Guide to Cryptocurrency Wallets
They are hot and they are cold - we explore the lyrics of cryptocurrency wallets.
A cryptocurrency wallet is a piece of software where you can securely store your cryptocurrencies, like how a bank helps to safeguard your money stored with them.
There are dozens of different crypto wallets out there to choose from, hence it’s important to understand the main differences between them to guide your eventual decision.
Types of crypto wallets
There are different types of crypto wallets, but the most popular ones are custodial wallets, non-custodial software wallets, and hardware wallets.
Let’s take a closer look at each one in greater detail.
Custodial wallets are the most popular and easiest to set up. Whenever you create an account and buy crypto with a popular exchange service like Binance, Coinbase, or Crypto.com, you are already storing your cryptocurrencies in a custodial wallet.
In a custodial wallet, a third party service provider creates a wallet address and stores your crypto for you by managing and abstracting the wallet infrastructure away. You can think of it as a bank offering you a savings account to keep your deposit.
To create a custodial wallet:
- Sign up for an account with a trusted and reputable custodial service provider such as Binance, Coinbase, Bybit, Gemini, or Crypto.com
- Buy or transfer in crypto
Pros of custodial wallets
Custodial wallets benefit from simplicity and security. Most reputable exchanges have refined their wallet infrastructure over the years to ensure that wallets are properly secured. This means that you can rely on these providers to safe keep your cryptocurrencies in storage without the complication of managing their security.
Cons of custodial wallets
Custodial wallets have limitations when it comes to participating in opportunties crypto has to offer, such as yield farming. Storing your crypto on an exchange or custodial wallet leaves it open to hacks, where your funds are vulnerable to being stolen. There is often a popular saying that goes, not your keys, not your coins. By leaving it to the custodial wallet provider, you are entrusting your funds to the service provider. If anything happens to the service provider, your funds might be at risk.
That brings us to self-custody, or storing your crypto in a wallet controlled by you, called a non-custodial wallet.
Non-custodial software wallets
Non-custodial software wallets gives you complete control of your cryptocurrencies. Instead of relying on a third-party to keep your cryptocurrencies safe, the responsibility of safeguarding your funds now fall onto you.
In non-custodial software wallets, you are typically in-charge of managing and keeping your private keys and seed phrases to the associated wallet address (or account) safe from privy eyes. Private keys are the soul of the wallet, and having them stolen or compromised in any way would mean the complete loss of funds stored in that wallet.
To create a non-custodial software wallet:
- Download a non-custodial software wallet app like MetaMask, Trust Wallet, Coinbase Wallet, Rainbow Wallet, or Phantom Wallet — the choice of wallet depends on the blockchain it supports
- Create a new account using the app, there is no need to share any personal information
- Back up and safeguard your private keys
- Transfer cryptocurrencies into the wallet
Pros of non-custodial software wallets
Non-custodial software wallets give you complete control of your cryptocurrencies and allow you to participate in the crypto-economy such as yield farming, DeFi and staking.
By being in control of your own private keys, you can be certain that your funds can not be stolen from you as long as you don’t lose them.
Cons of non-custodial software wallets
Self custody of cryptocurrencies is an advanced topic that may be extremely unfamiliar to many people. Private key management is challenging, and it is especially susceptible to being hacked.
For example, in recent months, there is a spike in phishing activities to extract private keys of high net worth individuals. As software wallets may expose the private keys of a wallet over the Internet, there is a higher risk associated with using them (e.g. copy-pasting private keys may be keylogged).
For investors that have huge amounts of funds stored in DeFi, the risks of losing their funds when using non-custodial software wallets may not be worth it. These group of people may want to consider using a hardware wallet.
Hardware wallets are also non-custodial in nature, where the user also self-custodizes his cryptocurrencies by managing the private keys to the account. However, unlike software wallets, hardware wallets store the private keys offline in a secure element stored on the hardware device, typically the size of a thumb drive.
The security of a hardware wallet is unmatched, as the private keys and seed phrase never leaves your device, and your cryptocurrencies can be kept secure even when your computer is hacked or phished.
To create a hardware wallet:
- Purchase a hardware wallet like Ledger
- Install the required software and apps
- Transfer crypto into your hardware wallet
Pros of hardware wallets
Hardware wallets are the most secure way of storing cryptocurrencies, as they allow you to self-custodise your cryptocurrencies and remove the risk of a third-party losing your funds if they are hacked.
Most third party service providers also store the majority of their funds in cold storage in an enterprise grade hardware wallet to prevent hacks.
Cons of hardware wallets
Their main issue is inconvenience, since hardware wallets require the use of the physical device to authenticate and sign transactions.
Their complexity to use, such as setting it up, installing the required applications and keeping it nearby, makes it a tougher sell for frequent traders. They are best used for funds that are not frequently touched.
The other issue they have is cost, as they cost US$100-US$200 to purchase, compared to their free software wallet counterparts.
Check out our guide on the best hardware wallets below.
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