A wallet is software, whether independent or embedded in hardware, that keeps the private keys secure so that no one can steal the crypto in your blockchain addresses.
How Do They Work?
To understand how the Wallets work, let us understand how crypto is stored and transferred.
Wallets hold the private keys of your blockchain addresses which actually hold your crypto. At any point in time, a crypto token never leaves its own blockchain even when they are bridged. A wallet makes sure that your private keys are only exposed to the blockchain where you want to transact.
Let us take a look at an example of how a crypto wallet works.
Suppose you want to send 100 USDT to someone for any reason.
- First you will access your blockchain address where the crypto is stored, through your wallet (private keys are not exposed now).
- If you have a hardware wallet, you need to turn it on and connect it with the mobile app or desktop utility.
- If you have a hot wallet (software wallet), just open it.
- Now your wallet will connect with the blockchain when you enter the wallet password.
- You then need to enter how much crypto you wish to send and to whom.
- Usually you need to enter the destination address (it’s public keys).
- However, with blockchain domains, things have become a lot easier. For example to send crypto to Vitalik Buterin, you just need to enter “vitalik.eth”.
- Now, you expose your private keys to the blockchain (via the wallet) and sign the transaction to prove that you are the rightful owner.
- Your crypto is now sent and the destination address will receive it within a few minutes or seconds.
Types of Wallets
Wallets can be divided based on their physical attributes (hardware or software) or based on whether the end uses has the private keys or not (custodial vs non-custodial).
Cold Wallet
A cold wallet is that crypto wallet which is dormant most of the time except when you need it. These wallets provide a greater safety because they are offline for most of their lives. Most cold wallets are hardware wallets these days. However, the term is also used for deep cold storage crypto vaults, like Coinbase Custody.
Paper Wallet
A paper wallet is just a piece of paper on which your private keys are noted (or seed phrases). You recover the wallet by entering the private keys and use it when required. Rest of the time, it remains offline.
This is different than an software wallet which always remains online.
Example: Metal card wallets, Mnemonics wallets, etc.
Hardware Wallet
A hardware wallet is that crypto wallet that relies on its own independent hardware to hold your private keys. It comes only alive when you need it and rest of the time, it lays dormant.
Most hardware wallets are cold wallets. However, they can also be custodial wallets but no such service has entered the crypto markets.
Example: Ledger Nano X
Cold Storage Wallet
This is different than a hardware wallet. Cold Storage wallets are crypto vaults that are used by large institutions like exchanges to keep a very large amount of cryptocurrencies, often in millions and billions.
Example: Coinbase Custody
Hot Wallet
A hot wallet is that which is alive and working most of the time. Such wallets are more frequently used and hence lie at a greater risk of being attacked.
Example: MetaMask
Desktop Wallets
Desktop wallets are those software that exist as desktop software. These wallets provide a greater security than mobile wallets because desktops are typically more secure.
Example: Guarda Wallet
Mobile Wallets
Mobile wallets are Android or iOS apps that are specifically designed to be used from mobile phones. They can be both custodial wallets like Lightning network wallets and non-custodial wallets like Trust Wallet.
Example: Trust Wallet, Satoshi Wallet, etc.
CEX Wallets
Centralized Exchange (CEX) wallets are those which come attached to exchanges like Binance, OKX or Coinbase. These wallets do not let you obtain the private keys but also provide with a recovery option in case you forget the password.
Remember, Coinbase has both CEX wallet and non-custodial wallet.
Example: Binance CEX wallet, OKX CEX wallet.
