How do crypto wallets work? You will need to use a crypto wallet in order to deal with cryptocurrencies. This is a device or a software program that will allow you to store your crypto assets and transfer them as and when required.
However, in order to make the right choice you will need to know each different kind of crypto wallets and how they work. If you do not, you are in the right place.
Ideally, a crypto wallet consists of a pair of keys namely the private keys and public keys.
The public keys are typically derived from the private key which acts like the address of the wallet and can be shared with others so that you can send or receive crypto coins.
A crypto wallet can have several different public keys. On the other hand, the private key is, well, private, and therefore needs to be a secret.
Remember, if you lose your private key, you lose all your crypto and access to it.
This article will let you know much more than how the crypto wallets work and their different types.
This knowledge will enable you to know the significance of a crypto wallet in dealing with crypto assets as well as the importance to ensure it is safe and secure to store your private key.
How Do Crypto Wallets Work?
Typically, crypto coins are not stored in a wallet per se. Instead, these are stored in the blockchain.
This blockchain network is a public ledger and stores data in ‘blocks’ which are actually the records of all the transactions made within the network and also the balances held by the users in different addresses.
The blockchain allows the participants in the network to know which user holds the key to the balances.
In order to interact, it is the wallet software that is used.
This itself stores the addresses and allows the users to see the balances in any given address as well as when the coins are moved from one address to another.
Ideally, most of the crypto wallets allow the users to send, receive and store crypto coins but there are a few specific types of crypto wallets that also comes with a special feature that allow the users to:
- Buy and spend crypto coins
- Swap between tokens
- Stake crypto coins for a fixed return and
- Access different Decentralized Applications or dApps that may be built on different networks.
The blockchain crypto wallets follow the same working process of email where there is the email address that you share with others to send and receive emails.
However, it is only you who can access your email address and read these mails by using a password.
In order to use a crypto wallet, you will need to follow a few specific steps for sending and receiving funds.
In order to receive funds, you will have to:
- Retrieve an address or the public key from the crypto wallet
- Find and click on the ‘generate address’ feature in the wallet
- Copy the QR code or alphanumeric address and
- Share it with the user who wants to send crypto coins to you.
On the other hand, if you want to send funds to another user, you will have to:
- Find and click on the ‘send’ feature of the crypto wallet
- Enter the address of the wallet where you want to end the coins
- Choose the amount of coins you want to send and
- Click ‘confirm.’
Both the processes are pretty simple and there are millions of people using crypto wallets out there. Some of the crypto wallets have a Graphical User Interface or GUI to make it more user-friendly.
The most important part of a crypto wallet is the private key which is like a safe deposit box.
You can also use non-custodial wallets which are not hosted by the crypto exchange or any third party.
These are more like a bank account but the only difference is that it is controlled by the private key which only you have access to.
The private key of the crypto wallet is used to ‘sign’ a transaction by a user to initiate it.
Types of Wallets
There are typically two major categories in which all the crypto wallets can be grouped together. These are:
- Software wallets and
- Hardware wallets.
The software wallets are browser extensions or simple desktop programs that are very easy to use for sending, receiving, and storing crypto coins.
These software wallets are also referred to as ‘hot’ wallets sometimes.
This is because the funds in it are stored online and therefore you may be worried about the safety of your coins.
A software wallet is however unique to each type of crypto coins.
The software wallet can interact with your computer in two specific ways.
You can use them on the web. In such cases it will be called the custody wallets and these are not entirely secure.
You can also use the software wallets in the form of an app that you can install on your smartphone or computer.
The private keys are then stored in the local device.
However, this does not make them 100% safe because to use them you will need to connect it to the internet and therefore be more vulnerable to cyber attacks or technical glitches in the hard drive or the web browser.
The software wallets can be further divided into three sub-groups such as:
- Web-based wallets that work as an extension of the browser
- Desktop wallets that you can use either on a desktop or a laptop computer and
- Mobile wallets that you can install and use on your mobile devices.
On the other hand, the hardware wallets are physical devices that you can plug into your computer through the USB port to serve the same purposes.
These are quite safe because all of the signing happens offline and these are quite difficult to hack.
This is why the hardware wallets are also referred to as ‘cold’ wallets or cold storage. These wallets can support multiple crypto coins.
The hardware wallets typically interact with your computer in three different ways such as:
- Through an app created by the manufacturing company of the hardware wallet
- Through a web-based interface or
- Through a different software wallet.
Typically, when you use a software wallet you will need to create a backup and store it safely.
However, in the case of a hardware wallet, unless you lose it or it gets damaged, there is no chance of such vulnerabilities.
There is also another type of crypto wallet called the paper wallet. These are very easy to use and are also quite secure.
A paper wallet refers to both a physical printout of your private and public keys or a piece of software that can generate the pair of keys after which these are printed.
However, these wallets can get damaged or destroyed easily due to fire or flood.
Features of Wallets
Now, since you know how the crypto wallets work, there are some specific features that these crypto wallets come with which you should also know about. Some of the notable features of crypto wallets are:
- These are easy to use and are just like any other software you use in your computer for your day-to-day jobs.
- The crypto wallets are very safe and secure to use because all that matters is how well your private key is stored and protected.
- You can access your crypto wallet from any device, from any place, and at any time to make instant transactions across the world with no borders or intermediaries.
- The cost of funds transfer is often much lower in comparison to transfer of funds made via a traditional bank.
- The wallets support transacting with multiple crypto coins which, in turn, helps in doing currency conversions easily.
However, all these types of crypto wallets come with their own pros, cons, and use cases.
Therefore, choose one according to your needs and preferences.
Need to Use a Wallet
Typically, you will not be able to transact cryptocurrencies if you do not have a crypto wallet, of any kind.
When you use a crypto wallet, you will not have to face the common issues that you may face when you use any traditional banking system.
Most importantly, it eliminates the need of an intermediary while making a transaction.
Moreover, transactions can be made quickly and without any hassles.
Since everything will be stored in your crypto wallet, it will be easy for you to keep proper track of all your coins, accounts, and balances.
And, since there will be only a single point of failure, there is a low chance of your data being jeopardized, corrupted, or even manipulated as it may be the case when you use multiple systems.
Most importantly, a crypto wallet ensures that all your transactions are secure because each of it will be cryptographically signed.
If you are wondering whether or not crypto wallets are safe to use, well, it can be said that they are but to varying degrees.
The security aspect of your crypto wallet depends on several factors which include:
- The type of crypto wallet you are using and
- The service provider involved.
If you are using an online wallet, you are at the mercy of the web server and its ability to prevent hacking, technical glitches and other issues.
These are intrinsically quite risky and your funds can be stolen quite easily as compared to those offline wallets.
There have been several incidents before where crypto coins worth millions of dollars were stolen and nothing could be done to retrieve them.
On the other hand, the offline wallets are far better to use because they provide better security since these are not connected to any online network.
These crypto wallets also do not need to rely on any third party for security.
However, irrespective of which type of crypto wallet you use, since securing the private key is the sole objective, you should take proper and diligent safety precautions from your end to ensure that it is secure.
For example, you should always have a proper backup of your wallet and store it in a safe place.
This will enable you to retrieve your private key in case it is lost.
You should also use both offline and online crypto wallets for ensuring higher safety and security.
Keep a small amount of currency in the online wallet for daily use and store the major part of your coins in a safe offline wallet.
Also, make sure that your software is updated on a regular basis. This will enhance the security aspect with the latest features.
You may also add additional security layers, the more, the better.
Always set a long and complicated password and also make sure that every withdrawal needs a password.
Finally, use a crypto wallet that has a good reputation and comes with a set of sophisticated features such as two-factor authentication, PIN requirement, multi-signature transactions and others.
Typically, when it is charged, the transaction fee involved in this aspect is just a tiny fraction of the fees that are usually charged by traditional banks to make a transaction.
Usually, the fees charged in this case may be the processing fee to make a specific type of transaction that needs to be paid to the miners participating in the network.
Sometimes, you may be allowed to set a low fee on your own.
However, in these situations your transaction will not be the priority and the speed will be quite low.
You may have to wait for hours at a stretch or even days for one transaction to get confirmed and be completed.
Therefore, if you want to make faster transactions, there is no way but to pay higher fees for that.
However, it can be said that, no matter whichever crypto wallet you are using, the transaction fee should not be something that you should worry about. It will be either zero, very low, or according to your wish.
Now, you may wonder whether or not the crypto wallets meet the fundamental objective of cryptocurrency, which is to make anonymous transactions. Well, apparently, yes, but if you look at it deeply the answer would be – not really.
Typically, crypto wallets, honestly speaking, are pseudonymous.
These wallets do not reveal the real identity of the user and store all the transactions permanently on the blockchain that are however accessible publicly.
This means that a person may not be able to see your real name or your residence address in it since it is not there but there are several other ways in which some people may use the data available in it, such as your wallet address, to trace your identity.
Though several crypto wallet companies are trying to find newer and better ways to beef up the security, anonymity, and privacy aspects through features like coin mixing and stealth addresses, these are the obvious drawbacks of the crypto wallets as of now.
Pros and Cons
There are some merits and demerits of using a crypto wallet which is also very important to know in the end.
One of the most significant advantages of using a crypto wallet is that it will give you self-ownership of your funds since you will be in total control of the private key.
Another advantage is that you will be able to send funds to whomever or wherever you like because decentralized cryptocurrencies do not need any censorship and no one has total control over the network. This makes it difficult to stop any transaction by anyone.
However, the significant downside of using a crypto wallet is user responsibility.
It is your sole responsibility for anything going wrong during the transaction process, and even before the transaction, in case you lose the private key.
Also, you will need to have some basic knowledge of computer usage to use the crypto wallets.
However, the learning curve will be even sharper if you want to get acquainted with the advanced features and functionalities of it as well as the lesser known aspects of this exciting financial ecosystem.
In order to use the right kind of crypto wallet, you will need to do some research and know how they work. If that is not an option to your liking, this article will surely be enough for you to know which crypto wallet is the best to invest in.