An Overview of the Different Types of Cryptocurrency Wallets

Beginner’s Guide / 05.10.2019

Asymmetric Cryptography or Public/Private Key Cryptography is the backbone of the modern information society. They comprise of two uniquely related cryptographic keys (basically long random numbers) where the key pair are mathematically related. Whatever is encrypted with a Public Key may only be decrypted by its corresponding Private Key and vice versa. Public Key Cryptography can, therefore, achieve Confidentiality.

For asymmetric encryption to deliver confidentiality, integrity and authenticity, users and systems need to be certain that a public key is authentic, that it belongs to the person or entity claimed and that it has not been tampered with nor replaced by a malicious third party.

Cryptographic wallets are built on the principle of Asymmetric Cryptography. With Public keys and Private keys, one can store assets, have them linked to a wallet and spend later. The entire area of Distributed technologies starting with Bitcoin, used this principle to effectively to engage in digital transfer.

To learn more about wallets, let us look at the several types of wallets in the market.

Hot Wallets

To transact with other people or entities using bitcoin, one usually accesses the internet to propagate the transfer of assets. Hot wallet refers to any cryptocurrency wallet that is connected to the internet. Generally, hot wallets are easier to set up, access and accept more tokens. But hot wallets are also more susceptible to hackers, possible regulation, and other technical vulnerabilities.

Operating a “hot wallet” is also a risk to its owner because most computer systems have hidden vulnerabilities of some sort that can eventually be used by hackers or malware to break into the system and steal the bitcoins. It is generally considered that keeping large amounts of bitcoins in a hot wallet is a fundamentally poor security practice. Most, if not all of the Bitcoin losses incurred in all the known hackings in Bitcoin history can be attributed to funds kept in hot wallets. Hot wallets are known to be immensely secure and for that reason, people use mechanisms like Cold Wallets and Hardware Wallet.

Bitcoin Wallets like FreeWallet, CoPay, etc are categorized Hot Wallets.

Cold Wallets

Cold storage refers to any cryptocurrency wallet that IS NOT connected to the internet. Generally, cold storage is more secure, but they don’t accept as many cryptocurrencies as do many of the hot wallets, because they are linked to one public-private key pair. Cold Storage offers little to no flexibility but high security.

Users looking for cold storage options can also opt for offline software wallets, which are quite similar to hardware wallets but are a more complex process for less technical users. An offline software wallet splits a wallet into two accessible platforms – an offline wallet which contains the private keys and an online wallet which has the public keys stored. The online wallet generates new unsigned transactions and sends the address of the user to the receiver or sender on the other end of the transaction.

Cold Wallets can then be divided into two, Paper Wallet and Hardware Wallets.

Paper Wallets

The most basic form of cold storage is a paper wallet. A paper wallet is simply a document that has the public and private keys written on it. The document is printed from the bitcoin paper wallet tool online with an offline printer. The paper wallet or document usually has a QR code embedded on it so that it can easily be scanned and signed to make a transaction. The drawback to this medium is that if the paper is lost, rendered illegible or destroyed, the user will never be able to access his address where his funds are.

Paper wallets are easy to use and provide a very high level of security. Using a paper wallet is relatively straightforward. Transferring Bitcoin or any other currency to your paper wallet is accomplished by the transfer of funds from your software wallet to the public address shown on your paper wallet. Alternatively, if you want to withdraw or spend currency, all you need to do is transfer funds from your paper wallet to your software wallet. This process, often referred to as ‘sweeping,’ can either be done manually by entering your private keys or by scanning the QR code on the paper wallet.

Hardware Wallets

A Hardware wallet is a physical electronic device that is designed to protect an individual’s cryptocurrency funds by securing their private keys. The idea behind hardware wallets is to separate the private keys from online methods of storage, such as a computer or smartphone, which are more susceptible to being compromised by a hacker. Storing your private keys offline prevents against this, as hackers would have to physically steal your hardware wallet to gain access to a user’s private keys.

There is a huge market for hardware wallets service providers. Each wallet with specific features of their own such as a wide range of supported coins, increased factor authentication, additional flexibility and so on.

Custodial Wallets

Custodial Wallets are services and exchanges that don’t provide you access to private keys and store them on servers. The main advantage of custodial wallets is that you can restore access to your account in case you’ve lost your password. The bad news is they can freeze your funds in case of maintenance or due to KYC requirements. There is always a risk that your money may be stolen in case of hacking attacks

Some investors choose to keep their cryptocurrencies in accounts linked to popular exchanges like Bitstamp or Poloniex. These companies, which hold your funds within their infrastructure, can be considered as hot wallet service providers. This means that if an attacker gains access to the Poloniex servers and infiltrates their customer accounts, you might suffer a loss. Because many of the top digital currency exchanges allow users to transfer between various fiat currencies and cryptocurrencies, it’s common for most users to hold a small amount of any of several currencies in their accounts.

A custodial wallet is considered as the weakest link in the cryptocurrency space. Time has shown that it is incredibly easy to manipulate loopholes and steal funds from a custodial wallet.

Conclusion

While we still have a very long way to go before purchasing and storing cryptocurrency becomes accessible for the mainstream and non-technical audiences, and old saying goes states “there is a long way to go for innovation” as well. Innovation in the wallet space is immensely important, as most application right now are too dense and technical for a wide and general audience. In order to achieve greater global adoption, it is very important for creative innovators to minimize technicalities and maximize ease-of-use.

When talking about which wallet one must choose to maintain their cryptocurrency balances, there is no rigid answer. It all depends on the individual’s preferences. If the individual prefers to have crypto bought and sold regularly and assumes the risk of centralization, a custodial wallet is more than enough. But if an individual wishes greater flexibility and security, and does not want to take the risk of giving it to someone else, a hot wallet is the best choice. It is very important for users to have a thorough research before getting into any kind of long-term commitment.

Crypto Adventure has prepared you a list with the most trusted cryptocurrency wallets of all types. Pick your favorite!

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Sudarshan M is a long time crypto-enthusiast. Pulled in by bitcoin early on, it did not take long for Sudarshan to divert all of his academic attention from business studies to blockchain by doing his Masters and eventually pursuing his PhD in the subject.