It has been just over a decade since the introduction of bitcoin, and there are still debates about which cryptocurrency wallet to use. If you are researching this question you either already have some cryptocurrency and are looking into keeping them safe, or you want to do some prior research before jumping into the world of cryptocurrency. Before we delve into the various types, let’s briefly talk about how these wallets work. The next few paragraphs may be a bit technical but it will make understanding and comparing wallet types much easier later on.
A Bitcoin or cryptocurrency wallet (referred to as crypto wallet from here on out) contains a singular thing — your private key. Unlike traditional money, cryptocurrency is not a physical thing and unlike traditional money, cryptocurrency doesn’t need to be stored in a traditional fashion. Cryptocurrency is stored in the blockchain, a sort of ledger that is decentralized, locked up by what is known as a private key. At the very core of it, a crypto wallet’s function is to talk to the blockchain on your behalf using the private key stored inside it, in a manner dictated by what you are trying to accomplish.
Let’s say Bob wants to pay for his groceries with bitcoin; he will open his crypto wallet, enter the store’s “public key”, enter the amount of bitcoins, and initiate the transaction. Now his crypto wallet will sign the transaction with the private key and send it off to the blockchain.
Let’s see another example where Alice wants to be paid in Bitcoins for doing Karen’s yard work. Alice will open her crypto wallet, show Karen her public key (which is generated from the private key), and then to send Alice the money, Karen will do what Bob did at the grocery store.
Crypto wallets may have other bells and whistles, such as letting you buy cryptocurrency directly instead of going through an exchange, or letting you convert from one crypto to another on the fly. But for any crypto wallet, the most important bit is the private key. Now that we have an understanding of crypto wallets, let look at the three most common types and see the pros and cons of each.
1. Cloud Wallet
Also known as online wallets, these run on the cloud and can be accessed from any device with an internet connection. This is the most convenient type of crypto wallet and by far the most insecure. This kind of wallet requires the private key to be stored in third-party servers which is also known as the cloud. This leaves your private key vulnerable as there is no guarantee of the server’s security from hackers. And because the private key is stored on the service provider’s servers there is no guarantee that the provider or someone working for them will not steal your private key and your cryptocurrency. Let’s look at something a bit more secure.
2. Software Wallet
There are many software wallets available that you can download and install on your computers or smartphones. Most software wallets are free and the private key, in this case, remains on the device where the software is installed on. Software wallets require a bit more work during setup as it is important to back them up before use but from there on out it as easy to use as a cloud wallet.
A software wallet can be a tad more secure as the private key lives on your device — so only you have access to it unlike the cloud wallet — but the device is still connected to the internet which means the private key is still vulnerable to hacking.
To address the security issue a third kind of wallet was invented.
3. Hardware Wallet
This is arguably the most secure kind of wallet for storing the private key. Most hardware wallets have a small form factor and are similar in size to a flash drive. Hardware wallets require connecting to a smartphone or a computer as it needs the internet to make transactions but the private key resides inside and never ever leaves the wallet. Thus, even if the smartphone or the computer is hacked, the private key remains safe.
Hardware wallets have one big trade-off — convenience. Most hardware wallet manufacturers are fully focused on security and completely forgo the user experience. Bitcoin was invented to be used as money and this use case requires ease-of-use and mobility. Software wallets and cloud wallets are extremely convenient but insecure and hardware wallets are extremely secure but inconvenient.
If you want to use cryptocurrency as money, the solution to maximize security and convenience is to keep a majority of your crypto inside a hardware wallet and some in a software wallet on your phone. When running low all you need to do is top off your mobile wallet from the hardware wallet like fuelling up your car.
Or you can check out vault E at hodllabs.io. Our goal is to get rid of this trade-off and instead have a wallet that is as convenient as a software wallet without sacrificing on security. It is okay to store crypto in multiple wallets and ideal if someone has a lot of it but I don’t like my wallet giving me allowance money and I don’t think a lot of others do either.
Managing the Security of Your Wallet
Since cryptocurrencies are susceptible to online threats, it’s important to pay attention to the safety and security of your wallet and coins.
Are Wallets Anonymous?
Although most wallets aren’t linked to your identification, it is possible to trace your ID using your wallet data. As blockchain technology uses public ledgers, backward engineering of your identity is possible. Luckily, this isn’t easy and requires a lot of expertise, skill, and knowledge. Therefore, most crypto wallets are pseudo-anonymous, which is very close to anonymous.
What About the Security Levels?
Although wallets are designed to offer optimum security, the implementation of security incentives differs greatly amongst the different types of wallets. Usernames and passwords are the primary security measures. But if possible, you should use two-factor authentication, encrypt your wallet, and only use trusted wallets. Other security measures to follow while using a digital wallet include:
Ensure Software Updates — This helps to patch the latest security holes and ensure top-notch updated security measures.
Take Backup — Make sure you have a backup of your software or hardware wallet so that you don’t lose your assets to software or hardware failure.
Avoid Exchanges — Although it may seem like a convenient option, exchanges in cryptocurrencies aren’t regulated or legally bound to compensate their users and thus, there’s a high chance of losing all your money overnight. In the past, exchanges have been hacked, shut down, or simply disappeared. Thus, using an exchange platform with a stellar reputation is very important.
Protect Your Keys — Above all, remember that no keys mean no coins. Keep your private keys safe because if you lose them, you will lose your investment forever.
And finally, no matter which wallet you choose, make sure you are confident about it so that you can get a good night’s sleep knowing that your coins are safe and sound!