Decentralized networks empower their users. They enable users to carry out required tasks that were previously delegated to third parties. Banks, for instance, store savings in a “safe or vault” instead of the average Joe stashing their dollars under the mattress. Blockchain has empowered its users. Now, Bitcoiners can store their savings securely in a wallet without the need for a third party. Of course, big corporations in the crypto universe function like banks: they take custody of savings in exchange for certain features or services. These are not wallets; they’re exchanges. Keeping savings in an exchange is not the safest bet. Especially considering the millions of dollars that have been lost by crypto enthusiasts in hacks or scams.
Wallets aim to be the new bank accounts because they store and keep track of money, in this case digitally. Furthermore, bank accounts and wallets share similar limitations when it comes to the assets it can store. A USD bank account cannot store Euros and vice versa. The same principle applies to digital wallets. They can only store tokens that run on the same network, e.g. decentralized applications (tokens) created within Ethereum are stored in Ethereum wallets. The most common wallets one might have are Bitcoin and Ethereum wallets.
Wallets are the interface that enables operating within the network, e.g. the Bitcoin network. The reason being is because wallets, essentially, store private keys. Yes, most individuals believe that wallets store Bitcoin and other coins, a common misconception. In reality, wallets are hardware, apps, or websites that oversee private keys.
Figure 16 - With a wallet anyone can transfer any amount of Bitcoin at a very low fee
2. Private Keys
Private keys are needed to access Bitcoin and other coins. Without the private key representing a coin, it’s impossible to dispose of the said coin. That is because private keys are secret codes that open a safe. A safe to which a certain amount of cryptocurrency corresponds. Wallets store this string of digits instead of actual Bitcoin.
It’s important to note that whoever holds the private key is the one who has access to the real money. The one who can dispose of it deliberately. Caution is always advised when trusting private keys to a third party, like an exchange, since they become the possessors of the coins linked to the private key. In a way, private keys function like bearer bonds. Bearer bonds are characterized by the fact that the one who physically holds the instrument is presumed to be the legitimate owner.
Considering that private keys are like bearer bonds, there are inherent risks like losing access to the private key. It’s thought that nearly 20% of all Bitcoin in circulation is lost! That is because negligent individuals lose their access code to their wallets. The fierce security that thrusts the network can be a flaw. It’s impossible to access the Bitcoin lost because of the encryption protecting the private key at all costs. Misplacing access codes has become a mainstream situation that led to the rise of an industry: wallet hunters.
The infamous Blockchain Bandit represents another risk facing private keys. Hackers and a**holes are constantly trying to steal Bitcoin and other coins by getting a hold of private keys. Experienced bandits use complex methods to guess the pass-codes of weak private keys. The Blockchain Bandit is known for robbing 45,000 ETH by guessing private keys. Some scammers have the audacity to request private keys directly from newcomers.
There are other risks to private keys, but they depend on the type of wallet used to store them. Some wallets may weigh convenience over security and vice versa. It depends on the user’s preferences.
4. Types of Wallets
Hot Wallets vs Cold Wallets
The first distinction to be made is between hot and cold wallets. A wallet is said to be hot if it can be accessed through the internet such as via an application, website, or desktop connected to the internet. This makes this type of wallet more convenient but prone to internet attacks! Hot wallets are recommended for storing the private keys linked to disposable income. Not a high amount and one that is intended to be spent.
Savings and investments, on the other hand, are better off stored in cold wallets. Cold wallets are not connected to the internet. Thus, the only risk is the loss of the physical possession of the wallet. No hacker can access the private keys stored within the cold wallet. They would have to physically steal the wallet to get a hold of the private keys. Cold wallets are recommended for those who seek more security and are not as worried about convenience. The most common cold wallets are paper wallets and hardware wallets.
Figure 17 - A “cold” wallet is like keeping your cryptocurrency in a vault the size of a USB stick
Probably the most convenient type of wallet. This type of hot wallet stores private keys on the device instead of a third party’s server. There are two risks when using mobile wallets. The first one is that your private keys are at risk of being stolen by hackers since your mobile device is connected to the internet. The second risk is the loss of the device holding the private keys. If access to the mobile device is lost, the private keys are lost as well. The catch of using mobile wallets is the ease at which one can dispose of Bitcoin or other coins. Mobile wallets can be used to make everyday purchases or even send some Bitcoin to friends. Do not confuse mobile wallets with website wallets that offer access through an app. These are not mobile wallets but are online wallets.
Online wallets are third parties that store private keys. So, basically they function like a bank: taking custody of money until claimed for use by the actual owner. Most online wallets are pretty safe, but it's advised to use popular wallets (web wallets with the most users). Web wallets are somewhat insecure but extremely convenient. Since private keys are stored online, hackers target these servers to get a hold of private keys and the money they’re linked to. Online wallet providers constantly incorporate security mechanisms. For example, Coinbase offers an extra feature to secure wallets. Coinbase’s vault works like any other vault. Funds are stored in a cold wallet, so crypto-assets held are safe from a hack! An extra layer of protection is added because funds stored in the “vault” have a withdrawal delay of 48 hours in which the withdrawal can be canceled. So, if someone tries to withdraw funds from another account, the owner can cancel the said transaction. It’s not all bad news for online wallets. Web wallets are the most convenient type because private keys can be accessed from anywhere. Things have become easier ever since most online wallets offer users access to their private keys through their mobile devices.
Desktop wallets are considered to be hot wallets because they connect to the internet with your desktop. Enabling hackers to get access to your private keys. Similar to mobile wallets, desktop wallets bear the risk of losing private keys. Again, if the desktop is lost, stolen, or crashes, the private keys are gone. Desktop wallets may be the most inefficient since they’re not as convenient as mobile or online wallets, and they are as insecure as online wallets. The good thing about desktop wallets is that the crypto investor has complete control over the private keys.
Best Desktop Wallet
Hardware wallets are devices, like a USB, that serve the sole purpose of storing private keys. This type of storage, cold storage, is one of the most secure because keys are stored in an independent physical device with no access to the internet. The only way to steal the private keys is by physically taking the wallet. Yet, another layer of protection is added with a secret code to access the wallet. One can think of the secret access as another way to lose private keys, but most hardware wallets have methods to recover the access code. Security increases at the cost of convenience. It’s recommended that hardware wallets are used for money that is not intended to be used in the short term because coins can be disposed of only when the wallet is connected to a computer.
Paper wallets consist of storing private keys by literally writing your seed (a group of words that can give access to restore your digital wallet) and your private key in a piece of paper. All include the alphanumeric key and the QR code for easier use. No one has access to the private keys because they only exist on paper. They are the most secure type of wallet if stored properly, in a safe, a secret place, but are probably the least convenient. To dispose of the private keys linking the paper wallet to another type of wallet is required. It’s recommended that paper wallets are used for long term savings and investments.
Figure 18 - A paper wallet: seed (12-24 group of words) and private key in a piece of paper
The Best Wallet?
Objectively there is no perfect wallet. The best wallet depends on its owner. Bear in mind that not all wallets support all crypto because they can run on unsupported blockchains. Some wallets support most crypto, but it’s best to check that the selected wallet can store the crypto in question. If not, it will be lost forever.
If storing Bitcoin for the long run is intended, then cold wallets are the best fit. Now, which type of cold wallet is the best depends on the likes of the owner. For those who don’t like to use paper, hardware wallets are recommended.
Hot wallets are the best option when looking for convenience. Private keys can be accessed from anywhere in the world, as long as there is an internet connection. Buying a beer in the local pub, sending friends money, or buying groceries can be done without hesitation. As always, the benefits suppose some kind of flaw. In this case, security.
It’s an everlasting battle over convenience and security. Depending on the amount of money to store and the intended use of the money, the best wallet can be one or the other. It’s best to go over the best and most popular wallets of each category. This way one can select the best fit.
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List of References
How to Store Cryptocurrencies, Bearer Bonds, page 23
How to Store Cryptocurrencies, Risks, page 23
How to Store Cryptocurrencies, Risks, page 23
How to Store Cryptocurrencies, Risks, page 23
Mobile wallets, page 26
Hardware wallets, page 27