone wallet application that has been on the market since 2017, according to the official website, with over 25 million users. Installation is simple, and the interface is intuitive. There are versions for Android and iOS. The wallet is non-custodial, KYC verification is not required. Supports 53 blockchains and over 1 million types of assets. App access to purchases, cryptocurrency exchanges, and the ability to access various DeFi-applications. Support service - extensive help center with a special section on self-solving problems.

SafePal - wallet, that can be installed as a mobile application on Android or iOS or purchased as a hardware version. It supports 32 blockchains and 30,000+ tokens, NFT and DeFi. The wallet is non-custodial, KYC verification is not required. On-site technical support - Help Center.

Anonymity 

Blockchain technology was initially marketed as a way to manage your finances in an anonymous and decentralized manner. Now that concept has blurred. But still, for many cryptocurrency users, the issue of anonymity is very important. Because of the nature of blockchain, anyone can use the network explorer to trace any transaction in any blockchain by address or transaction hash.

Anonymity on the blockchain is very relative. Rather, it will depend on the willingness and incentives of the person seeking transaction information on the blockchain.

Nevertheless, some wallets position themselves as anonymous:

Wasabi wallet 

The wallet creates a process that makes it difficult for third-party observers and transaction participants to track funds. Uses Tor anonymous network, and supports bitcoin only. It is a desktop program; there are versions for Windows, macOS, and Linux.

Samourai wallet 

The anonymous wallet app for Android only supports bitcoin. Some of its options:

- No address reuse.
- You can hide the app on your phone.
- Fully encrypted client part and offline mode.
- Tor and VPN support.
- Export wallet anywhere - you can export your wallet to any bitcoin wallet.
- Wallet recovery by seed phrase.

Just in case, we need to pay attention to this fact. Concealment technologies, such as the use of anonymizers and technologies like mixers, can be seen by CEX like Binance as deliberately illegitimate. Because mixers and similar services are often used by owners of illegally obtained funds. And cryptocurrencies participating in such services can theoretically fall under sanctions in centralized services when introduced to such services. Therefore, it is necessary to study well all the nuances and facts at the time of the decision to use such services, including anonymous wallets.

As an option for those who are particularly interested in anonymity, it is worth looking into anonymity-focused cryptocurrencies. For example:

  1. XMR (MONERO)
  2. ZEC (ZCASH)

Security

The current geopolitical situation has forced a new look at asset security. Users of some crypto services faced the possibility of account blocking. Therefore, the question of which wallet to store assets in is relevant now. One should choose a non-custodial wallet.

Regarding wallet security in general. Even if the wallet is non-custodial, there is still a node that can affect the application. For example, in the Ethereum network, Infura is such a node. And theoretically, any wallet in the network can be blocked. It is recommended to enable VPN if there is a suspicion of blocking even when using DEX services.

Metamask

The service has blocked accounts in some regions and said it will strictly follow all U.S. sanctions. Such restrictions may not lead to a total loss of funds but may make accessing them less convenient.

MyEtherWallet

An open-source, non-anonymizing, non-custodial wallet. Designed for the Ethereum network and ERC-20 tokens. Reliable enough to support Ledger and Trezor hardware wallets. There are partner services that allow you to exchange fiat currency for crypto tokens. The wallet has an integrated DEX aggregator 1inch. There are applications for Android and iOS, as well as a desktop version. No personal information is required when creating a wallet.

1INCH wallet

This is a DEX app. Only the iOS version is available yet. The wallet is non-custodial, the seed phrase is with the owner of the wallet. As an aggregator, 1inch Wallet provides access to maximum liquidity and best token exchange rates on various DEXs. The wallet has swap, limit (analog of limit order on the exchange), and P2P functions.

Argent

This is a non-custodial wallet. It is based on the Ethereum blockchain and supports tokens of the ERC-20 and NFT standards (ERC-721, ERC-1155). There are DeFi-service integrations. Argent has an open-source architecture. There are Android and iOS versions. The wallet doesn't store the user's keys and seed phrases and supports security measures such as setting daily limits and biometric locking. KYC verification is not required.

Features: storage, purchase, stealing, and credits.

An important difference from other non-custodial wallets - is no seed phrase for recovery, and you can set up trusted contacts and block your account for security purposes. The security model is based on the notion that Guardians are trusted devices or people. Simply put, accounts on the Ethereum blockchain that the wallet owner authorizes to assist in the recovery and protection of the wallet. Guardians do not have direct access to the savings in the wallet.

The role of a Guardian can be:

  • A person the wallet owner trusts (friend, family member).
  • MetaMask account.
  • A Trezor or Ledger hardware wallet.
  • Argent Guard is an automated solution based on 2FA.

Vitalik Buterin expressed his approval of this security model.

 


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