What Is A Crypto Wallet & How Does It Work?
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Though most people are concerned about which cryptocurrencies to invest in when they first step into the virtual realm of blockchain, one must learn about the crypto wallet and its basics before anything else.
A crypto wallet is a piece of software that provides users with a gateway to interact with the blockchain to store, send, and receive crypto tokens. There are several types of crypto wallets, each with its own pros and cons.
This article will discuss how a crypto wallet functions and its main types.
Understanding Crypto Wallet
Did you know that you don’t fully own the crypto assets you keep in an exchange account? Yes, since an exchange account doesn’t allow you to store private keys to your crypto tokens, the funds stored there are not yours in the literal sense.
Moreover, there is a common saying in the cryptocurrency world: not your keys, not your coins.
So, is there a way to securely store your crypto assets with their full ownership? Yes, the answer is crypto wallets. Crypto wallets are software applications or hardware devices that enable users to store their crypto assets, including tokens and NFTs, along with public and private keys. On top of that, these wallets are also used to carry out transactions on the blockchain.
Hence, you can say that a crypto wallet is the blockchain world equivalent of our traditional bank accounts. The main purpose of both is to facilitate the transfer of money as well as store the funds securely. The public key is a long string of digits and letters that act as your crypto wallet address.
You can share this key with anyone who intends to send you crypto coins. The private key is a unique cryptographic signature that gives access to the actual crypto coins on the blockchain. If someone has access to your private keys, it’s more or less the same as having access to your crypto funds.
The first cryptocurrency wallet was that of Bitcoin’s founder – Satoshi Nakamoto. And the second cryptocurrency wallet was owned by Hal Finney – the first person to run the Bitcoin client software wallet.
Nakamoto sent Finney 10 BTC as a test, and it was the first-ever cryptocurrency transaction made through cryptocurrency wallets on the Bitcoin blockchain.
How does a Crypto Wallet Work?
Before moving further, there is one thing you need to be clear about. Though a crypto wallet provides you with full ownership of the crypto coins in your possession, it does not “store” those coins in a literal sense. Crypto coins are not stored anywhere. They are bits of data scattered all over the decentralized ledger of the blockchain ecosystem you are using.
A crypto wallet finds all these data bits and stores their security keys in the wallet. Then it associates a public address (or key) to all these bits, which is then used to send cryptocurrency to the wallet using a blockchain.
The wallet sums up the amount of all the crypto coins associated with the public address and shows you the total amount on the interface.
To receive crypto tokens in your wallet, you have to share your public address (also called wallet address) with the sender. To avoid any mistakes or typos, it’s better to simply copy it from the wallet interface instead of manually typing the entire alphanumeric string. Also, ensure that you and the sender use the same transactional network. Otherwise, the transferred funds will be lost forever.
Similarly, when it comes to sending someone crypto coins using your crypto wallet, you simply need to copy the address of the receiver’s crypto wallet and paste it into your wallet interface. Select the cryptocurrency you want to transfer and enter the amount. Select the transactional network and proceed to transfer.
Custodial vs. Non-Custodial Wallets
Every crypto wallet can be divided into two main categories, i.e., custodial or non-custodial wallets.
As apparent by the name, custodial wallets are those which are controlled by a third party or custodian. The custodian is responsible for the security of private keys and crypto funds. The storage places have a highly-complex and cutting-edge security system to avoid unauthorized access.
Several cryptocurrency exchanges, such as Binance and Coinbase, offer their users the service of custodial wallets. However, custodial wallets require users to complete lengthy KYC procedures and identity verification. These wallets are mostly recommended for new users due to their easy-to-use interface.
Non-custodial wallets, on the other hand, allow users to retain full control over their crypto funds and store their cryptographic keys locally. However, these wallets do not have a multi-faceted security wall like custodial wallets. On the bright side, you can use these wallets anonymously, as you do not have to verify your identity.
Instead, a non-custodial wallet provides the user with a seed phrase that acts as the pin to the wallet. This phrase is usually a combination of 12 random words. The phrase cannot be changed; once lost, you lose your funds stored in the wallet.
Type of Crypto Wallets
Based on the technology used, cryptocurrency wallets can further be divided into three types. These are:
Also known as hot wallets, software wallets are the most convenient and easy-to-use type of crypto wallet. They are consistently connected to the internet and hold private keys online. As a result, accessing and using crypto tokens through a software wallet is much quicker.
Most software wallets are free to download from the web. One prominent example is Metamask.
They are available as desktop software, cell phone applications, and browser extensions.
Moreover, software wallets are much easier to integrate with different crypto platforms and exchanges. Some hot wallets, such as Trust Wallet, also give users easy access to Web 3.0, where you can use a huge number of crypto applications and trade thousands of crypto assets.
For this reason, software wallets are the most suitable for beginners and day traders who need to buy and sell their funds frequently.
However, because hot wallets are always connected to the internet, they are more prone to online attacks and breaches. That’s why using such a crypto wallet is not recommended if you wish to store a large amount of cryptocurrency or your holdings for a longer period.
As the name suggests, hardware wallets are physical hard disk devices used to store the private keys of crypto coins. Since these wallets are not connected to the internet all the time and store the keys offline, they are also termed cold wallets.
Hardware wallets come in different shapes and sizes, but they all work almost the same. They are typically USB-like devices that you need to connect to your laptop or cellphone to access the crypto tokens.
Some of them have a screen built-in and Wi-Fi connectivity, providing users with quicker access and straightforward transactional procedure.
Cold wallets are more suitable for storing large-value cryptocurrency funds for longer periods. As these wallets store cryptographic keys offline, they are completely safe from hackers and online breaches. However, in case you lose or break the device, there is no way to recover your funds.
Paper wallets are simple slips of paper with private keys to your crypto holdings written on them. Using this method to store your keys makes hacking and stealing your funds completely impossible. However, such wallets cannot be used for transactional purposes, limiting their use case drastically.
Moreover, losing or damaging a simple paper slip is very likely. Paper wallets were popular in the early days of the crypto industry when not many good options were available. However, with technical advancements, hardware wallets have improved significantly, and they provide much more functionality.
Though using crypto wallets may seem like an added step to your crypto transaction procedure, it is always wise to use one to ensure the security of your virtual assets. The type of crypto wallet suitable for you entirely depends on your needs.
If you are a new user and make a lot of transactions, using a hot wallet is better. However, for experienced users who intend to hold their crypto tokens for a long time, cold wallets make more sense. A reliable wallet is key.
Crypto wallets are an integral part of the security of virtual assets on the blockchain, which is important for widespread blockchain adoption.
Considering the ongoing technical advancement in the blockchain industry and other related sectors, this innovative technology will soon be a part of several other industries.
The editorial content of OriginStamp AG does not constitute a recommendation for investment or purchase advice. In principle, an investment can also lead to a total loss. Therefore, please seek advice before making an investment decision.