Cryptocurrency wallets, also called digital wallets, are electronic currency holders that store your funds virtually. Basically, it’s a software program.
It also contains information that identifies you as the owner. This comes in the form of a pair of public and private keys. These keys are what allow you, and only you, to access any funds transferred to you. The sending and receiving of funds is done on the blockchain ledger which requires the pair of keys. Any transactions made will be registered on the blockchain.
This differs from traditional e-wallets you might already use on a variety of services. These ordinary e-wallets simply hold funds transferred from your bank account, which can be used for whatever purpose. They are not encrypted in the way that digital wallets are, making them less secure.
Digital wallets don’t hold money per se; they simply hold data (the keys) which authorize you in the transaction. Your public key can be considered to be your account number on the blockchain, while your private key can be considered your PIN. For this reason, it’s imperative that you keep this information safe.
The Different Types of Cryptocurrency Wallets
Numerous wallets have been designed over the past few years, each with their own pros and cons. Some are more convenient but less secure, and vice versa. The most ardent of cryptocurrency users will want a highly secure wallet, but such a wallet is best used by someone who knows what they’re doing. A beginner may want to choose a more accessible form of storing their money.
Here are the 5 types of wallets, as well as their pros and cons.
Online wallets operate through the cloud. You can access them through a browser and on any device. Examples of online wallets are GreenAddress and the many exchanges that offer wallet service along with a trading platform.
One of the most popular types of wallets, online wallets are convenient, practical and come with multiple features. The fact that you can access your funds from any device is what makes them so popular. Many cryptocurrency exchanges have integrated wallets, giving you an all-in-one platform on which you can transact and trade.
However, since online wallets run online, they are also weak on security. Compared to the other types of wallets, they are easy to hack into. Your public and private keys are stored on a server and if this server is compromised, there is a chance of having your keys stolen.
Furthermore, if the server is down, you can’t access your wallet. You are completely a slave to the whims and faults of the third-party wallet provider. Lastly, some online wallets also impose restrictions on how much you can transact in a day.
For all the above reasons, online wallets are best suited to beginners who don’t have much to lose. Users will some familiarity with cryptocurrency and those serious about it will want to choose one of the other types of wallets.
Desktop wallets, as the name suggests, run on your desktop. You simply download software packages from desktop wallet providers onto your computer and install them. They run like any desktop application. Popular desktop wallets are Electrum, Exodus and Copay.
They offer a middle ground between online wallets and other wallets. They’re user friendly, have access to multiple features and can be accessed from your main device.
However, if your system is compromised because of a virus, you could have your wallet information stolen. You could also lose your funds if your system is damaged. Another disadvantage is that desktop wallets will download the entire blockchain ledger onto your computer which is large in size (somewhere in the region of 50gb) – a time and bandwidth-consuming inconvenience.
Desktop wallets are also suitable for beginners because they’re a gateway to more advanced wallets. You can beef up the security of desktop wallets by installing backup procedures and implementing wallet rotation. This takes a bit of technical know-how, but it’s a good way for a beginner to move into more secure forms of storage and learn about some technical aspects of wallets.
Mobile wallets are nothing more than applications on your phone. They’re the best in terms of convenience because you can use them to purchase items at stores. Examples of mobile wallets are Mycelium, Airbitz and Bitcoin Wallet.
However, they are also very insecure, ranking only above online wallets. Mobile phones are notoriously susceptible to hacking, so it isn’t wise to use mobile wallets as your main storage for funds. If your phone has been hacked or you lose it, your money’s as good as gone.
We wouldn’t advise using mobile wallets as your primary cryptocurrency wallet. It’s best if you have a small amount of funds on a mobile application so that you can use them for in-store payments, but that’s about it. It’s similar to your cash wallet. You don’t carry too much cash with you because it’s risky, you only carry as much as you need for your daily expenditure.
For anyone planning on making moderate or large investments in cryptocurrency, hardware wallets are the way to go. They aren’t stored on the cloud or any specific device and they aren’t connected to the internet. Most often, they come in the form of a USB drive that you plug into your system when you wish to use it. The public and private keys are stored on this drive. Private keys are generated offline which makes it difficult for hackers to obtain. The Ledger Nano S and Trezor are two very well-respected hardware wallets.
Hardware wallets are incredibly secure and that’s because they’re almost never connected to the internet. You can make online transactions when you plug it in and use it. There is also a growing support for hardware wallets with web applications. You can also password protect a hardware wallet for further security.
The downside of hardware wallets is that they are expensive and require some understanding of technology. Additionally, if you lose the USB drive, you’ve lost the wallet and all your funds. In our opinion, they’re worth it because the security offered is unmatched, with the exception of the following wallet.
Among all wallets, paper wallets are the most secure. With these wallets, public and private keys are generated which can then be printed on a piece of paper – they’re a hardcopy version of your keys. It also refers to software that securely generates the keys.
Like hardware wallets, they are also highly secure because they are offline. You can use paper wallets in tandem with online, desktop and mobile wallets. Some wallets will let you print existing keys for your wallets. For example, BitAddress and BitCoinPaperWallet will let you do this.
Once you’ve got these printed keys, you can use them for any transaction by simply adding the pair of public and private keys into any existing wallets.
The main disadvantage of paper wallets is that it’s easy to lose a piece of paper. Losing your pair of keys is like losing your bank account number and PIN, and you don’t want that to happen. You can print multiple copies to prevent this, but this makes physical theft more likely. They’re also inconvenient to use and require technical knowledge for key generation.
Hot Wallets vs Cold Wallets
In reading about wallets, you might come across the terms “hot wallets” and “cold wallets”. All the different types of cryptocurrency wallets fall under either one of these two types.
In general, anything that is connected to the internet is less secure than something that is not. This is the difference between “hot” and “cold” wallets, with internet-connected wallets being “hot” and the other being “cold”.
Online, desktop and mobile wallets are hot wallets, while hardware and paper wallets are cold wallets.
Which Wallet is the Most Secure?
Paper and hardware wallets will best protect your funds. They’re undoubtedly the best choices for larger amounts of funds. Any wallet that is not connected to the internet is many times safer than those that are.While they may be inconvenient, any serious investor or enthusiast must consider using paper and/or hardware wallets.
That doesn’t mean that only these wallets should be used. Different wallets are inherently suited for different purposes. The convenience of online and software wallets makes them ideal for small, regular transactions.
You can also increase the security of software wallets by backing up data in case of system failure. If you keep your devices protected and up-to-date, your funds are much better protected.
Online wallets are the least secure and should therefore be used as little as possible.
It’s best to divide your funds among the different types of wallets.
Keep in mind that one wallet is not necessarily worse than another. It all depends on the intent you have for your cryptocurrency. If you take cryptocurrency seriously, and are putting a lot of money and time into it, then you’re better off starting with a more secure (but tricky to handle) wallet, such as a hardware or paper wallet.
However, if you’re just dipping your foot into cryptocurrency waters and trying to get a feel for how the market works, you’re best starting off with an online or desktop wallet. They’re easy to use and will help you learn how wallets and exchanges work. Once you’ve grown more accustomed to wallet use and trading, you can proceed to a different kind of wallet.
A word of advice though: with the way world is heading and the spiking value of cryptocurrency, even a beginner should keep in mind that security is the most important aspect of a wallet. Don’t store all of your funds in one wallet, and certainly not in just an online wallet.
As a general rule:
- Use online, desktop and mobile wallets for small transactions.
- Use wallets on exchanges for trading.
- Use hardware or paper wallets for secure storage of large amounts of funds.
We can’t emphasize it enough – divide your funds among different types of wallets.
If you’d like more advice on cryptocurrency basics, let us know what we should write about in the comments below.