Takeaways
- Crypto wallets securely store digital keys to access your coins on the blockchain.
- Crypto wallets don't hold your coins, they hold the public and private keys.
- Crypto wallets come in various hot and cold wallets, each with pros and cons.
- Many cryptocurrency exchanges provide crypto wallets as part of their offering.
- Crypto wallets are a necessary tool to manage your digital assets, and losing your keys could mean losing access to your investments.
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What is a Crypto Wallet?
A crypto wallet is a digital wallet connected to a software program or a physical device that stores the keys you use to send and receive blockchain cryptocurrency tokens. Within your wallet, public and private keys interact with various blockchains, enabling you to send and receive digital currency and simultaneously monitor your balance. You must have a crypto wallet if you want to use Bitcoin or any other cryptocurrency.
A crypto wallet is not a genuine wallet because it does not store your cryptocurrency itself. Instead, a crypto wallet saves the cryptographic keys you need to interact with a blockchain. These wallets could also be considered your interface with the cryptocurrency network and are sort of the safe deposit box for your keys to access and transact with your coins.
Practically speaking, a crypto wallet manages your keys and enables transactions. Crypto wallets come in many different types:
- Mobile App Wallets are programs downloaded from app stores that house your keys for ease of use in everyday transactions. (Read more about Hot Wallets.)
- Exchange Wallets are wallets located within your custodial account on a cryptocurrency exchange and are used for quickly buying and selling cryptocurrencies from your online account. (Read more about the best cryptocurrency exchanges.)
- Software Wallets are computer programs that run on your laptop or desktop and serve as a reasonably secure way to store your keys.
- Hardware Wallets are offline storage devices that resemble USB drives and are one of the most secure forms of storage because they are offline and highly portable. (Read more about Cold Wallets.)
The security of your crypto wallet is only as good as how your keys are managed. If your keys are stored online, they are more vulnerable to hacking, theft, and other cyberattacks simply because they are more accessible online. On the other hand, offline storage or “cold storage” is more secure but much less convenient.
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How a Crypto Wallet Works
Unlike a traditional wallet or purse, a crypto wallet is a critical digital tool for managing your cryptocurrencies securely but does not hold your coins. Instead, your crypto wallet handles the cryptographic keys that grant you access to blockchain currency tokens. Here's a closer look at how a crypto wallet operates:
Public and Private Keys
Your crypto wallet will contain a pair of keys. Your public key is directly related to your private key. The public key acts like an address. You share this key with others to receive cryptocurrency.
Your private key is like your password. The private key in your wallet should be kept secret because it is the mechanism used to convert encrypted transfers to plaintext. Your private key allows you to access your funds, transfer coins, and authorize buying and selling.
Transaction Management
If you need to send cryptocurrency, you need the person’s public key (address) and the amount to be sent. You initiate a transaction to send currency to the recipient’s public key, and your wallet uses your private key to sign this transaction.
Using these keys ensures that not only is the transaction secure, but you can also authorize transfers from your wallet.
Blockchain Interaction
Once this transaction is signed, it is broadcast to the blockchain network. The new transaction is then selected by miners, who add a new block to the blockchain. The transaction is verified, confirmed, and recorded in a decentralized ledger by other nodes in the network [1].
Balance Tracking
Your wallet does not store your currency. Instead, it houses the keys to your coins, which are located on the public blockchain network.
Your wallet (and keys) queries the blockchain to display your ownership balance associated with your key addresses. The blockchain will update these balances as new transactions are confirmed.
Security Features
As cryptocurrencies have evolved into a legitimate and fast-growing asset class, safely securing your investment has become an important focus point for investors. Many crypto wallets enhance their security with features like encryption.
Encryption adds an extra layer of protection for the information within your wallet. Some wallets will also require multi-signature transactions, and you must use more than one key to authorize any transaction.
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Why You Need a Crypto Wallet
A crypto wallet is a necessary digital tool for managing your cryptocurrency investments. If you are investing in cryptocurrencies for the first time, you need to find a wallet that works for you. Your crypto wallet will store important cryptographic keys that prove your ownership of your digital assets. Having the keys to your coins is like having the password to your bank account; if you lose your keys, you can't access your investments.
Wallets provide a user-friendly interface for interacting with your digital currencies because they modify the complex processes of blockchain into understandable and manageable actions. This makes cryptocurrency accessible even for beginner investors who are new to the technical details of blockchain technology.
Crypto wallets are peripheral requirements for safely owning Bitcoin and other cryptocurrencies because they safeguard your private keys, the only way you can access your cryptocurrency. Losing your private key means losing access to your coins, so let’s look at the two main types of crypto wallets, each with its nuances.
Hot Wallet
A cryptocurrency hot wallet is a digital wallet that is connected to the Internet, which is why it is called "hot." This type of wallet is perfect for managing your coins on your laptop, desktop, or phone because it provides quick and easy access to your funds. The downside to a hot wallet is that it is much more susceptible to online threats, like hacking and malware attacks, than its more primitive cousin, the cold wallet (more on this below).
Well-built hot wallets are designed for everyday use. Many financial and crypto advisors advocate holding smaller amounts of cryptocurrency in your hot wallet because of their hacking vulnerabilities. Hot wallets can be in custodial accounts on web-based cryptocurrency exchanges or in more tailored mobile apps.
Best For: Beginners Investors, New Bitcoin Traders, Investors with Limited Cryptocurrency Exposure, Daily Cryptocurrency Users
Cold Wallets
A cold storage wallet, or cold wallet, is a type of cryptocurrency wallet that is not connected to the internet. It is called a “cold” wallet because it is offline.
This type of wallet is far more secure, and crypto evangelists typically holds cold wallets in addition to their hot wallets. They tend to carry more coins in their cold wallets because it minimizes the risks of online threats like hacking and other software vulnerabilities.
Cold wallets can take forms like paper wallets, where private keys are literally written on a piece of paper and stored in a safe deposit box, or hardware wallets disconnected from the internet. The primary advantage of a cold wallet is its enhanced security.
Best For: Advanced Investors, Seasoned Bitcoin Traders, Investors with High Cryptocurrency Exposure, Long-term Cryptocurrency Holders
Smart Summary
If you are thinking about investing in cryptocurrencies for the first time, understanding how crypto wallets work is essential for the long-term security of your digital assets. Cryptocurrencies have morphed into a billion-dollar industry over the last decade, surpassing asset classes like silver in market capitalization. You can gain exposure to crypto by investing directly in a currency or spot Bitcoin ETFs, recently approved by the Securities and Exchange Commission [2]. Read more about choosing the best online brokerage account.
(1) Science Direct. A comprehensive review of blockchain technology: Underlying principles and historical background with future challenges. Last Accessed April 25, 2024.
(2) Securities and Exchange Commission. Statement on the Approval of Spot Bitcoin Exchange-Traded Products. Last Accessed April 26, 2024.
