Crypto wallets are tools used to interact with a blockchain network to access cryptocurrencies, like Bitcoin and Ether. Contrary to popular belief, crypto wallets don’t store your crypto like their physical counterparts. Instead, crypto wallets store private keys, which allow you to access funds on the blockchain.
Below, we explore the different types of crypto wallets along with their advantages and disadvantages.
What Are Private and Public Keys?
Before doing a deep dive into crypto wallets, it’s essential to have a basic understanding of private and public keys along with their primary functions. Private keys allow you to send transactions on a cryptocurrency blockchain, while public keys allow you to receive transactions. Public keys encrypt transactions and make it so that only a person with a particular associated private key can access funds.
Public-key cryptography, used in Bitcoin’s protocol, relies on public and private keys for encryption and decryption. The two keys are generated together in a pair and are connected through some clever math. The math makes it so that private keys can easily generate public keys; however, public keys cannot easily generate private keys.
The relationship between the two keys means that users can freely share the public key without compromising the private key. On the other hand, the private key must be kept safe to ensure the crypto’s security in an associated transaction.
As a reminder, crypto wallets serve the purpose of protecting your private keys and therefore ensuring the security of your crypto assets. However, the method of security varies depending on whether you’re using a hot or cold wallet.
Hot Versus Cold Wallets
The terms hot and cold wallets simply delineate whether or not a wallet connects to the internet or not. Hot wallets can connect to the internet, while cold wallets cannot. Hot wallets offer ease of access to your crypto, while cold wallets are more typically considered to be more secure.
|Hot Wallets||Cold Wallets|
|Connected to the Internet?||Yes||No|
|Crypto Accessibility||Crypto can be easily traded||Additional steps required to trade crypto|
|Security||Easier to hack||More difficult to hack|
|Price||Free options available||You can expect to pay at least $50|
|Best for||Day-to-day transactions||Long term asset holding|
Below, we discuss some considerations when selecting between a hot or a cold wallet for personal use:
Since hot wallets can connect to the internet, they are perceived as more convenient. Having your crypto on a hot wallet allows you to buy, sell or trade your crypto quickly, without having to make any transfers before any desired transactions on your end. That said, since hot wallets can be compromised more easily, it’s not a wise idea to keep private keys for a large amount of crypto on a hot wallet.
Hot wallets are only as secure as the device on which your private keys are stored. Therefore, it’s recommended for people with hot wallets to activate 2-factor-authorization on any device, which might have access to private key information, including computers and phones.
Unlike hot wallets, cold wallets store private keys on devices that are not connected to the internet. As a result, cold wallets are considered to be more secure but less convenient to use. While it’s easy to store private crypto keys on a cold wallet, it’s a little more time-consuming to send crypto out from a cold wallet, considering the lack of internet connectivity.
You will generally want to store private keys with access to large amounts of crypto funds in a cold wallet. Doing so will serve as a layer of protection since you’ll be less susceptible to malicious online hacks.
It might help to think of your hot wallet as a coin purse, which should have access to limited funds for everyday use. A cold wallet is where the private keys for your largest crypto-assets should reside and is more akin to a bank vault.
What Are the Different Types of Crypto Wallets?
Currently, the three most prominent types of crypto wallets are listed below:
- Software wallets
- Hardware wallets
- Paper wallets
Remember that hybrid versions or slight variations on the wallet types mentioned above do exist since the only requirement of a crypto wallet is that it can store your private keys.
Software Wallets Explained
Examples: Bitcoin Wallet, Electrum, Exodus
A software wallet is an application you download or access through a personal device, like a phone, laptop, or tablet. The application allows you to manage and trade your crypto assets. Software wallets are typically connected to the internet, making them hot wallets. There are three primary forms of software wallets:
Users can access online wallets through a web browser with any device. While online wallets are highly convenient for accessing your crypto assets, they are also vulnerable to hacks. You’re entrusting the website you use to generate a wallet with user credentials, which can be used to compromise your wallet and its assets. Generally, it’s not recommended to store large amounts of crypto in an online wallet; however, it can be a helpful tool for small transactions, given its accessibility.
A mobile wallet is an app you download on your phone, enabling you to make purchases or manage your crypto with your phone. Mobile wallets are great for users who want to use crypto for day-to-day transactions.
Be aware that a mobile wallet is only as secure as the phone it is stored on. Users of mobile wallets will want to ensure they are using a password-protected phone and that they can access their mobile wallet if their phone is stolen or lost. This can be accomplished by downloading the mobile wallet app to more than one device.
|Pro Tip: Purchases With Crypto Are Taxable Events|
When you make a purchase with cryptocurrency, the crypto you trade is subject to a certain amount of capital gains tax, depending on how long you held the asset. The reason for the taxable event is that the IRS currently considers crypto to be property rather than currency. If you’re interested in learning more about crypto’s tax implications, read our crypto tax guide.
Desktop wallets are software programs you download, which provide you control of deposited crypto assets. Similar to mobile wallets, desktop wallets are only as secure as the device the software program is stored on. Therefore, it’s recommended to scan your computer for malware or keyloggers before downloading a desktop wallet. Generally speaking, people with large amounts of crypto should steer clear of desktop wallets, or any type of software wallet, in favor of a hardware wallet.
Software Wallet Benefits:
- There are several free software wallets available for use.
- Software wallets make your crypto assets readily accessible for use.
- Since software wallets don’t physically exist, they can’t be destroyed.
Software Wallet Drawbacks:
- Software wallets are susceptible to online exploits since they are hot wallets.
- The quality of software wallets from a security standpoint varies widely.
Are software wallets hot or cold wallets? Software wallets are hot wallets.
Hardware Wallets Explained
Examples: Ledger, Trezor, NGRAVE
Hardware wallets are physical devices, typically resembling USB drives, which securely store a user’s private keys. Several companies develop hardware wallets, and each one’s hardware wallet operates differently. Most commonly, hardware wallets allow users to set personalized PINs required to access a user’s private keys.
Since crypto isn’t physically stored on the device, if you lose your hardware wallet, you can still recover access to your assets, provided you retained the seed phrase. The seed phrase is a list of words associated with your private keys and is created when you set up your hardware wallet. Having access to your seed phrase allows you to recover access to your crypto even without the original hardware wallet.
Hardware Wallet Benefits:
- Generally speaking, safer than paper wallets or software wallets due to hardware wallets being cold wallets.
- Not vulnerable to malware or malicious online actors.
Hardware Wallet Drawbacks:
- While prices vary, you can expect to pay between $50 and $200 for a hardware wallet.
- Crypto is less accessible since the hardware wallet requires a physical connection to a computer.
- Hardware wallets can vary in terms of ease of use.
Are hardware wallets hot or cold wallets? Hardware wallets are cold wallets.
Paper Wallets Explained
Examples: Private keys written on a piece of paper or engraved on a sheet of metal
A paper wallet refers to private and public keys written down or printed on a piece of paper or any other physical material. The keys are generated through open-source software widely available through a slew of free-to-access websites. Paper wallets were prominent in the early days of Bitcoin when other types of wallets were more primitive from a security standpoint.
Today, paper wallets are generally perceived as insecure options, considering the open-source software that generates private and public keys are susceptible to malicious online exploits. Crypto enthusiasts who choose to use paper wallets are encouraged to ensure their computer is free of malware or keyloggers before creating a paper wallet.
There are several other notable risks associated with paper wallets. For one, you could misplace the paper or material where the private key is written, rendering your crypto effectively lost forever. Another common criticism of paper wallets is that they are susceptible to damage based on the environment where they are stored. For example, a small fire could destroy a paper wallet, or water could make the private key illegible.
Paper Wallet Benefits:
- Quick to set up and have your private and public keys on a paper wallet in less than ten minutes.
- You can generate paper wallets for free through online open-source software.
Paper Wallet Drawbacks:
- Your private key is only as secure as the open-source software you used to generate it.
- Paper wallets are susceptible to the environment where they are stored.
- Losing your paper wallet means you lose all the crypto associated with the said wallet.
Are paper wallets hot or cold wallets? Paper wallets are cold wallets.
How to Pick a Crypto Wallet
When selecting a crypto wallet, the type of crypto user you are will determine what the best wallet is for your needs. For example, if you’re someone who just buys and holds crypto, then a hardware wallet is likely best for your needs. On the other hand, if you’re an active crypto trader, it might make sense to have a software wallet, specifically a mobile or online wallet, which holds the private keys to crypto you plan to trade in the near term.
The most significant consideration most crypto users will have to make is the tradeoff between security and accessibility. Generally speaking, the more accessible your funds are, the less secure they are. So, while hot wallets may be great for trading crypto, they are inherently less secure than cold wallets.
Another primary consideration surrounding selecting a crypto wallet is price. While software and paper wallets are mostly free-to-use, hardware wallets typically begin at around $50. If you have a negligible amount of crypto, it might make sense for you to utilize a software wallet. As you acquire more crypto assets, you’ll want to consider making a hardware wallet purchase.
For some users, it might make sense to have two crypto wallets: A hardware wallet, which holds the majority of your crypto assets, and a software wallet, which holds funds you plan to use in the short term. Using two wallets provides users with a good mix of security and accessibility.
Crypto Wallet FAQs
Below, we answer some of the most common questions surrounding crypto wallets.