This blog explains what Cryptocurrency Wallets are and how to use them. It covers everything from the features of Crypto Wallets to the risks involved in using them and also lists down the most popular Crypto Wallets and their features. Topics covered:
- What are Cryptocurrencies?
- What are Cryptocurrency Wallets?
- How do Cryptocurrency Wallets work?
- Types of Cryptocurrency Wallets
- Parameters to be considered before choosing Cryptocurrency Wallets
- Risks involved in using Cryptocurrency Wallets
- Popular Cryptocurrency Wallets
Starting from the barter system to gold, then to paper currency, now we have arrived in the age of cryptocurrency. With the availability of more than 1300 cryptocurrencies, it is absolutely necessary to explore this domain. But why did cryptocurrencies gain such popularity? To understand that, let’s first understand what cryptocurrencies actually are!
What are Cryptocurrencies?
Let’s break down the word to understand it. ‘Crypto’ usually refers to cryptography, which involves using encryption techniques to secure transactions between different entities while currency refers to money. Hence, cryptocurrencies are a type of currency which is secured via encryption and can be traded digitally or virtually between entities and based on the blockchain technology. And just like we have online wallets to store our digital currency, we require special wallets to store, send or trade cryptocurrency.
What are Cryptocurrency Wallets?
Cryptocurrency wallets are necessary if one wishes to store, use, sell or buy cryptocurrencies. Cryptocurrency, as we know uses encryption mechanisms to secure transactions. Due to this, it involves the use of private and public keys. But what are these? A public key acts like an account identifier for a person whereas a private key acts as a password required to use the cryptocurrency similar to an ATM pin. A sender will require the public key of the receiver to send him the cryptocurrency and the receiver will be able to access and use these cryptocurrencies by using the private key. A private key must be protected in order to avoid fraudulent activities such as hacking, stealing of cryptocurrencies, etc. The cryptocurrency wallets are used to store these keys using which the cryptocurrency transactions take place. Crypto wallets display the amount of cryptocurrency in one’s wallet hence enabling one to monitor the balance.
How do Cryptocurrency Wallets work?
Unlike the cryptocurrency exchanges which allow buying and selling of cryptocurrencies with real money or currencies like USD and EUR, crypto wallets are used to store, send and receive cryptocurrencies (some crypto wallets may have in-built exchanges for conversion of cryptocurrencies to real money and vice versa). Once you buy a cryptocurrency from an exchange, it gets stored in your account of the exchange. However, it isn’t recommended to store the cryptocurrencies on the wallet provided by the exchange due to the fact that, in this case, the exchange will own your private key and not you. Hence you can transfer it to your own crypto wallet to gain control over the cryptocurrencies owned by you. To do so, you need to first generate a public key and a private key on your wallet, thereafter you can transfer your cryptocurrencies from the exchange to your wallet using this public key address. Once this is done, you can easily perform transactions and send cryptocurrencies to other accounts using their public keys and receive cryptocurrencies to your account by sharing your public key with the sender. The public key acts like an email address which is an identifier for a specific account. On the other hand, the private key will act like a password which you use to access your personal email account. Private keys are used to gain access to your cryptocurrencies which is why it is absolutely essential to keep it safe and secret to avoid hacking, stealing and other attacks.
Types of Cryptocurrency Wallets
Crypto can be broadly divided into two types, hot wallets and cold wallets. The main difference between these types is that hot wallets are connected to the internet or are online whereas data is stored in offline mode in cold wallets. These wallets can, in turn, be divided into the following categories:
- Desktop Wallets (Hot Wallet)
These are installed and stored on computers and laptops just like we install any other softwares. However, desktop wallets are at a risk of getting affected by a computer virus or malware, hence an antivirus software and a strong firewall are always recommended. Some examples are Exodus, Jaxx, Electrum etc.
- Mobile Wallets (Hot Wallet)
These wallets are basically mobile applications which can be easily downloaded on any mobile device. These are easier to use and are lighter applications than the desktop softwares. Some of the mobile applications may also have its desktop or web versions. Few examples of mobile wallets are Mycelium, Coinomi, GreenAddress etc.
- Web Wallets (Hot Wallet)
These wallets are provided as online platforms for cryptocurrency transactions and can be accessed through web browsers like Google Chrome, Mozilla Firefox etc. These wallets are riskier as they are connected to the internet and store your private keys online and are easily prone to hacking and online attacks. Some of the available web wallets are Coinbase, BitGo, Copay etc.
- Paper Wallets (Cold Wallet)
Paper wallet refers to a physical copy of your public and private keys which may just be a piece of paper. This also refers to any printed copy of the private and public keys generated through a software. It is considered to be one of the safest wallet as it is not prone to any online risks of losing your private key. It can also consist of a QR code which can used while performing any transactions.
- Hardware Wallets (Cold Wallet)
Devices like USB qualify for hardware wallets. As the private and public keys are stored physically in some hardware device, they provide a higher level of security as they are less vulnerable to online attacks and hence qualifies as the safest option. These can be connected via PCs and used with online softwares.
Parameters to be considered before choosing Cryptocurrency Wallets
- Coins Supported
You may select the wallet based on the coins or cryptocurrencies it supports and the coins in which you might to interested to trade in. Every wallet supports or validates the transactions for some types of cryptocurrencies like Bitcoin, Ethereum, Ripple etc. Some wallets might also be specific to just one type of cryptocurrency and would allow transactions involving only that cryptocurrency.
- Transaction Cost
This is one of the most important deciding factors to select a cryptocurrency wallet. Transaction fees vary from one wallet to another and hence one must know about it before starting to use a wallet. Transaction cost may be either fixed, dynamic or user-defined. Fixed costs may be directly given as a specific amount (eg: 0.0005 BTC) or may be specified as a percentage and will depend upon the amount you transact (eg: 5% of the transaction amount), dynamic costs may depend on factors like congestion on the network, availability of miners etc. and will vary accordingly. User-defined transaction costs are decided by the user depending on the urgency of the transaction; lower the transaction cost set by the user, higher will be the amount of time taken to complete the transaction and vice versa.
One of the biggest advantages of using cryptocurrencies is its underlying technology; Blockchain, which provides anonymity to the cryptocurrency users. But is it actually impossible to track any identity? Even though your identity is not directly linked to your public address on the blockchain, someone may be able to track the transactions to your public address and using that one may be able to identify your IP address eventually tracking down your identity. Hence, a wallet may provide the ability to generate multiple public addresses for different transactions making it difficult to track the identity of that person using different public addresses.
- Backup Features
In case you lose your private key, you are at a risk of losing your entire data and your stored cryptocurrencies, as you won’t be able to access them without the private key. Some wallets come with the feature of providing backup in case of any mishaps where you lose your data like your private keys. Features such as using a passphrase to recover data are available in certain wallets.
- Hierarchical Deterministic Wallets
We have already discussed the problems associated with acquiring anonymity over the blockchain and also mentioned a solution which was the generation of multiple public addresses for transactions. Hierarchical deterministic crypto wallets or HD crypto wallets are the wallets which are capable to create multiple private and public addresses using a series of calculations thereby preserving your privacy over the blockchain. They also provide a functionality to aid the recovery of a lost crypto wallet by means of using a seed phrase which is the transformation of your private key into a series of words.
Risks involved in using Cryptocurrency Wallets
Spoofing is when the malware attempts to change the sender’s address without his knowledge thereby making a person transact cryptocurrencies to the wrong address from the crypto wallets. The crypto wallets may become prone to such attacks due to lack of security protocols which makes it absolutely necessary to check the degree of security a crypto wallet is providing.
- Loss of Crypto Wallet
Loss of wallets leads to loss of one’s public and private keys which in turn means losing your stored cryptocurrencies. In cases where your private keys are encrypted or protected, it will be impossible for anyone to crack your private key as it can have 2^256 possibilities. However, in case your private key is known to someone else, then one might be able to access and use your stored cryptocurrencies.
- Centralized Structure
As all public addresses are stored on the blockchain, it becomes easier for a hacker to track the transactions on a public address which allows the hacker to identify the addresses with large amounts thereby making these public addresses a vulnerable target for attacks.
- Transaction Costs
As discussed earlier, transaction costs play a huge role in selecting a crypto wallet as some wallets charge as high as 50% transaction fees. And ignoring these details may lead to huge losses which are irreversible.
- Reversing Payments
As these payments are irreversible, it is of utmost importance to enter the correct public address of the receiver as payment once done cannot be reversed and may result in losses in case of entering the wrong address in the crypto wallet.
Popular Cryptocurrency Wallets
Cryptocurrencies supported: BTC, ETC, ETH, LTC and many more listed here.
Features: - Available on multiple platforms like Windows, Linux, Chrome, Firefox, Mac OSX, Android, iOS. - Allows conversion between Bitcoin, Ether, and DAO via Shapeshift. - Doesn’t store user wallet details on the centralized server thus providing higher security.
Cryptocurrencies supported: BTC, LTC, ETH, DASH, XRP and more.
Features: - Built-in exchange to convert altcoins to bitcoins - Intuitive and easy to use interface - Encrypted private keys for higher security. - Available on Windows, Mac OS, Linux.
Cryptocurrencies supported: BTC, ETH, XRP, XMR and many more.
Features: - In-built functionality for exchanges called Atomic Swap - Higher security due to encrypted private keys - Currently available on Windows, Mac OS, Ubuntu, Debian, Fedora and soon launching mobile wallet for Android and iOS. - Ability to buy cryptocurrencies with USD and EUR via Changelly and ShapeShift.
Cryptocurrencies supported: BTC
Features: - Great security as the coins are stored locally on the wallet and not accessible by third party. - Can be integrated with cold storage options like Trezor or Ledger - Offers five different types of accounts like HD, Bit ID, Single Address, ‘Watch Only’ Account and Hardware account. You can read more about them here. - Provides a decentralized in-person exchange called ‘Mycelium Local Trader’ to enable trades between buyers and sellers and also calculates reputation ratings based on trades. - It is a mobile crypto wallet available on Android and iOS.
Cryptocurrencies supported: BTC, BCH
Features: - Multiple signatures wallet with the functionality to share the wallet. - Allows secure in-app wallet generation and backup as it is a Hierarchical Deterministic (HD) crypto wallet. - Securely stores multiple, distinct wallets. - Available on Windows, Linux, Mac OS, Android and iOS
Cryptocurrencies supported: BTC
Features: - Encrypted Private Keys - Availability of Cold storage - Available on Windows, Mac OS, Linux, Android - Supports third-party plugins, Multisig services etc.
Cryptocurrencies supported: BTC
Features: - It is an HD (Hierarchical Deterministic Wallet) thus providing good security. - Available on Windows, Mac OS, Linux, Android, iOS and F-Droid. - Instant transaction confirmation. - HIgher security due to two-factor authentication. - Allows creating paper wallet backup.
Cryptocurrencies supported: BTC, BCH, ETH, LTC and more.
Features: - HD multisig hardware crypto wallet. - Compact USB crypto wallet. - Supports third-party apps - Compatible with Windows, Linux, Mac OS. - Easy backup and recovery with the 24-word recovery phrase
Cryptocurrencies supported: BTC, ETH, XRP, BCH and more.
Features: - Hardware wallet allowing offline storage. - Easily accessible due to the 12-24 word recovery phrase. - Ability to generate many public addresses. - Compatible with Windows, Linux, Mac OS.
We have covered the major concepts related to crypto wallets in this blog. However, there are a lot of misconceptions surrounding the topic of cryptocurrencies. This course explains everything right from the basics of cryptocurrencies and working of crypto wallets to developing and backtesting cryptocurrency trading strategies like Ichimoku Cloud strategy.
Disclaimer: Any information regarding Cryptocurrency in this article is intended to convey general information only. This article does not provide investment, legal, tax, etc. advice. You should not treat any information in this article as a call to make any particular decision regarding Cryptocurrency usage, legal matters, investments, taxes, Cryptocurrency mining, exchange usage, wallet usage, etc. We strongly suggest seeking advice from your own financial, investment, tax, or legal adviser. Neither QuantInsti® nor the author of this article accept responsibility for any loss, damage, or inconvenience caused as a result of reliance on information published in, or linked to, from this article.