Cryptocurrency wallets are crucial to the web3 ecosystem as they are the primary pathways for people to interact with the crypto space. Wallets store tokens, enable transactions and ensure that crypto users maintain ownership of their tokens through specific verification processes.
Our Learn Center introduction to crypto wallets will lay out the main types of crypto wallets, how they work, and why they're vital to the crypto system. There are different types of crypto wallets, all of which offer their own advantages and disadvantages, and our Learn Center will serve as a guide to how each can help crypto investors interact with the crypto world.
Crypto Wallets: An Overview
Cryptocurrency wallets allow you to securely send, receive, and store your cryptocurrencies like Bitcoin, Ethereum, or other coins. These wallets are designed to interact with the blockchain network, which is a decentralized ledger that records all crypto transactions made on the network.
Crypto wallets offer crypto users a number of ways to utilize their crypto. They primarily allow users to store crypto and make transactions (like buy and sell their digital assets). In recent years, the use cases for crypto wallets have expanded, with many wallets now offering everything from DeFi applications to NFT storage and management.
Crypto Wallet Addresses
Crypto wallet addresses are unique identifiers used to receive cryptocurrency payments. A wallet address is a string of alphanumeric characters that is associated with a specific cryptocurrency wallet on a blockchain network.
When a user wants to receive cryptocurrency, they will typically provide their wallet address to the sender, who will then use that address to send the cryptocurrency to the receiver's wallet. Each cryptocurrency has its own specific format and length for wallet addresses, and they can be generated from most cryptocurrency wallets.
Wallet addresses can be shared with others to receive cryptocurrency payments, and they are often displayed as a QR code to simplify the process of sharing the address. It is important to ensure that the wallet address provided is accurate and matches the intended cryptocurrency network, as sending cryptocurrency to an incorrect or invalid address can result in the loss of funds.
It is also important to note that crypto wallet addresses are hashed versions of public keys, another essential component to crypto wallets.
The Two Types of Crypto Keys: Public and Private
Public and private keys are generated using cryptographic algorithms that utilize mathematical computations to create a unique set of keys for each cryptocurrency wallet.
The most common cryptographic algorithm used for generating public and private keys is the Elliptic Curve Digital Signature Algorithm (ECDSA). This algorithm generates a random private key, which is a long string of alphanumeric characters, using a cryptographic function. The private key is then used to generate the public key, which is a shorter string of alphanumeric characters.
The public key is generated by performing a mathematical operation on the private key, and it is used to derive the wallet address associated with the cryptocurrency wallet. The wallet address is used to receive cryptocurrency payments, while the private key is used to sign and authorize transactions from the wallet.
How public keys work
Public crypto keys work by providing a unique identifier for a specific cryptocurrency wallet on a blockchain network. They are used to receive cryptocurrency transactions from other users.
When a user wants to send cryptocurrency to another user, they will specify the amount and the recipient's public key, which is a string of alphanumeric characters associated with the recipient's cryptocurrency wallet. The sender will then broadcast the transaction to the blockchain network, where it will be verified and added to the network's ledger.
Once the transaction is verified, the cryptocurrency is transferred from the sender's wallet to the recipient's wallet. This process is secure and transparent, as all transactions on a blockchain network are recorded on the distributed ledger and can be viewed by anyone on the network.
It is important to note that public keys do not provide access to the cryptocurrency funds stored in the wallet, as this requires the private key. Public keys can be shared with others to receive cryptocurrency payments, and they are often displayed as a QR code to simplify the process of sharing the address.
How private keys work
Private crypto keys are a crucial component of a cryptocurrency wallet and are used to access and manage the cryptocurrency funds stored in the wallet.
Private keys are generated using cryptographic algorithms such as the Elliptic Curve Digital Signature Algorithm (ECDSA), which uses mathematical computations to create a unique set of keys for each cryptocurrency wallet. The private key is a long string of alphanumeric characters that is kept secret and should never be shared with others.
When a user wants to send cryptocurrency from their wallet, they will use their private key to sign and authorize the transaction. The private key ensures that only the owner of the wallet can access and manage the cryptocurrency funds stored in the wallet, as it is required to sign and authorize transactions from the wallet.
It is important to keep the private key secure and not share it with others, as anyone with access to the private key can potentially access and control the cryptocurrency funds in the wallet. There are various methods for generating and storing private keys securely, including using hardware wallets or paper wallets.
Types of Wallets: Non-Custodial Wallets vs. Custodial Wallets
Cryptocurrency wallets can be broadly classified into two categories: custodial and non-custodial wallets.
Custodial wallets
A custodial crypto wallet is a type of cryptocurrency wallet where the private keys of the wallet are held by a third-party service provider. When a user creates an account with a custodial wallet provider, the provider generates a users' private keys and the keys are stored on their behalf. The private key is not as accessible to the user, and the service provider is in charge of helping users secure and manage their funds, much like a bank with their customers' bank accounts.
Custodial wallets are commonly offered by cryptocurrency exchanges and other online services that provide a platform for users to buy, sell, and trade cryptocurrencies.
Custodial wallets can offer some advantages over non-custodial wallets. They may be more user-friendly, as the service provider takes care of managing the user's funds. They may also offer additional features, such as instant trades and easy conversion between different cryptocurrencies.
However, custodial wallets also have some disadvantages. Since the user does not have actual control over their private keys, they are reliant on the security measures of the service provider for the protection of their funds. If the service provider is hacked or goes out of business, the user may lose access to their funds. Additionally, custodial wallets may have higher fees.
Non-custodial wallets
A non-custodial crypto wallet is a type of cryptocurrency wallet where the user has complete control over their funds and private keys. This means that the user is responsible for keeping their private keys safe and secure, and they are the only ones who have access to their funds. Non-custodial wallets are also known as "self-custody" wallets because the user is the custodian of their own assets.
Non-custodial wallets are typically considered to be more secure than custodial wallets because the user has full control over their funds. In a custodial wallet, the user's funds are held by a third party, which introduces an additional risk factor. However, non-custodial wallets also require more responsibility and diligence on the part of the user, as they must ensure that their private keys are backed up and kept safe.
Types of Wallets: Hot Wallets vs. Cold Wallets
Hot and cold wallets are two of the primary types of wallets that crypto users like to employ for their crypto balances.
Hot wallets
Hot wallets are digital cryptocurrency wallets that are connected to the internet and allow users to easily send, receive, and manage their cryptocurrencies. They are called "hot" wallets because they are constantly connected to the internet, making them more convenient to use, but also more vulnerable to hacking attempts.
Hot wallets can come in many forms, including desktop and mobile applications, web-based wallets, and even hardware wallets that are designed to be connected to a computer or mobile device.
Hot wallets are typically used for small to medium amounts of cryptocurrency that users plan to spend or trade frequently. They offer a high level of accessibility and ease of use, but they are not considered as secure as cold storage solutions such as hardware wallets, which store cryptocurrency offline and are therefore less vulnerable to hacking attempts.
Cold wallets
Cold wallets are a type of cryptocurrency wallet that is not connected to the internet, and therefore provides a high level of security for storing cryptocurrencies. These wallets are also known as "cold storage" because they are not connected to the internet, which makes them less vulnerable to hackers and other malicious security threats.
Cold wallets can come in many forms, including hardware wallets, paper wallets, or even offline computers that are used exclusively for storing cryptocurrencies. These wallets are typically used for large amounts of cryptocurrency that users plan to hold for a long time, rather than for frequent spending or trading.
Hardware wallets are one of the most popular types of cold wallets. They are small devices that are designed to be connected to a computer or mobile device to allow users to manage their cryptocurrency holdings. These devices store the private keys that are required to access and manage cryptocurrency funds, and they are protected by encryption and other security features.
Paper wallets are another type of cold wallet that involves printing out the private key associated with a cryptocurrency wallet and storing it in a secure location, such as a safe. While paper wallets can be a low-cost and convenient option for storing cryptocurrency, they are also more vulnerable to physical damage and loss than hardware wallets.
Multi-signature Wallets
A multi-signature crypto wallet is a type of cryptocurrency wallet that requires multiple signatures, or approvals, in order to authorize a transaction. In other words, it is a wallet that requires more than one person to sign off on a transaction before it can be executed.
Multi-signature wallets are typically used in situations where multiple separate parties are involved in the management of a cryptocurrency account, such as a business or a joint investment. By requiring multiple signatures, multisig wallets technically provide an added layer of security and reduce the risk of unauthorized transactions or theft.
For example, a 2-of-3 multisig wallet would require two out of three designated signatories to approve a transaction before it can be executed. This means that if one of the designated signatories is unavailable or compromised, the transaction cannot be executed without the approval of at least two of the remaining signatories.
Multisig wallets can be created using various combinations of private keys and public keys. They can also be used in conjunction with other security measures, such as two-factor authentication or biometric authentication, to further enhance their security.
Expanding Use Cases for Crypto Wallet Apps
While crypto users still primarily depend on wallets to make transactions, they can now choose wallets based on additional use cases as wallets evolve with the rest of web3.
Nowadays, it's very common for wallets to help users manage and conduct transactions with NFTs, for example. The need for Bitcoin wallets to integrate Taproot support is another case study in expanding wallet use cases as the Ordinals protocol drove demand for inscriptions.
Given their importance, wallets will continue to serve as the main gateway for many users to not only interact with crypto, but with the wider web3 world. That's why it's critical for users to understand how wallets work, the different types of wallets that are available,
