Cryptocurrency Wallets Explained
A cryptocurrency wallet is a software program that securely stores your public and private keys. It is these key pairs, or secure digital codes, that your wallet uses to interact with a blockchain to give you access to view your balance, send and receive cryptocurrency. You can think of your wallet as like your local bank branch or ATM that provides you access to your funds stored within the bank, or blockchain, in the case of crypto.
Remember, the blockchain is a highly secure public ledger that keeps track of all cryptocurrency transactions. For anyone new to this, keep in mind that crypto wallets don’t contain any physical coins because crypto coins are digital.
To make this easier to understand, here’s another example. This time let’s compare a crypto wallet with something you probably use on a daily basis, your email.
Your wallet is like an email account for your cryptocurrency; you share your email address but not your password. Your public keys are like your email address, and private keys are similar to the password you use to login into your email. You give out your wallet address so that people can send you coins much like how you provide your email address to your contacts to send you messages.
When it comes to security, however, you would never give out your email account password to anyone. Likewise, to keep your coins safe in your cryptocurrency wallet you never give out the private keys (or password/passphrase) to your crypto wallets.
How do cryptocurrency wallets work?
Your cryptocurrency wallet connects you to the world of digital currency, namely, blockchains. It allows you to interact with this ledger, which records all crypto transactions and gives you access to your digital currency.
Whether a Bitcoin wallet, an Ethereum wallet or a general wallet, all crypto wallets work using the same principles via tools called keys. But, just as these are not physical wallets that you carry around, these are not physical keys that you carry around, either.
Each method of digital storage features a public address, a public key and a private key. These are quite literally the keys to securing and transacting your cryptocurrency online.
What is a public address?
A public address is an outward-facing identifier for your cryptocurrency wallet. It is the target destination for digital currency of which you buy ownership. When you purchase cryptocurrency, the seller sends a record of ownership to your public address. Usually, you provide your public address for transactions, much like you would your BSB and bank account details for a traditional money transfer through the bank.
What is a public key?
A public key is similar to your public address, but not quite the same. It verifies that you are the owner of a public address that can send and receive cryptocurrency.
A public key is a random combination of letters and numbers. An example of a public key could be: 0x286717D6E417A7801d0ecED32d8b7Ff2241078d6.
Public keys are matched to the private key held within the crypto wallet but unlike traditional banking details, these keys do not provide any information about the wallet’s owner.
What is a private key?
A private key acts as a sort of password for cryptocurrency wallets. It is inward-facing and allows users to access their crypto wallet to buy, sell, and monitor their digital currency. Again, think of it as the password to your email account. It is the key cog of your cryptocurrency security.
What types of crypto wallets are available?
There are plenty of different crypto wallets available. The best one for you depends on your general trading habits and which provides the most security in your situation.
There are two main types of wallets: hot storage wallets (digital) and cold or hardware wallets (physical). Both have their pros and cons, and there is not necessarily a right or wrong answer when it comes to figuring out which crypto wallet is best for you.
With its continous market growth, keeping your cryptocurrencies safe has never been more important. Twelve years after the launch of the world’s biggest digital asset, high-profile hacks remain an issue — with malicious actors managing to run into the night with millions of dollars in ill-gotten gains. Thankfully, many centralized exchanges now have insurance policies to protect against such events, and set aside a part of their profits in the event that they need to reimburse their customers.
What Is Hot Storage?
Hot storage is used to describe crypto wallets that are connected to the internet. These wallets might run on devices such as phones, tablets and computers — and they’re ideal for keeping small amounts of digital assets secure.
Although they’re exceedingly mobile, and give you the ability to access your digital assets anywhere, funds held in hot storage can be vulnerable if malicious actors manage to hack into the device where a wallet is stored.
Notable mentions among the software wallets available are Exodus, Atomic and Electrum.
What Is Cold Storage?
In contrast to hot storage, cold storage is not connected to the internet.
Cold wallets tend to manifest themselves in the form of a physical device, such as a small but compact piece of hardware.
Prefer to (carefully) scribble down your public and private key on a piece of paper? Congratulations! This is a form of cold storage, too. (Although this does eliminate the risk that a hacker will be able to access a private key, it creates a whole new danger of you losing the piece of paper, meaning access to your crypto is gone forever). Because of this, it’s common to see people store such types of paper very, very carefully in safes and vaults — anywhere that’s nice and secure.
Cold storage are cryptocurrency wallets that are not connected to the internet or any other unsecure networks when not in use. This is done to provide an additional layer of security over that offered by the more widespread hot wallets, which are software wallets stored on a user’s local computer or accessed from a service provider’s servers via a website interface.
Cold wallets are employed by individual cryptocurrency users as an affordable and relatively simple way of insulating one’s crypto funds against the threat hacks, phishing and other vectors of attack that may lead to permanent loss of coins.
They are even more in demand with businesses that hold custody over their customers’ funds, such as cryptocurrency exchanges. By storing the coins that belong to tens or even hundreds of thousands of users in a centralized manner, these businesses become highly enticing targets for hackers and physically separating most of the reserves from the Internet is the only reliable way to protect from attacks.
Cold Storage Comes In Many Different Forms, The Two Most Popular Ones Being Paper And Hardware Wallets.
A paper wallet is a piece of paper with the public address and the private key of the wallet printed on it. The public address is used to receive cryptocurrency and the private key to access the funds stored and send them. Paper wallets often come with QR codes that can be scanned with a smartphone for ease of use.
A hardware wallet is an electronic device that must be physically plugged into a computer to be accessed. These can range from amateur homemade inventions to commercially available consumer devices (often in the form-factor of a USB stick or drive) to proprietary solutions designed by professional engineers to order.
Most widespead examples of this being the Ledger Nano and the Trezor.
Ledger manufactures cold storage wallets designed for users who want increased security. Their wallets are a physical device that connects to your computer. Only when the device is connected can you send Bitcoins from it. Ledger offers a variety of products, such as the Ledger Nano S and the Ledger Nano X (a bluetooth connected hardware wallet).
Trezor is a pioneering hardware wallet company. The combination of world-class security with an intuitive interface and compatibility with other desktop wallets, makes it ideal for beginners and experts alike. The company has gained a lot of the Bitcoin community’s respect over the years. Trezor offers two main models – The Trezor One and Trezor Model T (which has a built in touch screen).
Other, less popular cold wallet types include smart cards and even sound wallets, which store private keys in the form of audio on CDs or vinyl records.
Hot Storage vs Cold Storage: The Pros and Cons
As with everything, hot wallets and cold wallets come with their own distinctive set of advantages and disadvantages.
If we’re getting competitive about it, hot wallets have the upper hand because they are very easy to use. They’re already connected to the internet, meaning it’s a convenient way of accessing crypto. Usually, they’re also free to use — and it’s easy to find a wallet that’s compatible with any cryptocurrency. While Cold wallets can be carried in your pocket wherever you go — and they can connect to computers via USB for things like firmware updates. (Then again, some argue that this means these devices will be connected to be the internet every now and again.)
But the main factor driving the popularity of cold wallets is far greater levels of security.
Hot wallets are extremely vulnerable to cyber attacks. While most providers have robust measures in place to provide added security, hackers have been turning to increasingly sophisticated measures in order to target victims. In some cases, criminals have created seemingly legitimate companies to win someone’s confidence and gain access to their computer.
The main challenge surrounding cold wallets is twofold. First, you’ll have to cough up money to buy one — often between $60 and $170 — and you might need a little technical knowhow in order to get it set up.
Crypto exchange accounts can be considered hot wallets — although security measures vary from platform to platform. More respected and established exchanges usually enforce stricter security measures and store the vast majority of assets under management in cold wallets, keeping a small percentage in hot storage for ease of access.
Famous Hacks Involving Hot Wallets
As hot wallets are more dangerous to use compared with cold wallets, it’s unsurprising that they’ve become the subject of several notable hacks.
KuCoin fell victim to a major hacking attack in September 2020 — with criminals stealing funds from Bitcoin, Ether and ERC-20 hot wallets. It was initially thought that $150 million had been stolen, but it later emerged that this figure was closer to $280 million. Thankfully, “on-chain tracing, contract upgrades and judicial recovery” meant that at least 84% of these funds were later recovered.
In July 2019, cryptocurrency exchange Bitpoint — which is owned by the Japanese firm Remixpoint — also saw its hot wallet ransacked. The damage was estimated at $32 million, which is roughly a fifth of the assets that the platform had under management. Assets including Litecoin, Ether, Bitcoin and Ripple were taken. Tellingly, the company’s cold wallets were not affected by this incident. However, it is still possible that cold wallets can also be compromised — but not in the exact same way as hot wallets. Cold wallet provider Ledger suffered a hack in December 2020, but customer funds weren’t stolen — customer information was. Over 272,000 Ledger customers had their names, mailing addresses and phone numbers leaked online by hackers, making them vulnerable to phishing attacks and other nefarious tactics to get at their cold storage crypto.
While this type of “hack” of a cold wallet is relatively rare, the Ledger incident showed that crypto holders should always be on their guard and follow best practices for safe crypto storage.
How do I decide which wallet to use?
Deciding which type of wallet to use depends on a variety of factors, including:
- How often you trade. In general, hot wallets are better for more active cryptocurrency traders. Quick login ability means you are only a few clicks and taps away from buying and selling crypto. Cold wallets are better suited for those looking to make less frequent trades.
- What you want to trade. As mentioned earlier, not all wallets support all types of cryptocurrencies. However, some of the best crypto wallets have the power to trade hundreds of different currencies, providing more of a one-size-fits-all experience.
- Your peace of mind. For those worried about hacking, having a physical cold wallet stored in a safe deposit box at the bank or somewhere at home, provides the safest, most secure option. Others might be confident in their ability to keep their hot wallets secure.
- How much it costs. It is important to investigate the costs associated with each wallet. Many hot wallets will be free to set up, but charge a fee each time you trade. Meanwhile, cold wallets, like any piece of hardware, will cost money to purchase.
- What it can do. While the basics of each cryptocurrency wallet are the same, additional features can help set them apart. This is especially true of hot wallets, many of which come with advanced reporting features, insights into the crypto market, the ability to convert cryptocurrencies and more. Security features can also be a good differentiator.
A Quick Recap
If you’re going to be dealing in larger volumes of crypto, investing in cold storage might prove advantageous. It’s crucial that you do your own research and assess the pros and cons of different products on the market first.
Another top tip is to perform plenty of due diligence into the security measures that are enforced by crypto exchanges. You should fully expect these platforms to keep the lion’s share of the assets they have under management tucked away in cold storage.