Similar to a bank account in the traditional finance industry, a crypto wallet is a crucial element of your journey into the exciting world of cryptocurrencies.
In fact, a cryptocurrency wallet is probably the first thing you will create when getting started with digital assets.
In this article, we will explain what crypto wallets are, how they work, and describe their main types. We’ll also guide you through the basics of creating your first cryptocurrency wallet.
Let’s dive in!
What Is a Crypto Wallet?
A crypto wallet is a tool – a software program that is sometimes accompanied by a hardware device – that allows you to interact with the underlying blockchain network.
From a more practical perspective, a cryptocurrency wallet allows you to send, receive, and store digital assets.
Think of it like a bank account, which is the key element for accessing your financial institution’s products and services (e.g. online banking, loans, savings accounts, etc.).
However, unlike bank accounts, most crypto wallets allow you to maintain full control over your funds by managing both your private and public keys to your wallet.
Blockchain networks, the underlying technology powering cryptocurrencies, use public-key cryptography to encrypt data and protect users.
Cryptographic technology has two crucial elements: the private key and the public key. With public-key cryptography, the sender uses the public key to encrypt data, while the recipient utilizes his private key to decrypt the information.
In terms of cryptocurrencies, the public key refers to your wallet address, which you are safe to share with anyone.
On the other hand, you use your private key to create digital signatures and verify transactions. For that reason, it must be kept in secret as sharing it with anyone else can compromise your funds’ security.
For better understanding, think of the public key as your bank account number and your private key as your login credentials to your online banking platform.
Sharing your account number allows you to receive funds from others. However, if you do the same with your login credentials, cybercriminals and malicious parties will try to gain access to your funds.
How Does a Cryptocurrency Wallet Work?
Each cryptocurrency wallet type works a bit differently than the others.
For example, while custodial solutions manage your private keys, others offer you full control over your funds.
Also, some wallets allow users to interact with only one cryptocurrency. In contrast, other crypto wallet services provide all-in-one solutions in which you have access to numerous coins and multiple integrated decentralized applications (DApps).
With that said, the core functions of all cryptocurrency wallets are based on public-key cryptography.
For that reason, they use the same process for sending and receiving digital assets, like in the following example:
- Alice wants to send Bitcoin to her colleague, Bob. To initiate the transaction, she opens her cryptocurrency wallet on her smartphone and logs into her account.
- Alice then pastes Bob’s public key (wallet address) as the recipient’s address and selects the amount of BTC to send to Bob.
- After specifying the fee, Alice initiates the transfer. The wallet software uses Alice’s private key to sign the transaction, then communicates with the Bitcoin blockchain to transmit it to the miners (users responsible for maintaining the network, validating transactions, and adding new blocks to the chain).
- In exchange for the fee Alice paid for the transfer, miners will include the transaction into a new block and process it.
- After one confirmation, Bob receives the BTC Alice sent him when opening his wallet. Since the transfer has already been confirmed by miners, it can’t be reversed by anyone.
- In addition to the public and private keys, it’s important to mention the secret or seed phrase as well.
The seed is a mnemonic phrase generated from your cryptocurrency wallet’s private key, which you can use to restore or import your wallet via an external application.
For that reason, it’s crucial to write down your seed phrase and store it in a secure place physically or on your computer (or both).
What Are Crypto Wallets Used For?
In their most simple forms, crypto wallets are used for the following four core functions:
- Holding digital assets securely
- Receiving cryptocurrency from others
- Sending coins to other users
- Paying for products and services at merchants using the crypto in your wallet
In addition to the above, some more advanced cryptocurrency wallets provide additional features to their users, such as:
- Built-in conversions or swaps between multiple digital assets
- Connecting to third-party blockchain-based solutions, such as decentralized finance (DeFi) applications
- Buying and selling cryptocurrency with fiat currency within the app
- The option to use the digital assets in your wallet with crypto cards
- Staking coins
- Digital asset borrowing and lending services
- Access to loyalty programs, such as receiving cashback on your purchases
- Advanced security features
What Are the Different Types of Crypto Wallets?
As mentioned earlier, there are multiple types of cryptocurrency wallets present on the market, which we will explore in this section.
As their name suggests, custodial wallets store your private keys in their custody, meaning that you are not in full control over your funds, but the service provider is.
This structure is similar to what financial institutions use to manage your funds in your bank account.
In the crypto space, the most popular use-cases for custodial wallets are centralized exchanges, in which the service provider manages the funds of their users.
As a result, they can usually offer a better trading experience to their users as they have access to more liquidity while matching buyers with sellers more efficiently.
In addition to the above, custodial wallets’ main advantage is that you can transfer cryptocurrencies for free or at minimal costs to other users and wallet addresses on the platform as the transfers take place in the provider’s internal network.
This is especially useful when you seek to avoid transfers in congested blockchain networks that are infamous for their excessively high transaction fees and long processing times.
Also, as the service provider controls the private keys, they are responsible for solving issues with transfers related to wallets on their platform.
Since you don’t have to move your coins to an external wallet, you will also be able to access the provider’s other services (e.g. staking or crypto lending products) with your custodial wallet.
Furthermore, in exchange for providing a custodial solution, some service providers offer specific guarantees or protections against security incidents, fraud, or other less fortunate events that could negatively impact your cryptocurrencies.
On the other hand, the lack of such security guarantees can compromise your funds’ safety when a cybercriminal successfully breaches the service.
Unfortunately, bad actors can acquire the private keys to user wallets from the service provider’s servers upon a successful hacker attack, allowing them to steal your funds from your custodial wallet.
Also, with custodial wallets, you have to trust the service provider that it manages your funds properly, without the risk of losing your digital assets due to exit scams or bankruptcy.
For these reasons, custodial wallets are often seen as the least secure option to store cryptocurrencies.
Moreover, some exchanges use higher fees for withdrawals than for standard wallet-to-wallet transfers to protect themselves from losses, increasing the costs for users.
With non-custodial wallets, you are in full control of your private keys and your cryptocurrencies. They feature better security than their custodial counterparts, especially if you follow the best practices of storing your coins safely in your wallet (we will talk about this later).
Also, most non-custodial wallets allow you to set your own fees for crypto transactions, which you can use to speed up transfers or decrease processing costs.
On the other hand, many non-custodial wallets lack the ability to connect natively to other services. To access them, you have to transfer your digital assets to external wallets.
Furthermore, unlike with custodial wallets, you don’t have access to customer service support. For that reason, you can’t request help for any of your transfer-related mistakes.
There are many types of non-custodial wallets, which we will introduce in the sections below.
Desktop wallets are software solutions that you download and install on your computer to store cryptocurrency.
As they reside on your computer, desktop wallets store your private keys on your hard drive.
For that reason, you don’t have to rely on any third-party service providers to store your private keys securely.
Desktop wallets encrypt your private key with your password. No one can access your cryptocurrency holdings unless they successfully log into your wallet or acquire your seed phrase.
Desktop wallets are convenient for crypto users as you don’t have to visit a website to access and interact with your coins.
Also, most desktop wallets support multiple platforms, meaning that you can access your cryptocurrency holdings from mobile, tablet, and other devices as well.
On the flip side, desktop wallets are hot wallets, which means that they are connected to the internet most of the time.
Due to the continuous online connection, desktop wallets are considered less secure than cold wallets that stay disconnected from the web.
To ensure your funds’ safety, it’s crucial to access your desktop wallet from a computer that is entirely free of viruses and malware.
Furthermore, some desktop wallets fail to offer two-factor authentication features, an excellent measure for users to enhance their crypto funds’ security.
Similar to desktop wallets, mobile wallets are also software-based solutions that allow you to store cryptocurrency.
Since you can carry your smartphone anywhere you go, mobile wallets provide continuous access to your cryptocurrencies.
Most smartphone wallets offer QR code or near-field communications (NFC) functionality. As a result, you can scan a QR code or tap your phone against a terminal instead of manually typing or copy-pasting a wallet address to send funds to someone or pay for a product.
While this feature makes it convenient to transfer crypto, it also minimizes the chance of sending funds to other wallets than you have originally intended to.
Also, almost all mobile wallets provide two-factor authentication features to users, allowing them to store their funds more securely.
Like some desktop wallets, many service providers offer you the option to sync your mobile wallet with other devices.
On the flip side, similarly to desktop wallets, mobile wallets are also continuously connected to the internet.
Note that unless you have biometric security (e.g. facial recognition, fingerprints) or a strong PIN enabled on your smartphone, hackers can easily steal your crypto from your mobile wallet in case they manage to acquire your device.
Online wallets are software-based crypto wallets that are operated via a cloud server, allowing users to interact with their digital assets by simply opening the platform via their web browsers.
Web wallets are convenient for users as they can access their cryptocurrency holdings basically from any device with an internet connection.
It’s important to note that even if you are in possession of your seed phrase, web wallets store your private keys on the server, which they have exclusive access to. Doing so can not only compromise your funds’ security to the organization running the server itself but also to cybercriminals (in case they manage to breach the service provider’s database with a successful hacker attack).
With that said, multiple service providers have addressed the issue by implementing security measures, such as implementing multisignature technology into online wallets.
Multisig web wallets provide additional security to users as they require multiple signatures – one from the service provider and one from the customer – in order to move funds.
However, online wallets require a constant connection to the internet, which decreases their overall security.
Hardware wallets are considered the most secure solutions currently on the market to store cryptocurrency.
One of the reasons for the above is the lack of cases in which users’ funds were stolen from a hardware wallet.
With a hardware wallet, your private keys are stored on a secure physical device, which only connects to the internet when you use it to transfer funds. For that reason, such crypto storage solutions are called cold wallets.
To access your digital assets on the hardware wallet, you have to plug the physical device (like a pen drive) into your computer, entering a PIN on the device to unlock it.
You also have to provide your PIN via the device every time you seek to move funds to another wallet.
For that reason, it’s not enough for cybercriminals to hack the software side of the hardware wallet. Still, they also have to acquire the physical device to steal your cryptocurrencies, which is a highly unlikely scenario.
Hackers might also be able to obtain your crypto on the hardware wallet if they manage to tamper with the device’s firmware before it gets shipped to you.
To avoid such a case, it’s crucial to purchase hardware wallets only from the manufacturer itself or certified resellers.
Hardware wallets support numerous (often over 1,000) cryptocurrencies, allowing users to store a diversified digital asset portfolio using a single device.
While hardware wallets provide excellent security to users, they cost money, and the initial setup can be challenging.
An interesting form of storing cryptocurrency is via a paper wallet.
As its name suggests, a paper wallet is a piece of paper on which users can print their public and private keys. Most paper wallets include the keys as both alphanumeric strings and QR codes (for scanning via a smartphone).
To create a paper wallet, users can utilize a free service that automatically generates a BTC address on the Bitcoin blockchain. As the final step, the user prints out his private and public keys on a piece of paper.
Like with other crypto wallets, users can share their public keys to accept digital asset transactions.
To send cryptocurrency, the user has to load his private keys via a software wallet by either manually typing it or scanning the QR code.
Since the private keys are printed on paper and stored in a physical form, paper wallets are a form of cold wallets that can effectively protect users from hackers.
Despite their cold storage-related benefits, experts recommend most users to avoid keeping their crypto holdings on paper wallets.
One of the reasons for the above is due to the fact that it’s super easy for a piece of paper to get lost in one’s apartment or get damaged over time.
Furthermore, it’s impossible to use paper wallets to send partial balance transfers (e.g. your total balance is 5 BTC, and you want to only send 1 BTC to a friend).
Instead, you have to transfer all your paper wallet balance to another wallet before sending your recipient a partial transaction. If you fail to do so, you could lose a significant share of your crypto holdings.
The reason for the above is due to the fact that, unlike other wallet types, paper wallets don’t handle change addresses for you during transactions.
A change address is necessary every time you make a crypto transfer as your wallet’s unused balance will be put into that address until the transaction gets confirmed by miners.
Think of it like paying with a $50 bill for a $5 cup of coffee. In such a case, you give $50 to the cashier, who will give back the $45 as change. Despite that the $45 belongs to you, you will only have access to it after the cashier finalizes the transaction and gives it back to you.
For that reason, if you decide to use a paper wallet, it’s crucial to send your whole balance at once to one of your other (non-paper wallet) addresses before sending a transaction to the recipient.
Also, since you have to import your private keys to your other wallet to initiate the transfer, it is recommended you throw away your existing paper wallet and create a new one to store crypto to ensure your funds’ safety in the future.
Warning: One of the most popular paper wallets, BitcoinPaperWallet.com, has been recently found installing a backdoor that has led to the loss of nearly 125 BTC ($6.4 million) of user funds. In addition to BitcoinPaperWallet.com, some reputable crypto solutions have issued warnings against multiple paper wallets after the exploit was discovered. While the two paper wallets we have included as examples in this article are not on the domain warning list, we advise you to be very careful and do your own diligence to ensure your funds’ safety.
Web 3 (DeFi) Wallets
Web 3 or DeFi wallets are the newest types of cryptocurrency wallets, allowing users to connect their wallets and interact with numerous decentralized applications.
DeFi wallets are software-based, with most of them offering support for multiple platforms, such as desktop, mobile, and web.
Suppose users seek to explore the decentralized finance space. In that case, they can connect their Web 3 wallets natively via their browsers or via WalletConnect by scanning the QR code of a DeFi application with their mobile wallet (via their smartphone cameras).
As a result, in addition to basic functionality like receiving, sending, transferring, and paying with crypto, users can access numerous other DeFi activities. Examples include lending and borrowing, yield farming, staking, exchanging, and swapping digital assets.
While web 3 wallets are continuously connected to the internet, some of them have implemented advanced security measures, such as guardians.
Unlike traditional crypto wallets that use a seed phrase for recovery, guardians are people you know and trust that are responsible for recovering your wallet and approving transactions that have exceeded your limits.
With that said, since web 3 wallets are hot wallets that store your private keys on either your smartphone or your computer’s hard drive, they are unable to provide the same level of security as hardware wallets.
Are Crypto Wallets Safe?
Generally, cryptocurrency wallets from legit service providers are considered safe in the digital asset community.
However, your funds’ actual security level is based on two factors: your crypto wallet type and the practices you follow to keep your money safe.
While we will talk about the latter more in detail in the next section, let’s see how different wallet types compare in terms of security (we have merged desktop, web 3, and mobile wallets under software wallets in the table below):
|Custodial wallets||Software wallets||Online wallets||Hardware wallets||Paper Wallets|
|Party controlling the private keys||The service provider||The user||The user||The user||The user|
|Location of the private keys||On the service provider’s servers||On the device (smartphone, desktop hard drive)||On the service provider’s servers||On the hardware device||On a piece of paper|
|Type of wallet based on the internet connection||Hot wallet||Hot wallet||Hot wallet||Cold wallet||Cold wallet|
|Wallet recovery||By the service provider||Via the seed phrase or guardians (for web 3 wallets)||Via the seed phrase||Via the seed phrase||Via the seed phrase|
|Risk of virus and malware infections||Low||High||High||Minimal||High|
|Risk of hacker attacks||High||Low||High||Minimal||Minimal|
|Risk of phishing attacks||High||Medium||High||Low||Low|
|Additional layer of security for outgoing transactions||Two-factor authentication (2FA) via email or SMS||PIN, password, or biometrics (facial recognition, fingerprints), guardians for select web 3 wallets (after reaching the user’s daily limit)||Password, PIN, or multisignature features||Typing a PIN via the hardware device||Creating a new paper wallet after each outgoing transaction|
|Overall level of security||Low||Medium||Low||Very high||Varies (based on the user’s security practices)|
How to Ensure Your Funds’ Safety While Using a Cryptocurrency Wallet
It’s crucial to follow the best security practices to ensure your funds’ safety in your crypto wallet.
For that reason, we have collected below the best tips and tricks to improve your digital asset wallet’s security:
- Don’t underestimate the importance of backups: When you create a new wallet, the service provider will give you a seed phrase. As it is essential to recover your funds, it’s crucial to write it down and store it at a secure place both physically in your home and digitally on your computer. While you shouldn’t keep your seed on a cloud server (e.g. Dropbox, Google Drive), storing multiple copies in different folders on your computer is recommended.
- Use strong passwords: While this advice may sound like a too obvious one, 24% of Americans utilize super weak passwords like “abc123”, “Admin,” and “123456”, according to Google. For that reason, it’s crucial to use a strong password (that you can easily remember) for your cryptocurrency wallet. This way, you can avoid cybercriminals “guessing” your login credentials while minimizing the chances of a successful brute-force attack.
- Update your wallet regularly: Software versions can become outdated over time, with some releases potentially including security vulnerabilities. For that reason and to access new features, it is important to update your crypto wallet app regularly. Downloading the latest version of the firmware is even more important for hardware wallets as they can improve your device’s stability.
- Turn on advanced security options: Advanced security features, such as PINs, biometrics, 2-FA, and multisig, can drastically enhance your funds’ safety. While setting them up may seem complicated at first, we strongly advise using them.
- Always copy-paste wallet addresses: Every time you send funds from your wallet, you have to use the recipient’s public key (wallet address). However, compared to bank accounts, the strings are quite long and complex. For that reason, you should never type the wallet address manually when sending an outgoing transfer. Instead, you should copy and paste it or scan the QR code via your smartphone device. This way, you can minimize the risks of sending a transaction to the wrong wallet, which would result in losing your funds (as crypto transfers can’t be reversed). As the last step, always double- and triple-check the recipient’s wallet address to ensure that your transaction is going to the right place.
- Consider getting a hardware wallet: If your funds’ security is essential for you and you have the budget, consider getting a hardware wallet. Buying a physical device to store your coins securely is one of the best investments in the crypto space.
- Do your own diligence: As always, it’s crucial to do your own diligence before using a new cryptocurrency wallet. Do a background check on the company behind the solution and monitor the web for external user feedback and expert reviews to ensure that the service provider can be trusted. This step is especially important when you store your funds in a custodial wallet where the provider controls your private keys.
Features to Look for When Choosing a Crypto Wallet
Cryptocurrency wallet features differ not just by the type of the wallet but also by the actual solution.
For that reason, we have collected the most important features to look for to select the crypto wallet that best suits your interests:
- Security: Your funds’ safety should be your top priority when choosing a cryptocurrency wallet. Before selecting one, look for advanced security features like 2-FA, multisig, and biometrics. You should also check whether the solution is a hot or a cold wallet and if you are the one who controls the private keys.
- Multi-coin support: Do you prefer to hold a single coin or multiple cryptocurrencies in one wallet? If you plan to keep numerous digital assets, it’s essential to select a wallet with multi-coin support.
- Convenience: While some don’t mind complex apps, others prefer cryptocurrency wallets with clean interfaces that offer users a convenient experience. As some concepts in the industry can be super complicated, we recommend considering ease of use as a priority, especially if you are new to the space.
- Integration with other apps: Are you looking to simply hold cryptocurrencies in the long-term, or do you prefer to use them in decentralized finance applications as well? If the latter is true, it’s important to check whether your crypto wallet can integrate with other apps.
- Customization: Some users prefer simplicity, while others like to tailor every aspect of their apps to fit their needs. For that reason, the latter group should look for a digital asset wallet with high customizability. As a plus, wallets that you can personalize often allow users to adjust their fees for outgoing transfers, which can be useful when blockchain networks are congested.
- Reputation: It’s hard to trust service providers with no or negative reputation with your money. For that reason, to ensure the safety of your funds and get the best user experience, it’s crucial to select a trusted crypto wallet solution with excellent user reviews.
- Built-in features: Many crypto wallets only provide basic functionalities to users. On the other hand, some digital asset wallets offer an all-in-one solution to store your cryptocurrencies, featuring built-in features, such as a crypto exchange, atomic swaps, staking, yield farming, as well as lending and borrowing.
- Privacy: Anonymity on the web is important for many users. If you are looking for increased privacy, consider selecting a crypto wallet with the Hierarchical Deterministic (HD) feature, in which the solution automatically creates a new wallet address after each transfer. When anonymity is a top priority, you should also choose a wallet where you don’t have to submit Know Your Customer (KYC) and Anti-Money Laundering (AML) documents.
How to Create a Crypto Wallet
Now that you know the essentials about crypto wallets let’s see how to create one.
First, let’s see how to set up a custodial wallet:
- Visit the service provider’s website to create a new account.
- Fill in the forms with your personal data and confirm your email address and phone number.
- After your account is created, most custodial wallet service providers require you to verify your identity and residence to comply with KYC and AML regulations. To do that, you have to submit certain documents (e.g. a government ID and a utility bill) to the company.
- Upon successful submission, the service provider will review your documents and notify you when the process is complete.
- Buy crypto using the service or transfer coins to your new wallet to get started.
Creating a non-custodial crypto wallet works a bit differently. We have outlined the actual steps to set a non-custodial software wallet below:
- Visit the service provider’s website or the app store on your smartphone to download the crypto wallet application on your device.
- The next step is to create a new wallet account. Don’t worry, unlike at custodial solutions, you don’t have to provide any personal details here.
- Set up a password or a PIN for your cryptocurrency wallet.
- Write down the seed phrase and store it securely both in physical and digital form.
- Your new wallet is ready! The last step is to get some coins from an exchange or another wallet.
Crypto Wallets: The Key for Entering the Digital Asset Space
Like bank accounts in the traditional finance space, crypto wallets represent your own hub in the digital asset world.
You use your cryptocurrency wallet to send, receive, hold, and pay with coins, with some solutions offering additional functionalities, such as external app integrations and built-in features.
Crypto wallets have multiple types, with each offering a different level of security, convenience, as well as features.
While digital asset wallets from trusted service providers are considered safe, you should always do your own diligence and use the best practices of holding coins to stay secure in the crypto space.
If you have the budget, consider purchasing a hardware wallet from the manufacturer or a certified reseller, as it is currently the safest solution to store cryptocurrency.
Frequently Asked Questions (FAQ)
What is the safest wallet for cryptocurrency?
Since they provide cold storage solutions without being continuously connected to the internet, hardware wallets are considered the safest cryptocurrency wallets.
Furthermore, hardware wallets require users to confirm outgoing transactions by typing a pin via the physical device. As a result, even if the wallet’s software side gets breached, hackers can’t steal the funds from hardware wallets (as they would need to acquire the physical device as well).
By now, there haven’t been any reported security incidents that have led to coins getting stolen from user accounts on hardware wallets.
What is the best crypto wallet?
The best cryptocurrency wallets support multiple cryptocurrencies and are convenient to use even for beginners while offering high security and multi-coin features for users.
To select the best crypto wallet, it’s also crucial to use a solution from a trusted, reputable service provider.
Optionally, you can also look out for privacy and customization settings as well as integration with decentralized apps.
Do I need different wallets for different cryptocurrencies?
While some cryptocurrency wallets support numerous digital assets, others allow users to only store one or just a few coins.
If you plan to hold coins with higher market caps, you don’t need to create multiple wallets. Instead, you should choose a crypto wallet that supports various blockchains (e.g. Bitcoin, Ethereum, EOS, Binance Smart Chain) with multi-coin functionality.
As a rule of thumb, you should check which coins a wallet solution supports to ensure that you can store all your cryptocurrencies in one place.
However, if you seek to store your crypto on a single wallet, it’s crucial to ensure that the solution features a high level of security to protect your funds.
Are crypto wallets anonymous?
The anonymity of cryptocurrencies and related solutions (including wallets) has been an interesting topic in the digital asset space.
While it’s a myth that all crypto transactions are anonymous, some coins provide a higher level of privacy to customers.
The same is true for digital asset wallets. While most of them do not require KYC or AML checks from users, the majority are rather pseudo-anonymous than fully private.
Although, it’s important to mention that Hierarchical Deterministic (HD) wallets – that use a new wallet address after each transaction – provide additional privacy to users.
Are there any transaction fees for crypto wallets?
Like with all money transfers, transactions sent from most crypto wallets do involve some fees.
While there are no costs for receiving transactions, you have to pay network fees to miners or validators for processing outgoing transfers.
Non-custodial crypto wallets use variable network fees, meaning that the costs you pay depend on how loaded the blockchain is. The more congested a network is, the higher the fees you pay for cryptocurrency transactions.
On the other hand, custodial wallets (e.g. centralized exchange accounts) use fixed fees that are often higher than their non-custodial counterparts.
While many wallet solutions allow users to set their own fees for outgoing transfers, others have introduced cost-free transactions where the service provider covers the users’ network fees.
However, if the network gets congested, the latter service providers will likely (re-)introduce fees to remain profitable.