Unlike traditional wallets that hold our cash and credit cards, crypto wallets don’t actually store cryptocurrency. We can think of crypto wallets as gateways or tools that allow us to communicate with a blockchain network, like Bitcoin or Ethereum. The wallet generates the information (public and private keys) we need to use cryptocurrencies.
Since all transactions on a blockchain are public, our crypto transactions are encrypted using a pair of public and private keys for security. Public keys encrypt the transaction.
Private keys decrypt the transaction.
If someone steals our private keys, then they could steal our crypto. WE SHOULD NEVER SHARE OUR PRIVATE KEYS!
Some wallets use seed phrases to recover our funds on the blockchain.
When we open our wallets, we are shown our seed phrases. We should write down the seed phrases and keep the seed phrases in a safe place in case we need to access them later. If we lose them, we could lose our crypto forever.
Here's a crazy story of someone who has lost $500+ million (7002 BTC) in crypto because he forgot his password.
Types of crypto wallets
We can think of wallets as either being hot or cold.
Hot walletsare more convenient to use for trading and making transactions. Software wallets are hot wallets and they can either be web, desktop, or mobile applications.
Web wallets use a browser, so it doesn’t require any installations on our computer
Desktop wallets are downloaded on our computers and are considered safer than web wallets
Mobile apps are similar to desktop wallets but specifically designed for smartphones, making them convenient for accessing our coins anywhere
Cold wallets offer us an even safer option.
Cold wallets are physical hardware wallets that hold the keys offline, making them more resistant to hackers.
To use a hardware wallet, we would connect it to our computers. The device randomly generates public and private keys stored directly on the device behind additional security layers. They are less convenient for making transactions but tend to be more secure and better for long-term investors holding coins.
Lastly, we can theoretically write our keys down on a piece of paper to create a paper wallet. This is ill-advised as paper wallets are obsolete and unreliable. Paper can be easily lost and destroyed—software and hardware wallets are much better alternatives.
As a beginner exploring decentralization for the first time, a CEX will automatically create a wallet for us. To interact with DEXs we can choose to start with a browser-based hot wallet like Metamask. Once we get the hang of custody of our own wallets, we can turn to other hot or cold wallets.