Crypto Wallet Types Explained

What is a crypto wallet?

In short, a crypto wallet is a tool that you can use to interact with a blockchain network. There are various crypto wallet types which can be divided into three groups: software, hardware, and paper wallets. Depending on their working mechanisms, they may also be referred to as hot or cold wallets.

The majority of crypto wallet providers are based on software, which makes their use more convenient than hardware wallets. However, hardware wallets tend to be the most secure alternative. Paper wallets, on the other hand, consist of a "wallet" printed out on a piece of paper, but their use is now deemed as obsolete and unreliable.

How do cryptocurrency wallets work?

Contrary to popular belief, crypto wallets don't truly store cryptocurrencies. Instead, they provide the tools required to interact with a blockchain. In other terms, these wallets can generate the necessary information to send and receive cryptocurrency via blockchain transactions. Among other things, such information consists of one or more pairs of public and private keys.

The wallet also includes an address, which is an alphanumeric identifier that is generated based on the public and private keys. Such an address is, in essence, a specific "location" on the blockchain to which coins can be sent to. This means you can share your address with others to receive funds, but you should never disclose your private key to anyone.

The private key gives access to your cryptocurrencies, regardless of which wallet you use. So even if your computer or smartphone gets compromised, you can still access your funds on another device – as long as you have the corresponding private key (or seed phrase). Note that the coins never truly leave the blockchain, they are just transferred from one address to another.

Hot vs. cold wallets

As mentioned, cryptocurrency wallets may also be defined as "hot" or "cold," according to the way they operate.

A hot wallet is any wallet that is connected somehow to the Internet. For example, when you create an account on Binance and send funds to your wallets, you are depositing into Binance's hot wallet. These wallets are quite easy to set up, and the funds are quickly accessible, making them convenient for traders and other frequent users.

Cold wallets, on the other hand, have no connection to the Internet. Instead, they use a physical medium to store the keys offline, making them resistant to online hacking attempts. As such, cold wallets tend to be a much safer alternative of "storing" your coins. This method is also known as cold storage and is particularly suitable for long-term investors or "HODLers."

As a way to protect users' funds, Binance only holds a small percentage of coins in its hot wallets. The remaining is kept in cold storage, disconnected from the Internet. Noteworthy, Binance DEX provides an alternative for users that prefer not to keep their funds in a centralized exchange. It's a decentralized trading platform that allows you to have total control of their private keys, while also being able to trade directly from their cold storage devices (hardware wallets).

Software wallets

Software wallets come in many different types, each with its own unique characteristics. Most of them are somehow connected to the Internet (hot wallets). The following are descriptions of some of the most common and important types: web, desktop, and mobile wallets.

Web wallets

You can use web wallets to access blockchains through a browser interface without having to download or install anything. This includes both exchange wallets and other browser-based wallet providers.

In most cases, you can create a new wallet and set a personal password to access it. However, some service providers hold and manage the private keys on your behalf. Although this may be more convenient for inexperienced users, it's a dangerous practice. If you don't hold your private keys, you're trusting your money to someone else. To address this problem, many web wallets now allow you to manage their keys, either entirely or through shared control (via multi-signatures). So it's important to check the technical approach of each wallet before choosing the most suitable for you.

When using cryptocurrency exchanges, you should consider making use of the protection tools available. The Binance Exchange offers several security features, such as device management, multi-factor authentication, anti-phishing code, and withdrawal address management.

Desktop wallets

As the name implies, a desktop wallet is a software you download and execute locally on your computer. Unlike some web-based versions, desktop wallets give you full control over your keys and funds. When you generate a new desktop wallet, a file called "wallet.dat" will be stored locally on your computer. This file contains the private key information used to access your cryptocurrency addresses so you should encrypt it with a personal password.

If you encrypt your desktop wallet, you will be required to provide your password every time you run the software so that it can read the wallet.dat file. If you lose this file or forget your password, you will most likely lose access to your funds.

Therefore, it's crucial to backup your wallet.dat file and keep it somewhere safe. Alternatively, you can export the corresponding private key or seed phrase. By doing so, you will be able to access your funds on other devices, in case your computer stops working or becomes inaccessible somehow.

In general, desktop wallets may be considered safer than most web versions, but it's crucial to make sure your computer is clean of viruses and malware before setting up and using a cryptocurrency wallet.

Mobile wallets

Mobile wallets function much like their desktop counterparts but designed specifically as smartphone applications. These are quite convenient as they allow you to send and receive cryptocurrencies through the use of QR codes.

As such, mobile wallets are particularly suitable for performing daily transactions and payments, making them a viable option for spending Bitcoin, BNB, and other cryptocurrencies in the real world. Trust Wallet is a prominent example of a mobile crypto wallet.

Just as computers, however, mobile devices are vulnerable to malicious apps and malware infection. So it's recommended that you encrypt your mobile wallet with a password, and backup your private keys (or seed phrase) in case your smartphone gets lost or broken.

Hardware wallets

Hardware wallets are physical, electronic devices that use a random number generator (RNG) to generate public and private keys. The keys are then stored in the device itself, which isn't connected to the Internet. As such, hardware storage constitutes a type of cold wallet and is deemed as one of the most secure alternatives.

While these wallets offer higher levels of security against online attacks, they may present risks if the firmware implementation is not done properly. Also, hardware wallets tend to be less user-friendly, and the funds are more difficult to access when compared to hot wallets.

To overcome the lack of accessibility, you can use Binance DEX to connect your device directly to the trading platform. This is a secure way of accessing your funds because the private keys never leave your device. Some web wallet service providers also offer a similar service, allowing hardware wallets to be connected to their browser interface.

You should consider using a hardware wallet if you plan to hold your crypto for a long time or if you're holding large amounts of cryptocurrency. Currently, most hardware wallets allow you to set up a PIN code to protect your device, as well as a recovery phrase – which can be used in case your wallet is lost.

Paper wallets

A paper wallet is a piece of paper on which a crypto address and its private key are physically printed out in the form of QR codes. These codes can then be scanned to execute cryptocurrency transactions.

Some paper wallet websites allow you to download their code to generate new addresses and keys while being offline. As such, these wallets are highly resistant to online hacking attacks and may be considered an alternative to cold storage.

Owing to the numerous flaws, however, the use of paper wallets is now considered dangerous and should be discouraged. If you still want to use it, it's essential to understand the risks. A major flaw of paper wallets is that they aren't suitable for sending funds partially, but only its entire balance at once.

For example, imagine that you generated a paper wallet and sent multiple transactions to fund it, summing a total of 10 BTC. If you decide to spend 2 BTC, you should first send all 10 coins to another type of wallet (e.g., desktop wallet), and only then spend part of the funds (2 BTC). You can later return the 8 BTC to a new paper wallet, though a hardware or software wallet would be a better choice.

Technically, if you import your paper wallet private key into a desktop wallet and spend just part of the funds, the remaining coins will be sent to a "change address" that is automatically generated by the Bitcoin protocol. If you don't manually set the change address to one that you control, you will likely lose your funds.

Most software wallets today will handle the change for you, sending the remaining coins to an address that is part of your wallet. But the important thing to remember is that your paper wallet will be empty after sending its first transaction out – regardless of the amount. So don't expect to reuse it later.

The importance of backups

Losing access to your cryptocurrency wallets can be quite costly. So it's important to back up them regularly. In many cases, this is achieved by simply backing up wallet.dat files or seed phrases. Essentially, a seed phrase works like a root key that generates and gives access to all keys and addresses in a crypto wallet. Also, if you opted for password encryption, remember to back up your password as well.

Closing thoughts

Crypto wallets are an integral part of using Bitcoin and other cryptocurrencies. They are one of the basic pieces of infrastructure that make it possible to send and receive funds through blockchain networks. Each wallet type has its advantages and disadvantages, so it's crucial to understand how they work before moving your funds.