What is a Software Wallet and how does it work?

A software wallet is a digital storage medium for cryptocurrencies that typically takes the form of a software program, application or web service. Software wallets facilitate the transfer or transaction of one or more cryptocurrencies by holding the private key(s) that correspond to their location on the blockchain.

Software wallets encompass desktop applications, mobile applications and even websites or browser add-ons. In all cases, software wallets host the private keys that allow you to access your cryptocurrencies in a digital manner. Anyone who can access your software wallet has the ability to transact your cryptocurrency.

Examples of software wallets are offered by major exchanges, including Coinbase, Gemini and BlockFi. They are generally free and can take the form of bitcoin and altcoin wallets, allowing you to hold multiple cryptocurrencies like Bitcoin or Ethereum

The main appeal of software wallets are their convenience, as they all require some form of internet connection to interface with your cryptocurrency holdings. Software wallets offer easy access to your cryptocurrencies without requiring you to scan a QR code or plug in a USB drive, as is the case with paper and hardware wallets. However their security capabilities vary depending on which platform you choose.

What software wallets should I use?

When choosing a software wallet, you should pick the option that offers the best combination of convenience and security on the platform that best suits your habits. Software wallets come in three variants:

  • Desktop wallets
  • Mobile wallets
  • Online wallets

Desktop wallet

Desktop wallets are computer applications installed on your desktop computer; these applications store the private keys associated with your cryptocurrency. Most desktop wallets store your private key locally on your harddrive while allowing you to transact your cryptocurrencies in real time, assuming you have an internet connection. 

Desktop wallets are attractive for active traders who prefer trading cryptocurrencies through their desktop or laptop computers, and want to easily manage their holdings while conducting research on the same device. They offer speedy trade execution in most cases, and are usually compatible with multiple cryptocurrencies.

Desktop wallets come with a few shortcomings. They are only as secure as the device you choose to host your wallet on and can be vulnerable to hacks and intrusion software if your device is compromised. In the event that your computer crashes and your data is not properly backed up, the private key saved on your desktop wallet may also be lost. 

Desktop wallets are a good choice for frequent traders, but should not be relied on to hold large quantities of cryptocurrency, given their cybersecurity vulnerability.

Mobile wallet

Mobile wallets are applications installed on your smartphone device; these applications store the private key needed to access your cryptocurrency locally within your smartphone, and allow you to transact your cryptocurrencies directly through your smartphone device. 

Mobile wallets appeal to active traders who want 24/7 access to their cryptocurrencies on the road. Mobile wallets are the most portable option for transacting cryptocurrencies and allow access to your holdings wherever you have a wireless internet connection. Some mobile wallets offer added capabilities like QR code scanning and cold storage. 

Mobile wallets feature similar shortcomings to desktop wallets as they’re dependent on the security of your mobile device. If your smartphone is compromised, your mobile wallet may be vulnerable to malware or viruses. 

Additionally, given their portability, you’ll want to take steps to ensure that the smartphone itself is not lost or destroyed. It’s generally a good idea to use these primarily for transactional purposes and minimize the amount of cryptocurrency hosted through your mobile wallet.

Online wallet

Online wallets are web-based applications that can be accessed from any browser or installed as an add-on. Unlike desktop and mobile wallets, online wallets rely on a third-party to hold your private key rather than storing it locally on your device. 

Online wallets are popular with active traders who want fast access to their cryptocurrency from any device; they are generally the quickest and most convenient way to transact your holdings. Many online wallets are also integrated with trading exchanges.

The downside of online wallets is that they require you to trust the safety and security of your cryptocurrency holdings to a third-party host. While this method is certainly convenient, it relies on the security protocols and servers of the third-party to secure your private key rather than storing them locally on your device. 

As with all software wallets, it’s generally a good idea to minimize the amount of cryptocurrency held within your software wallet to mitigate any potential cybersecurity and trustee risk.

Are software wallets safe?

Software wallets trade security for convenience and speed due to their close proximity to the internet; they’re less secure, from a cybersecurity perspective, than popular hardware wallet alternatives.    

The safety of your software wallet can vary, depending on whether you’re using a device that’s connected to the internet or isolated entirely for offline use. Generally, software wallets are hot wallets, better suited for transacting rather than the long-term storage of your cryptocurrency.

Desktop and mobile wallets both rely on the security of your local device to store your private key and deter malicious attacks from hackers and malware. Web-based wallets also require you to entrust the third-party host of the online wallet with your private key.

We recommend that users only keep enough cryptocurrency in their software wallet to satisfy their trading and transactional needs. The majority of your holdings should be safely stored offline in an appropriate cold wallet to mitigate any risk of loss.

We recommend that users only keep enough cryptocurrency in their software wallet to satisfy their trading and transactional needs. The majority of your holdings should be safely stored offline in an appropriate cold wallet to mitigate any risk of loss.

Risks of a software wallet

Users of software wallets encounter cybersecurity risk, risk of loss, and trustee risk, in the case of online wallets. We cover the risks of software wallets in detail.

Cybersecurity risk

Due to their proximity to the internet, software wallets carry heightened cybersecurity risk, especially if the device they’re hosted on has an active internet connection. Both mobile and desktop software wallets are vulnerable to malware and cyberintrusion. Safe cybersecurity habits should be practiced when securing your device.

It’s generally recommended that users of software wallets use them in tandem with a hardware or paper wallet for cold storage purposes. Large sums of cryptocurrency should be stored securely offline in a cold wallet. Software wallets should be relegated to storing small sums for trading and transactional purposes only.

Pro Tip: Cold storage for software wallets
Some users of software wallets choose to dedicate an offline desktop or mobile device to the storage of their cryptocurrencies. This can be done by transferring your holdings onto the private keys hosted on these devices via hardware wallet, or directly via one’s online connection; once complete, your device can be disconnected from the internet entirely.

Keep in mind that this method may not be foolproof if the device you’re transferring your assets onto has already been compromised. It also may not be practical for investors who rely on their device for other needs that require an internet connection. 

Risk of loss

Users of software wallets face the risk of loss with desktop and mobile devices, specifically if their device is stolen or if the underlying files are wiped without being properly backed up. Proper planning and forethought should be exercised to control for these risks. 

Users should take steps to ensure that their device is properly secured with separate passwords for both their device and wallet. Most software wallets also provide users with the means to backup and restore their cryptocurrency holdings by means of a seed phrase as a contingency.

Users should take steps to record and store these seed phrases in a secure location in the event their device is lost or stolen. Most software wallets allow the user to restore their crypto holdings using their seed phrase in the event their device is stolen, lost, or otherwise see its data wiped.

Trustee risk

Users of online wallets bear trustee risk due to their reliance on the third-party host of their web-based wallets. Online web-based wallets rely on the third-party host to maintain the servers that allow you to access your cryptocurrency. They also rely on the host to secure your private keys from hackers and malicious actors.

Over the past few years there have been multiple instances of security breaches, including intrusions recorded at major bitcoin wallets, like Binance and Electrum, where tens of millions of dollars worth of bitcoin and other altcoins were stolen. These were both instances where hackers were able to exploit loopholes in these online wallet platforms.

While the creators of major online wallets have taken major steps to secure their networks, the risk of exploitation by criminal elements is, by no means, remote. Users of online wallets should balance both convenience and security when considering where to store their cryptocurrency.

Hardware wallet vs software wallet: What’s the difference?

Software wallets are digital applications installed on your device, or accessed through your web browser, while hardware wallets are physical devices, resembling USB sticks, that store your private keys. Both types of wallets are meant to secure access to your cryptocurrency.

What’s better? Hardware or software wallet

Software wallets are generally more convenient, easier to use, and cheaper than hardware wallets. However, hardware wallets are more secure and don’t require any cloud-based servers or third-party hosts to protect your private keys. Whether one option is superior to the other depends on the needs and preferences of the individual user.

Software wallets offer more convenience since they are installed directly onto your device or accessed through the web. This allows for users to quickly place trades or transfer cryptocurrencies without having to go through intermediary steps. Transactions executed via software wallets are therefore generally more timely than those conducted through hardware wallet alternatives.

Software wallets also hold a price advantage, since most software wallets are free while the most popular hardware wallets must be purchased from reputable manufacturers and entail delivery costs. This can make software wallets more attractive to beginner investors, starting out with small sums, or those who don’t intend to take major positions in cryptocurrencies.  

Hardware wallets hold the edge in security. Thanks to their design, hardware wallets allow users to hold their private keys in an isolated location, offline, and theoretically outside the reach of hackers. 

Hardware wallets also preclude the need to trust any third parties when storing your cryptocurrency, this makes them an ideal method for protecting large amounts of cryptocurrency in cold storage.

Do I need a software wallet if I already have a hardware wallet?

We generally don’t believe one option to be superior to the other and believe a hybrid approach to be practical for most investors. 

Users should consider using software wallets to store the nominal portion of their cryptocurrency that they intend to use for trading or transactional purposes. The majority of their remaining holdings should be safely secured in an offline hardware wallet.

This hybrid approach allows active investors to mitigate their market risk by ensuring a portion of their cryptocurrency holdings is always liquid and available for trading within their software wallet. It also allows them to minimize their cybersecurity risk by ensuring the majority of their funds are secured in a hardware wallet until needed.