We all are today surrounded by digital currencies but what exactly do we mean by them? Digital currencies are a form of currency available only in digital or electronic form. It is also being called out by different names such as digital money, electronic money, electronic currency or cyber cash. They need to be accessed using a digital item like smartphones or computers as they only exist in electronic form. All cryptocurrencies are digital currencies, but not all digital currencies are cryptocurrencies. Digital currencies have utility similar to that of physical currencies. They can be used to purchase goods and pay for services.
Digital currencies also enable instant transactions that can be seamlessly executed across borders. For instance, it is very possible for a person located in America to make payments in India using digital currencies.
What are crypto wallets?
Crypto wallets basically hold the private keys, keeping your crypto safe and accessible. Sending, receiving and spending cryptocurrencies like bitcoin and Ethereum are also allowed using this. They majorly hold the passwords that allow us to access our cryptocurrencies, a tool we can use to interact with a blockchain network.
The crypto wallets can be divided into three major groups. They are as follows,
- Software Wallet
- Hardware Wallet
- Paper Wallet
Depending on their working Mechanisms they can be also defined as hot Wallets(Software Wallets) and Cold Wallets(Hardware Wallets and Paper Wallets).
A lot of people believe they are the source of storing cryptocurrencies instead they work as a sort of gateway providing the tools you need to communicate with a blockchain in simple understanding these wallets hold or generate all the essential information we require to use cryptocurrencies.
Let’s practically understand the working of crypto wallets with the help of an example.
Bob wants to receive a payment from his customer named Marley using a crypto wallet. The easiest way for Bob is to use a crypto wallet program; the following steps would allow Bob and Marley to complete this process.
- Bob creates a new wallet, the program generates multiple pairs of public and private keys along with several blockchain addresses. To understand in an easier way let’s assume a single pair of keys is generated for the process along with the single address.
- The public key is used to generate a unique bitcoin address. This address is provided to Marley to take the step further. Marley now sends bitcoin from his wallet to Bob's wallet. The coins remain in the blockchain; they are simply transferred from one address to another.
- Private key should in no way be shared by bob to anyone; it is used to sign new transactions and is what gives access to funds to the person. Private keys can also be used in case the account requires the access essentials. Losing or giving it to another person can lead to stealing of funds by that particular person who holds the private key. Private Key holds the place of the most important element in the crypto wallet.
- Modern wallets make use of a seed phrase, it works like a root key and it gives access to all keys and addresses. They can be used to generate multiple private keys so instead of making a backup of each private key in her wallet, you only require the root key that is the seed phrase.
Types of crypto wallets
As we discussed above there are majorly divided or referred to as hot and cold wallets, a hot wallet(Software wallets) is anyone that is connected to the internet. Hot wallets are convenient to traders and frequent users because they are easy to set up. The funds here are also quickly accessible. Talking about cold wallets(hardware and paper wallets) use a physical medium to store the keys offline and this makes them very resistant to hackers.
This method is also known as cold storage and is particularly suitable for long term investors.
Taking it further Software wallets comes in three different types of wallets namely,
- Web Wallets
- Desktop Wallets
- Mobile Wallets
Web Wallet
Web wallets allow interacting with blockchain via a browser interface so you don’t need to download anything on your computer. This includes both exchange wallets and other browser-based wallet providers. In most cases, you can create a new wallet and set a personal password to access it. However, some service providers hold and manage the private keys on your behalf. Although this may be more convenient for inexperienced users, it's a dangerous practice. They are ideal for small investments and allow quick transactions.
Desktop Wallet
You need to download and execute locally the desktop wallet in your system. Desktop wallets give you full control over your keys and funds. When you generate a new desktop wallet, a file called "wallet.dat" will be stored locally on your computer. This file contains the private key information used to access your cryptocurrency addresses, so you should encrypt it with a personal password. Desktop wallets are safer than web wallets.
Mobile Wallet
Mobile wallets are designed much like mobile apps making use of smartphones giving you convenient access to your funds. These are vulnerable to malicious apps and malware infection, encrypting your mobile wallet with a password and backing your private keys or the seed phrase is recommended if mobile phone gets lost.
Hardware Wallet
Hardware wallets are physical electronic devices that use a random number generator to generate public and related private keys. The keys are stored in the device itself and are not connected to the internet. Hardware wallets are more inconvenient for traders and frequent users. These wallets offer higher levels of security against online attacks; they may present risks if the firmware implementation is not done properly. Also, they tend to be less user-friendly, and the funds are more difficult to access when compared to Software wallets(Hot wallets).
Paper Wallet
Paper Wallet, a paper on which blockchain addresses and physical keys are printed. They are usually present as QR codes. They provide numerous flaws and are less used. Some paper wallet websites allow you to download their code to generate new addresses and keys while being offline. As such, these wallets are highly resistant to online hacking attacks and may be considered an alternative to cold storage. A major flaw is not being able to send partial funds.
Losing access to crypto wallets can be costly resulting in loss of your funds. Backing up the wallet data file and seed phrases goes to getting back your access to the wallets. The majority of crypto wallets are based on Software wallets which provide more convenience than hardware wallets but the hardware ones tend to be the most secure wallets. Paper wallets are generally called out as unreliable.
Disclaimer: This blog has opinionated information which does not make us liable for anything.