What is a Cryptocurrency Wallet?
In the world of cryptocurrency trading, you are your bank. To start trading in cryptocurrencies the first item you will need is a wallet. Wallets are software programs that store keys, both public and private. Wallets interact with various blockchains to allow users to send and receive cryptocurrency and check their balances. You can think of your wallet like it’s your bank account.
Keep in mind that a wallet doesn’t store any physical coins. The only two functions of your wallet are to keep your private keys safe and to connect to your coins blockchain. Private keys allow for the movement of funds to other traders and provide the ability to withdraw from your cryptocurrency account. A public key is also used in transactions and is needed to receive cryptocurrency to your wallet.
How Do They Work?
Cryptocurrency wallets function very differently from traditional wallets, so people tend to get a bit confused how they work. As mentioned before, they don’t store your coins. They aren’t located anywhere physically. Remember, all the records in cryptocurrency trading is being recording and stored on the blockchain of the cryptocurrency you are trading in. Here is the overall process of a transaction:
1. Someone sends you a type of digital currency
2. By doing so, they are giving you ownership of the coins to your wallet’s address
3. To get access to those coins, your wallet’s private key must match the public address those coins were given
4. If the keys match, you get your coins in your wallet, and the coins in the sender’s wallet will decrease.
The only proof this happened is the transaction record that gets added to the blockchain and obviously, extra coins in your wallet.
Things to Consider When Choosing a Wallet
Not all wallets support all currencies. It’s common for cryptocurrencies to offer their own wallets. Make sure your wallet is compatible with the coin (or coins) you want to trade in.
Single or Multi Coin Trader There are hundreds of coins to choose from, each very unique in framework and purpose than the other. You may choose to just focus on one coin, Bitcoin is the most popular for example, or you may be interested in trying out a few options. If this is the case, there are wallets available that allow for multi-currency use.
This is a tricky area. Your wallet won’t be linked your real identity; it gets an alias. However, as mentioned before, all transactions are stored on the blockchain. They are by the very nature of the blockchain technology and purpose – permanent and public.
Technically your wallet address could be traced to your real-life identity although this is unlikely. Don’t worry; there are projects underway to increase privacy and move toward full anonymity.
Accessibility & Usage
There are different types of wallets which we will be discussing in an upcoming section. How you want to use your wallet will affect which wallet you will want to use. You may even want to consider multiple wallet types; dividing your coins into more than one is considered safer. Some common situations:
If you intend on making everyday purchases that are small and frequent, then consider an online or software wallet. Just put the amount you will need on this wallet and keep the rest in a more secure option like a hardware wallet.
If you plan on saving up and making infrequent larger transactions than a hardware wallet is a better fit.
If you plan on playing on a cryptocurrency exchange, then use an online wallet. Be careful though and only put the amount you are planning to trade with on this wallet
The security of your wallets depends on the type of wallet you choose. Online wallets have proven to be the most vulnerable wallet option because the data is stored on a web server. You can be exposed to vulnerabilities which can be exploited by hackers trying to steal your funds. Offline wallets aren’t connected to an online network, so this isn’t an issue for this type of wallet. Regardless of the type of wallet you choose, you must take steps to protect yourself and your money. Remember, your private keys are unique to you, and if someone else should get them, they will have access to all the coins associated with that key. There is no way around the problem of losing your keys. If you lose your keys, you lose your money so be careful who you send money to. if made by error, you get hacked or scammed there is no way to reverse the transaction. Again, the blockchain technology prides itself on being tamper proof and permanent.
Additional Security Measures
Store only small amounts online for everyday use, keep the rest in a more secure wallet
Back up your wallet with what is considered cold or offline storage options which will allow you to recover your wallet if it is lost, stolen or there is a computer failure
Regularly update your wallet software, your computer and mobile device; you need to ensure all your devices have the latest security upgrades
Set long and complex passwords – don’t forget to make sure a password is needed to withdraw funds
Research your wallet options and choose those that have a solid reputation and provide extra security such as two-factor authentication
Types of Cryptocurrency Wallets
Cold or Hot
Classifying wallets can be confusing as there are groups within groups and the information changes as the technology does. The first classification is whether a wallet is ‘cold’ or ‘hot.’ A cold wallet is the considered the safest because it is not connected to the internet. Typically, you would store the bulk of your coins in a cold wallet. A hot wallet is the opposite. It is either connected to the internet or is located on it. These transactions happen much faster as being online makes your coins accessible so you would typically use a hot wallet for everyday use.
Software wallets basically mean that wallet software needs to be installed on your computer or mobile device. Software wallets are the most common type and are both considered to be Hot wallets. In this scenario, the software will store your private key directly onto the device. There are differences and similarities between desktop and mobile options which we will cover.
Desktop wallets require you to download software onto your computer or laptop, and they are considered to be a ‘Hot Wallet.’ They are only accessible from the device that has this software. A desktop wallet is easy to use and considered safer than online or mobile wallets. This entirely depends though on your online security habits. Should your computer get hacked, receive a virus or is damaged enough, you could potentially lose all of your cryptocurrency. Make regular backups of your wallet and store them on a different device to help offset the security issues.
Just like desktop wallets, mobile wallets require you to install an application on your phone. Due to the limited space on a typical mobile device, these wallets tend to be smaller and simpler than their desktop versions. However, mobile wallets allow you to use it anywhere that you go and can provide extra features that online wallets don’t have. Never keep all your cryptocurrency on your mobile device as it is too easy to lose, just like a traditional wallet.
Pros of Software Wallets
- Easy to use
- Your keys are stored in your device, not on a 3rd party server
- Mobile versions are more practical for everyday use
- More secure than online wallets
- Data is available at the user’s own computer or mobile device
- Easier to backup yourself
- You have control over your cryptocurrency
Cons of Software Wallets
- Wallet is lost if device is lost, stole or seriously damaged
- Desktop wallet can only be accessed at its physical location
- Hackers can hack the computer or mobile and gain access to wallet
Online (or web) wallets are also considered ‘hot wallets.’ They are the most user-friendly of all wallets and just require access to a web browser on any device that is connected to the internet. The most important point to remember is that while they may be the easiest to use, they are also considered the least secure. Online store your private keys on a server and are controlled by a third party. We strongly recommend not storing the majority of your coins on an online wallet. Online exchanges and wallets are extremely attractive to hackers.
Pros of Online Wallets
- Easy to use and set up
- Accessible from any internet connected device
- Online wallets are usually linked with cryptocurrency exchanges online
- Fastest way to complete transactions
- Ideal for holding small amounts of cryptocurrency
Cons of Online Wallets
- Your private keys are on a third party server
- More prone to hackers, malware, keyloggers, phishing scams and viruses
- Prone to technical glitches
- You have no full control over your coins; the website can limit or suspend your account whenever they want and for whatever reason
A hardware wallet is a special type of wallet that differs from software wallets in that they store a user’s private keys on a physical device. They are considered to be cold storage or a cold wallet. You are required to install an application on a computer or mobile phone. You need to then connect it to a physical device that looks similar to a USB when making transactions. Using a hardware wallet for transactions is a simple process: You plug it in, enter a pin, send the currency, confirm and then pull it out to store away when you are done. Your private keys (and money) are now stored offline in the device itself making it harder to get viruses, malware, and attacks from hackers.
Pros of Hardware wallets
- Overall better security than other wallet types
- Back up options and password protection are available
- Some devices come with screens eliminating the need to use a computer to back up your keys at all
- Depending on the hardware wallet you decide to use they can support different currencies
- Excellent for storing large amounts of cryptocurrency
- Very portable
Cons of Hardware Wallets
- Less user-friendly than web/online or desktop wallets but easier to use than paper
- You must purchase the device first, and they are often sold out
- Due to their small size, they can be lost or damaged
The most basic form of cold storage is the paper wallet. It was also the standard form of cold storage before the hardware wallet. They are easy to use and are the most hacker proof of all cryptocurrency wallets because your coin data isn’t stored on any device. A paper wallet simply refers to a literal physical copy or printout of your public and private keys. This usually involves using paper wallet software to generate the keys and then a printer. The document that you print usually has a QR code on it so it can be easily scanned to make a transaction. To transfer coins to your paper wallet, you transfer the funds from your software wallet to the public key in your paper wallet; either by scanning the QR code or manually entering the private keys. To transfer coins from your paper wallet, you do the reverse. This process is called ‘sweeping.’
Pros of Paper wallet
- More control on your wallet
- More secure than online and software wallets because both the private and public keys are printed on a piece of paper
- Can be stored and taken care of without internet connection
- One of the most hacker-proof crypto wallet choices
- Not stored on a computer
- Private keys not stored on a third-party server
Cons of Paper wallet
- Can get damaged with time
- If the paper is lost or destroyed, the user will never be able to access their address where the funds are
- Multiple copies to prevent damage make it more prone to being stolen
- More effort required to move cryptocurrencies around
- Most software and online wallets have this option
- If not, try out BitAddress.org and BitCoinPaperWallet
Where to Buy Cryptocurrencies
After you’ve chosen the wallet that suits your needs, the next step in to buy your first cryptocurrency. You can pay for your first coins with credit cards, cash, PayPal or bank transfers. Watch out; each has their own issues that you need to be aware of. Credit cards come with high fees, and PayPal has transactions limits. Cash won’t get you the best exchange rates and bank transfers are the slowest of all options.
Where you can buy them is another subject altogether. There are a few options that you can use, some depend on where you live:
Cryptocurrency exchanges: We will cover exchanges in this section.
Bitcoin ATMs: These are ATMs located in public places and allow you to use regular currency to buy bitcoins. You need a wallet first to transfer the coins.
Voucher Cards: These are slowly gaining popularity, you may even be able to buy them at regular stores in your area. They look like a gift card, are loaded like one, and you can redeem them online.
Direct Trading: This is done directly on a peer to peer platform, there are no exchanged here that act as ‘middlemen.’
What is a Cryptocurrency Exchange?
A cryptocurrency exchange is a website where you can buy, sell or exchange digital currencies. You have the option of trading between different crypto coins or for traditional fiat money like US dollars. Everyone trades together regardless of your experience level.
Types of Exchange
Cryptocurrency Exchanges/Trading Platform:
As mentioned earlier there are online sites that connect buyers and sellers. This type of exchange is like a traditional stock exchange. Traders make transactions based on the current cryptocurrency market price; the exchange acts as the intermediary and charges a fee for every transaction. Some exchanges allow you to convert your regular fiat money into cryptocurrency, eliminating the need to go elsewhere to buy your initial coins.
Direct trading platforms allow people to directly trade with another person. These platforms still charge a fee for each transaction. The major difference here is that the sellers set their own exchange rate and don’t use a fixed market price.
These websites allow anyone to buy and sell cryptocurrencies at a price set by the broker. Usually, this is the market price plus a small premium, very similar to 3rd part exchange brokers at airports.
How to Pick Between Exchanges
Where you are located: Some exchanges will limit what you can do on their platform depending on where you are in relation to them. You may have partial use out of the exchange or full. This information is easily found and should be used first to narrow your list of options down.
Has a solid and well-known reputation: There is a lot of information online about exchanges so be careful where you get yours. Try to get information from multiple sources to compare like industry websites, review sites, news and individual users. Make sure to look at the most recent data you can find as this industry is rapidly changing.
Shop around based on exchange rates: The exchange rates between exchanges can vary quite a bit so look at this early in your research.
Open about fees: Fees can be very different between exchanges so don’t assume there is a standard. If the fee information about deposits, transactions and withdrawals aren’t clearly outlined– don’t pick that exchange. Make sure you fully understand what you are reading, no need to rush, take your time to research your options.
Available payment options: The popular exchanges will offer the most payment options, credit card, debit card, wire transfer or PayPal. An exchange may or may not work for you if there are fewer options. Remember the drawbacks to each payment method mentioned earlier in this chapter.
Privacy: This is a big issue for some traders who prefer to remain completely anonymous. Many trading platforms require ID verification. However, verifying the identities of traders does decrease the likelihood of illegal activity on the exchanges.
Coinbase is an all in one cryptocurrency wallet-exchange-broker hybrid service that makes it easy to securely buy, use, store and trade digital currency. It is considered to be one of the most popular and well-known exchanges in the world. Coinbase traders can purchase Bitcoins, Ether (Ethereum) and now Litecoins through a digital wallet. For more advanced users, Coinbase has another product called GDAX which is an exchange for more advanced users wanting to trade in the same three currencies.
- Good reputation
- High level of security
- Reasonable fees
- Very beginner friendly
- Mobile app is available
- Can purchase coins through credit card or bank wire
- Stored currency is covered by Coinbase insurance
- Customer support service
- Limited payment methods
- Limited countries supported
While Kraken is a US-based exchange and trading platform, it also operates in Europe. One main drawback is that you can only use bank transfers to purchase Bitcoins. This platform, however, does allow you to trade from bitcoins to other popular fiat currencies and cryptocurrencies. Kraken is considered a better option for those who are more experienced and comfortable in trading.
- Good reputation
- Decent exchange rates
- Low transaction fees
- Minimal deposit fees
- Great user support
- Supported worldwide
- In general, follows regulatory guidelines
- Limited payment methods
- Not suitable for beginners
- Unintuitive user interface
- Can’t operate in every state in the United States; if you live in a state or country with strict rules Coinbase might be an option