As we keep our fiat currencies and valuable assets in wallets, bank accounts, or various funds, we should also store cryptocurrencies in their appropriate wallets. The concept of a digital currency wallet is not as complex, but unfamiliarity with it can easily lead to the loss of your capital.
A wallet is very similar to your bank account. Digital currency wallets enable you to send, receive, and display your balance. Cryptocurrency wallets come in different types, allowing you to choose one based on your needs or circumstances.
In this article, we aim to explain how many cryptocurrency wallets exist and how they operate? We will also introduce different types of wallets and examine the differences between cold and hot wallets ๐. Stay with Crypto Hovel.
What is a Cryptocurrency Wallet?
A Cryptocurrency Wallet is a type of wallet designed for storing, sending, receiving, and monitoring digital assets. It is often presented in two main types: hardware and software. In essence, this type of wallet, similar to a physical wallet, allows you to securely store your digital currencies with confidence.
A cryptocurrency wallet, in simple terms, is a software or hardware that generates and stores private and public keys. This program communicates with different blockchains, enabling users to send and receive various cryptocurrencies and control the amount of their digital assets.
From a technical perspective, cryptocurrency wallets are divided into two main categories: hardware wallets and software wallets. Hardware wallets use physical components such as security chips, providing higher security. On the other hand, software wallets are applications installable on various devices, allowing easy access to digital assets through them.
Cryptocurrency wallets have facilitated access to the blockchain. When cryptocurrencies were first introduced, manually sending them was possible, requiring the input of lengthy keys. However, with the existence of wallets today, this process has become much simpler.
How does a cryptocurrency wallet work?
The most important point to consider is that your cryptocurrency wallet is not actually a place to store your digital assets; instead, each cryptocurrency is recorded on its own blockchain. The wallet serves as an interface with blockchain networks, allowing you to observe and manage your cryptocurrencies.
The transfer of digital currencies is recorded and stored through transactions on the blockchain platform. When someone sends you Bitcoin or any other cryptocurrency, ownership of these tokens is transferred to the address of your wallet, a process known as “digital signature.” This signature, formed by the combination of the sender’s public and private keys, enables tracking and verification of transactions.
Now let’s delve into the introduction of the essential elements of a wallet to better understand its functionality.
Public and Private Keys
Public Key and Private Key are among the most crucial components of a wallet, utilizing an asymmetric encryption mechanism to securely store and authenticate received or transmitted cryptocurrencies.
The Public Key and Private Key use a type of encryption function. Mathematically, they are associated with the address of your cryptocurrency wallet, encoding the input sequence of letters or numbers into a new set of characters and numbers as the output. It’s worth noting that encryption creates a new layer of security, ensuring the invulnerability of your wallet to hacking.
- The Private Key in a digital currency wallet is a confidential address that should never be shared with anyone. Only with this key can you prove ownership and manage your digital assets.
- The Public Key, generated and encrypted in the wallet for sharing with others and receiving cryptocurrency, requires the Private Key for accessing transactions and proving ownership of digital assets.
Recovery Phrase
The term “Recovery Phrase” or “Seed Phrase” in a wallet refers to a list of words that stores all the necessary information for recovering your account in the wallet. This recovery phrase is usually generated automatically after registration and during the account creation process.
It is recommended to write down the words of this phrase in the exact order as displayed on paper and keep it in a secure place.
If at any time your wallet encounters issues due to hardware or software bugs, having this recovery phrase allows you to recover your cryptocurrency wallet account. Note that the recovery phrase is applicable only to accounts created on blockchain platforms and is the sole means of accessing the cryptocurrency wallet in case of password forgetfulness.
Custodial or Non-Custodial Wallet
When choosing a cryptocurrency wallet, one of the key decisions is the choice between Custodial and Non-Custodial modes.
- Custodial Wallet: Refers to wallets where a third party, typically a platform or wallet service provider, controls and maintains the private keys. This means that the control of all assets inside the wallet lies with that third party.
- Non-Custodial Wallet: Refers to wallets where users have complete control over their private keys, and there is no access to these private keys by the wallet provider’s team. Thus, the secure maintenance of the private key is solely the user’s responsibility.
If you lose the private key or recovery phrase of a non-custodial wallet, there is no way to recover the assets within it. It is advisable to always use non-custodial wallets for storing cryptocurrencies and ensure that private keys are securely maintained.
When using a custodial wallet, in other words, entrusting control of your assets to a third party, they have the authority to restrict your access to cryptocurrency assets if necessary and even lose them.
How Many Cryptocurrency Wallets Exist?
Perhaps you might assume that a wallet has only one type, and all wallets are similar, but this assumption is incorrect. Cryptocurrency wallets come in various types, and in this section, we intend to inform you about how many cryptocurrency wallets exist.
In general, digital currency wallets are divided into two main categories: cold wallets and hot wallets. The main difference between these two categories is that hot wallets usually have constant internet connectivity, while cold wallets are only connected to the internet when needed.
Hot Wallet
Upon creating a user account on an online exchange or downloading and installing a wallet-related software for your mobile or desktop, a hot wallet is generated. From then on, you can buy, sell, or trade your digital assets using this wallet.
Hot wallets come in three types: desktop, mobile, and web-based, requiring an internet connection. These wallets are suitable for daily transactions and connecting to more decentralized platforms. Wallets provided by exchanges are also considered to be of this type.
Desktop Wallet
A desktop wallet is software installed on a computer or laptop. To access your cryptocurrencies, you need access to your computer. In these wallets, the private key is stored on your computer. However, be aware that if a hacker remotely gains control of your device, they can easily access your wallet.
Mobile Wallet
A mobile wallet is very similar to a desktop wallet. Since this type of wallet is directly downloaded onto your device, it allows you to spend your coins in a store by scanning a QR code. In these wallets, encrypted private keys are stored on your mobile.
Web Wallet
The use of these wallets is possible through various devices from any location. Some web wallets are custodial, meaning you enter a website and use the wallet services. Others are non-custodial online wallets installed as extensions on various browsers like Brave, Safari, and Google Chrome.
Cold Wallets
Cold wallets are considered a suitable option for storing digital assets. These wallets only connect to the internet when the user wants to send or receive digital currency and are presented in two types: hardware and paper wallets. Performing transactions with hardware wallets is generally easier than with paper wallets, and due to the support services, they are more popular than their paper counterparts.
In the classification of wallets, those wallets whose private keys are stored offline are referred to as cold wallets. Paper wallets and hardware wallets fall into this category of wallets.
Hardware Wallets
In a hardware wallet, as the name suggests, the private key is stored on a hardware device (usually resembling a USB flash drive). This device essentially holds your private keys in a secure and offline environment.
To use this type of wallet, you need to install the relevant software on the user’s device (such as a mobile or computer). These software applications facilitate the communication between the device and the hardware wallet.
Although previous wallets are available for free, using a hardware wallet requires an associated cost.
Paper Wallets
Paper wallets have a mechanism similar to hardware wallets, with the difference that in paper wallets, the public and private keys are written or printed on a piece of paper. For this reason, they are more vulnerable than hardware wallets and need to be kept in a place away from moisture or heat.
Paper wallets are the least expensive cryptocurrency wallets, and to use them, you only need to print your public and private keys on a piece of paper. When you need to transfer funds, you can easily enter the keys into software or web wallets, or even simpler, scan the printed QR code.
Difference Between Hot and Cold Wallets
The cold wallet is recognized as a type of non-custodial wallet, in which the user alone has complete control over their cryptocurrencies, public key, and private key. In contrast, cryptocurrency hot wallets are often custodial and, in addition to the user, a server, acting on their behalf, holds the private key.
Furthermore, the most significant difference between hot and cold wallets is that hot wallets connect to the internet, while cold wallets can be used offline. This feature provides higher security for cold wallets, making them a preferred, safer option for storing digital assets by some individuals.
Although cold wallets offer high security, transactions with them are time-consuming and not very suitable for everyday use. For this reason, many individuals opt for hot wallets, which have a simple and quick setup and usage process, making them the most common and popular type.
What type are the wallets of cryptocurrency exchanges?
Cryptocurrency exchanges are another crucial aspect of the digital currency world, used for trading and exchanging cryptocurrencies. In decentralized exchanges, users utilize their personal wallets, while in centralized exchanges, users must create an account, and the exchange provides them with wallets for various cryptocurrencies.
The wallet provided by centralized exchanges is a custodial hot wallet. This means the exchange has complete control over the assets of all users. Therefore, at any time, for various reasons, including sanctions, the exchange can restrict the user’s access to their cryptocurrencies.
Additionally, if an exchange suddenly closes (for any reason) or its site becomes inaccessible, users will still not have access to their cryptocurrencies.
How to Choose a Suitable Wallet?
To select an appropriate wallet, attention must be paid to various factors. First, you need to know which cryptocurrencies you want to hold, where these cryptocurrencies are located, and which wallets support these networks.
If your intention is to hold for the long term, a cold wallet is preferable. However, if you intend to utilize various DeFi programs and trading on a daily basis, hot wallets, especially those installed as browser extensions, are more applicable to your needs.
๐ For more information on how to choose a suitable wallet and the factors involved, refer to the article “How to Choose a Suitable Wallet?” for in-depth insights.
Conclusion
The cryptocurrency wallet plays a crucial role as a fundamental tool in preserving and managing digital assets. Choosing the best cryptocurrency wallet is the most important step in entering the dynamic world of digital currencies. However, the question arises: How many cryptocurrency wallets exist, and how do we choose the appropriate wallet? The selection process must be carried out with precision and thorough examinations. In choosing a wallet, the type of wallet (cold or hot) holds great significance. Cold wallets store private keys offline on a hardware device, providing a high level of security. On the other hand, hot wallets are connected to the internet, and some of their information is stored in online components.
What is your experience with using wallets? Which wallet do you recommend for users? ๐ค Share your opinions and experiences with us in the comment๐. Also, if you have friends interested in this topic, share the article with them.๐ฃ๏ธ
Frequently Asked Questions
Why should we use a Cryptocurrency wallet?
Control over assets, preservation of privacy, high security, freedom, and convenience are advantages that using a digital currency wallet brings.
What is the cost of creating a cryptocurrency wallet?
Almost all software wallets for digital currencies are free, and you can easily download them from reputable websites and platforms. Some of these wallets may charge a nominal monthly fee for their services. In contrast to software wallets, hardware wallets for digital currencies are not free, and depending on your choice, you will need to pay a fee.
What are the key features of the best cryptocurrency wallet?
High security, support for a wide variety of digital currencies, low cost, and ease of use are features that make wallets for suitable cryptocurrencies desirable.