This is part 8 of a series of short cryptocurrency “explain it like I’m five” posts. If you’re just joining us, start here: Crypto ELI5 Part 1: What is a blockchain?
This series of blog posts is meant for the absolute beginner in cryptocurrency. They are also meant to be concise and easy to understand. If you’re interested in learning about crypto, some of the history of crypto, and how to get started with using crypto, follow along! We’ll be adding a new post daily and each post will build on the one previous to it.
What is a Crypto Wallet?
Contrary to what you might think, a crypto wallet doesn’t actually hold any of your cryptocurrency. Your crypto actually lives on the blockchain. A crypto wallet does store and secure your private keys, which are basically password(s) for getting access to your crypto. These keys prove your ownership of your cryptocurrency and allow you to make transactions with it. If you lose these keys, you lose access to your digital money, which is why it’s important to keep them safe!
There are four types of Crypto wallets:
Paper – Keys are literally written down on a piece of paper and physically stored in a safe place. Pros – hard for malicious parties to access because they’re stored offline (a cold wallet). Cons – difficult to transact with your crypto, and can be lost or destroyed.
Hardware – Keys are stored in a thumb drive that is stored in a safe place and only connected to a computer when you need to make transactions with your crypto. Pros – hard for malicious parties to access because they’re stored offline, and easier than paper to transact with your crypto. Cons – still requires an extra step, and can be lost or destroyed. Examples: Ledger Nano X, Trezor Model T
Non-Custodial Software Wallet – Keys are stored in software like an app. Pros – easier to transact with your crypto. You own your private keys and funds. Cons – Easier for malicious users to access because they’re stored on an internet connected computer or online. Security is only as good as your wallet provider’s security, and your own security practices. Examples: Electrum (Bitcoin), Daedalus (ADA)
Custodial Software Wallet – Cons – custodial wallets do not give you full control over your crypto funds and hold the private keys for you. Even though the custodian has an agreement with you that you “own” the funds in your wallet, the only true way of owning those funds is to have control of the private keys. The risk here is that the custodian can remove access to your funds or even lose your funds. An example of a custodial wallet is a Crypto Exchange Wallet. Pros – the easiest way to transact with crypto since funds are already on an exchange (no need to transfer funds to an exchange first). Easy to exchange your funds for different crypto currencies. Examples include: Coinbase, Binance
You’ll probably hear the terms “cold” and “hot” wallets. A hot wallet is a wallet that’s connected to the internet which is usually the case for non-custodial software wallets and custodial software wallets. A cold wallet is one that is not connected to the internet like a paper or hardware wallet. As mentioned above, cold wallets are considered more secure since they are harder for malicious parties to access.
So which wallet should you choose? It really boils down to user preference. I use a combination of hardware, non-custodial software, and custodial software. I keep the bulk of my crypto in a cold hardware wallet to keep it safe from malicious hackers. I keep a much smaller amount in a non-custodial wallet, and a very small amount in a custodial wallet for quick access and transactions. Whatever you decide to use, remember to have a security mindset. Use strong passwords. Keep passwords and private keys safe, secure, and backed up.
Check back in tomorrow for Crypto ELI5 Part 9: First Generation Crypto: Bitcoin
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