A blockchain wallet is a digital tool for storing and managing cryptocurrencies. Unlike a traditional wallet, a crypto wallet doesn’t hold the currency itself — the crypto tokens remain on the blockchain.
A blockchain wallet allows crypto users to interact with the cryptocurrency coins stored on the blockchain and complete transactions. These transactions may include buying products or services, trading crypto, or borrowing. (We’ll delve deeper into how it works in the next section.)
With cryptocurrencies like Bitcoin and Ethereum becoming more popular in the last decade, several types of crypto wallets have appeared on the market — from software-based to physical hardware devices that store your crypto offline.
It’s important to note that a crypto wallet differs from a crypto exchange. Crypto exchanges are online marketplaces where you can buy, sell, and trade cryptocurrencies. On the other hand, a crypto wallet is a piece of hardware or software that stores your crypto.
Before we cover how blockchain wallets work, it’s important to understand the technology behind them.
A blockchain is a decentralized system for storing data that acts like a database. It consists of “blocks” — units of data stored within the blockchain’s code. Each block has a unique number of the preceding block, creating a chain of blocks.
Blockchain technology enables the existence of cryptocurrencies, among several other things (e.g., supply chain, and logistics).
Cryptocurrency is stored electronically on the blockchain using cryptographic methods to verify the transactions and an algorithm to create monetary units.
The technology allows crypto traders to complete transactions across a peer-to-peer network without a central clearing authority.
A blockchain wallet is a crypto wallet that allows you to send and receive cryptocurrencies. Unlike a traditional wallet, a crypto wallet doesn’t store any of your crypto funds. Here’s how it works:
- When you create a blockchain wallet, you get two keys — a private key and a public key.
- The private key is your “digital signature.” You shouldn’t share it with anyone — it’s only for the account holder to know. A private key is for proving ownership of the tokens in your wallet so you can spend your funds.
- The public key is your “account number.” You can share it with others, and they can use it to send cryptocurrency to your account.
- Your blockchain wallet stores a record of your transactions and the keys used to perform them.
- The wallet allows you to easily exchange funds, and all transactions are cryptographically signed (i.e., protected by your private key).
It’s important to note that your private key should always be kept confidential. If someone gets hold of your private key, there’s a high chance that your account is no longer safe — and you should move your cryptocurrency to a new wallet.
If you own crypto assets, using a cryptocurrency wallet is an option. Keeping your cryptocurrency safe and secure is crucial, especially if your assets are highly valuable. With more people choosing to buy, store, and trade cryptocurrencies, crypto hacks have become a common threat.
Crypto users looking to securely store Bitcoin, Ethereum, or another cryptocurrency have many options to consider. However, not all of them offer the same level of security.
While some people may choose to keep their crypto funds in a crypto exchange, even the most reputable, trusted, and seemingly secure cryptocurrency exchanges are not bulletproof and could suffer an attack.
The biggest crypto hacks of 2022, including the collapse of a major crypto exchange FTX, taught us that anything can happen.
Here are some of the reasons you may choose to use a blockchain wallet:
- Security. While some types of crypto wallets are more secure than others, typically, blockchain wallets offer various security features that make them more secure than leaving your cryptocurrency in a crypto exchange.
- Convenience. Keeping all your cryptocurrencies in one place provides an easy and convenient way of managing all your crypto assets.
- Long-term use. A blockchain wallet provides a secure way to manage several types of cryptocurrencies long term.
- Low transaction fees. The cost of transferring funds using a blockchain wallet is typically lower than that of traditional banks.
- Allows instant transactions. With a crypto wallet, you can send and receive crypto funds instantly.
You can find several types of blockchain wallets on the market, each with its own pros and cons.
All blockchain wallets protect both your private and public keys — but which type of wallet you choose will depend on several factors and your preferences.
Blockchain wallets are most commonly categorized into hot and cold wallets. Hot wallets are connected to the internet and are also known as online wallets, while cold wallets are not and are called offline wallets.
Hot wallets are digital and always connected to the internet and the cryptocurrency network.
A hot wallet is linked with the user’s private and public keys and allows them to store, send and receive cryptocurrency tokens.
The most common hot wallet types are software wallets and exchange wallets. We’ll cover each of these below.
Because hot wallets are connected to the internet, they can provide many additional features that cold wallets do not. However, because of their connectivity to the internet, they are also somewhat more susceptible to hacking and cyberattacks than cold wallets.
Exchange wallets
Exchange wallets are provided by crypto exchanges — marketplaces where people can sell, buy, and trade crypto. These wallets are also known as custodial wallets because they are responsible for safeguarding a user’s funds.
While crypto owners can use these crypto wallets to hold and make crypto transactions, the wallet is owned and controlled by the exchange. Some popular exchanges that provide a custodial wallet service are Coinbase and Kraken.
Software wallets
Software wallets are software solutions for storing your private keys and keeping your crypto secure and accessible.
With a software wallet, you can also buy, sell, swap, lend, or earn cryptocurrency. You’ll typically be able to hold various cryptocurrencies in one place, although some wallets only deal in one cryptocurrency (e.g., Bitcoin).
Software wallets can be web based, mobile based, or desktop based, with many software wallets available on all three platforms.
Some popular software wallets are Exodus, Electrum, and MetaMask.
Cold wallets are not connected to the internet and store your private keys offline. Originally known as cold storage, cold wallets are less vulnerable to unauthorized access and cyberattacks than wallets connected to the internet.
The two main types of cold wallets are:
- Hardware wallets
- Paper wallets
Let’s look at each of these cold wallet types in a little more detail.
Hardware wallets
Hardware wallets are small, physical devices that store your private keys offline. A user can connect a hardware wallet to a computer via USB or a similar port to complete crypto transactions and transfers.
While they’re less convenient than online wallets, hardware wallets are considered more secure.
The most popular hardware wallet is Ledger. Ledger wallets look like USB flash drives and support most cryptocurrencies.
Paper wallets
A paper wallet is as simple as a printed piece of paper with your private keys and QR codes for facilitating crypto transactions.
Paper wallets used to be the most common method of storing private keys before cryptocurrency became popular. However, people increasingly now choose hardware wallets instead of paper wallets.
Blockchain wallets have many advantages and benefits. However, they also have some disadvantages to keep in mind. Let’s look at the pros and cons.
Advantages of blockchain wallets
- Security. Blockchain wallets provide a high level of security. While software wallets are typically connected to the internet and considered to be less secure, they are still protected with cybersecurity measures like two-factor authentication and cryptography. These security features typically make it difficult for hackers to steal your crypto.
- Convenient access. A blockchain wallet allows you to keep all your cryptocurrencies in one place. Software wallets are already connected to the internet, making it easy to access your funds. Hardware wallets can be a little less convenient — but once you learn how they work, using one should be relatively straightforward.
- Self-ownership. Keeping your private keys in a crypto wallet gives you self-ownership, meaning the cryptocurrency belongs to you and only you. In contrast, if you were keeping your money in a bank, it would technically be the bank’s property.
Disadvantages of blockchain wallets
- User responsibility. When you store your private keys in a blockchain wallet, you’re responsible for keeping them safe. This responsibility means that if your private keys are stolen, there’s not much you can do.
- Can be complex. Like most software or hardware, you’ll need to learn how your blockchain wallet works. While most software wallets will aim to be user friendly, they can be a little complex, especially for a beginner. Hardware wallets tend to be even more complex than software wallets, so you will need to learn how to use them for trading and confirming transactions.
- Malicious actors. Blockchain is a new technology, and just like all digital innovations, it attracts hackers. While blockchain wallets are considered safer than centralized accounts, they’re not completely hack proof. Malicious parties may come up with many ways to scam you out of your crypto — from phishing emails to upgrade scams. It’s important to remain vigilant when using your blockchain wallet because unlike traditional banks that may insure your money, crypto doesn’t have that level of protection.
A blockchain wallet is a safe way to store, manage and spend your cryptocurrency. However, several types of blockchain wallets exist, and their security varies by type.
Cold storage wallets, or hardware wallets, are typically considered more secure because they store your private keys offline. Hot wallets are always online and therefore may be more vulnerable.
Keeping your blockchain wallet safe is very important. A compromised wallet could lead to losing some or all of your cryptocurrency funds, which are usually impossible to recover.
Whereas fiat currency (i.e., traditional money) kept in banks is often protected by insurance, you don’t get the same level of protection with cryptocurrencies.
Therefore, it’s your job to do the best you can to keep your blockchain wallet safe. Here’s how you can increase your cybersecurity and protect your wallet from cyberattacks.
Use a hardware wallet
The safest option is using a hardware wallet. With a hot wallet, you can log in from anywhere, anytime — meaning the risk of getting hacked is greater.
In contrast, a hardware wallet cannot be hacked. However, if you lose your hardware wallet, you won’t be able to access your crypto funds until you find it.
Enable two-factor authentication (2FA)
2FA protects your accounts with an additional layer of security. If someone unauthorized attempts to log in, you will receive a message with a verification code. This additional security step makes it difficult for hackers to access your account — and your funds.
Create a strong password
Using a long, strong password is one of the most effective ways to protect your accounts, whether it’s your bank account or crypto wallet. Use a combination of letters, numbers, and special characters — and consider using a password manager for additional security.
Keep your crypto in multiple wallets
If you own a lot of cryptocurrencies, it would be wise to split up the funds and keep them in multiple wallets. Storing your crypto in several places will decrease your chances of losing all your crypto funds if one wallet is hacked.
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