WALLET MECHANICS

To buy and invest in cryptocurrencies like bitcoin, the first step is to choose the right cryptocurrency wallet. A cryptocurrency wallet is a software program, a device, or a physical medium designed to store public and private keys. It is used to track ownership, spend and receive digital currencies. In addition, users can monitor their cryptocurrency balance. The reference line of a cryptocurrency wallet can be drawn to a real-life wallet where we store our credit cards, coins, and cash. Yet, while the function is pretty much the same, there are many differences in how a digital wallet works.

There are many digital currencies like Bitcoin, Litecoin, Ethereum, and these currencies are stored in digital wallets. While most exchanges offer wallets for their users, security is not their primary business. Using an exchange wallet for large or long-term cryptocurrency holdings is generally not recommended. Having your crypto outside of the exchange and in your personal wallet ensures that only you have control over the private key to your funds. It also gives you the ability to store funds away from an exchange and avoid the risk of your exchange getting hacked and losing your funds.

Some wallets have more features than others. Some are Bitcoin only, and some offer the ability to store numerous types of altcoins. Some wallets also offer the ability to swap one token for another. So the question becomes, how do these wallets work?

How Does a Cryptocurrency Wallet Work?

In the case of a cryptocurrency wallet, cryptocurrency assets are not stored in the wallet, as they do not exist in a physical form. A digital wallet utilizes the power of blockchain to control the funds with the help of a public key, as mentioned in the previous post.

Private and public keys are two unique related cryptographic keys, which are usually long random numbers. A public key is available to the public and can be accessed via any public directory or repository. A private key, on the other hand, is only available to the owner of the wallet. The two keys are mathematically related. Thus, whatever is encrypted with a public key can only be decrypted using its related private key and the other way around.

To better understand how cryptocurrency wallets work, let’s look into the definition of a cryptocurrency wallet address. An address is an identifier that consists of 26–35 alphanumeric characters. Wallet addresses are unique for each person. The address can be generated by any user of a crypto wallet and can be used to receive cryptocurrencies. A wallet address is similar to the bank account number we have for fiat money transactions.

Types of Cryptocurrency Wallets

There are few types of cryptocurrency wallets, and all of them aim to provide different ways of storing and managing cryptocurrency assets. There are mainly two different categories of cryptocurrency wallets: hot wallets and cold wallets.

• Hot Wallets

Hot wallets are the wallets that are required to be connected to the internet, and because of this, these wallets are less secure. These wallets are highly accessible because of the internet, but these wallets are more vulnerable to security threats and attacks by fraudsters. Hot wallets are more user-friendly, but there is always a risk to users’ security and privacy.

They come in two forms - online and desktop wallets. Mobile wallets are also considered digital, but they could also be classified as a hybrid wallet because of their mobility.

The two huge perks that digital wallets have are their ability to hold any cryptocurrencies and that they’re free. You can find one that suits your wants and needs, register, and use it - free of charge. When you create an account on an exchange, download a mobile wallet, or download a desktop wallet on your laptop, you are creating a hot wallet. Hot wallets are meant for everyday cryptocurrency users.

Storing a large amount of digital assets in a hot wallet, such as a web wallet or a mobile wallet, is not advisable as it leaves your funds exposed to potential security threats, such as cyber theft. Therefore, you should only hold a small amount of crypto in hot wallets and your long-term investment in so-called “cold storage” in a cold wallet.

• Cold Wallets

Cold wallets are the types of cryptocurrency wallets for cold storage, and these wallets store crypto tokens in offline mode and provide improved security. Hardware wallets and paper wallets are both cold wallet options. However, hardware wallets are more popular as they are easier to use and come with customer support provided by the manufacturer.

These wallets store a user’s private key on something that is not connected to the internet and can come with software that works in parallel so that the user can view their portfolio without putting their private key at risk. You only connect your cold wallet to the internet when you want to make a transaction. Hardware wallets use a physical medium — typically in the shape of a USB stick — to store the wallet’s private keys, making them de facto unreachable to hackers or other

malicious parties.

To store crypto in your hardware wallet, you send it from a hot wallet to your hardware wallet’s public address. Conversely, suppose you want to send crypto from your hardware wallet to a friend or an exchange address. In that case, you connect your hardware wallet to the internet via the wallet’s dedicated software and then sign the transaction with your private key.

Paper wallets function similarly as hardware wallets. However, instead of a physical USB-like device, paper wallets are pieces of paper that contain a public wallet address and a private key. Therefore, they have to be kept securely in a safe or somewhere where they cannot be easily found to avoid theft of your cryptocurrency. To send coins from a paper wallet, the wallet has to be imported into a hot wallet via a scan of the private keys so the coins therein can be spent.

Cold wallets are the staple of security when it comes to cryptocurrency storage. Hot wallets are the most vulnerable wallets in the world. All of the digital wallets store your security keys and codes in their online servers, which are extremely susceptible to hacker attacks, scamming attempts, and other ill intent-driven actions. Sure, most of the high-profile hot wallet offering sites and companies have major security measures put in place, but all it takes is the smallest loophole for your savings to be gone forever.

Cold storage wallets, however, have a reputation for being impenetrable. The fact that your codes are nowhere else but in that little device surely offers a huge feeling of calmness. Moreover, some of these devices emphasize security so much that even if you plug them into a computer with a virus (a keylogger, leacher, or any other type of malware), your device would remain safe and secure.

While cold wallets provide a superior storage solution in terms of security, the main drawback is that they are impractical for everyday crypto usage as it is more cumbersome to send crypto from a cold wallet. They also tend to be expensive. Another huge drawback is that cold wallets have a very limited variety of cryptocurrencies they can store. Most of the cold storage wallets out there are only able to store the main crypto coins in the market, such as Bitcoin, Ethereum, Litecoin, etc.

How to Protect Your Asset

Choosing which crypto wallet to use is entirely up to you and your needs as a user. If you plan to buy and hold your crypto assets, for example, you are better off putting your digital currency into cold storage, i.e., into a cold wallet. Conversely, if you are a regular crypto spender, you are probably better off holding some of your crypto on a mobile wallet.

However, regardless of which type of cryptocurrency wallet you prefer, put in place the following rules to protect your assets:

• Don’t share your private keys: It is important not to share your private key with anybody. It is a combination of letters and numbers that should only be known to you. Think of it as the PIN code to your credit or debit card; you would not want anybody to know that information.

• Back It Up: Always backup your wallet and private keys. As a bare minimum, it is advised to have at least one backup on a CD or a USB drive to make sure you have a “hard copy” of your wallet and keys at any time. Remember, if you lose your wallet and your keys, you also lose access to all the cryptocurrency assets on that wallet.

• Be Smart With the Password: When it comes to the password protection of your crypto wallet, take it seriously. Come up with an extremely hard and unique password that includes numbers and letters (both uppercase and lowercase). Do not share your password with anyone.

Crypto wallets are an integral part of using Bitcoin and other cryptocurrencies. They are one of the basic pieces of infrastructure that make it possible to send and receive funds through blockchain networks. Each wallet type has its advantages and disadvantages, so it's crucial to understand how they work before moving your funds.

“Encryption works. Properly implemented strong crypto systems are one of the few things that you can rely on." - Edward Snowden