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Millions of people use cryptocurrency wallets, but there is a considerable misunderstanding about how they work.
Unlike traditional pocket wallets, digital wallets do not store any currency. So, Cryptocurrencies do not get stored in any single location or exist anywhere in any physical form. All there is are records of transactions stored on the blockchain.
Cryptocurrency wallets are software programs that work with public and private key pairs. Moreover, the wallets provide a user interface via which you can monitor their recorded balance on the network and conduct transactions.
So, when a person sends you Bitcoin or any other type of digital currency, they are permanently signing off ownership of the coins linked to their wallet address.
And once the transaction is verified, the network records Bitcoins ownership on your address.
A cryptocurrency wallet functions in the same way as your bank account. So, in the sense that you can interface with the network and transact (deposit and withdraw) (crypto)currencies to and from your bank account. Moreover, with a cryptocurrency wallet, you manage your cryptocurrencies in the form of validated transactions on the blockchain. So, the wallet generates and stores private and public keys, interacts with the respective network (blockchain). Moreover, it enables users to perform and sign transactions.
The field of cryptography is fundamental to many cryptocurrency systems such as Bitcoin. Cryptography is the practice of secure communication in the presence of third parties. In other words, cryptography allows for data to be stored and communicated in such a way that third parties are prevented from reading the contents. Moreover, cryptography is utilized in the creation of public and private keys to make cryptocurrency systems a secure network upon which users can safely operate.
While you are reading about wallets, you might come across the terms hot storage and cold storage. All the different types of cryptocurrency wallet fall under either one of these two types. So, in general, anything that is connected to the internet is less secure than something that is not. Therefore, this is the difference between hot and cold wallets, with internet-connected wallets being hot and offline wallets being cold. Moreover, online, desktop and mobile wallets are hot wallets, while hardware and paper wallets are cold wallets, also known as cold storage or hardware wallets (specialized USB enabled devices). Some might say that hardware wallets are prone to physical damage, loss or theft. However, the advantage is that they are far less likely to fall victim to hacks and provide a lot more security.
Online (cloud) wallets, exchange wallets and desktop and mbile wallets are typical hot storage wallets.
Hardware and paper wallets, also known as hardware wallets. are typical cold storage wallets and provide maximum security.
There are several types of wallets that provide different ways to store and access your digital currency.
Cryptocurrency wallets can be broken down into three distinct categories; software, hardware, and paper wallets. Software wallets function on a desktop, online or mobile device. Hardware wallets use software but fall in their own category.
Hardware wallets or cold wallets are well worth the investment and are unrivaled in terms of security. Moreover, hardware wallets make it possible to easily transact while also storing your funds offline and away from danger. Hardware wallets differ from software wallets in such a way that they store a user's private keys on a hardware device like a USB. Although hardware wallets facilitate transactions online, the keys are are stored offline for increased security. Hardware wallets are compatible with several web interfaces and support many different cryptocurrencies. Making a transaction is easy. Users plug in their hardware device to any internet-enabled computer or device, enter their pin or password, sign of on a cryptocurrency transaction and confirm. It just depends on which hardware wallet you decide to use.
Desktop wallets are downloaded and installed on a PC or laptop. Desktop wallets are only accessible from the single computer on which they are downloaded. Desktop wallets offer one of the highest levels of security but if your computer is hacked or gets infected with a virus, the threat of losing your assets is real.
Mobile wallets are software applications on your phone. Mobile wallets are one of the most useful wallets for everyday use because they can be used anywhere and at anytime (including retail stores). Mobile wallets are much smaller in size and simpler to use and configure than desktop wallets because of the limited space available on mobile devices. Mobile phones are woven into our lives, society and culture and mobile payments are rapidly becoming more mainstream. It cannot be denied that there is a lot of development happening around mobile wallets and cryptocurrency payments. It can be a good idea to have at least one mobile wallet to carry a small amount of cryptocurrency with you.
Online wallets are the most notorious because users don't own their private keys. Exchange wallets are a prime example. Online wallets are accessible from any computing device and any location. However, while they are more convenient to access, your private keys are stored online. Effectively the wallet is controlled by the exchange, and you can log in with a username-password combination. This automatically makes any centralized storage provider a huge target. These targets - usually large exchanges - are more likely to be targetted by hackers or malicious actors. Almost all of the big hacks involved custodial exchange funds being compromised.
Paper wallets are easy to use and provide a very high level of security. While the term paper wallet can refer to a physical copy or printout of your public and private keys, it can also refer to a piece of software that is used to generate a pair of keys which are then printed securely. Users are provided with either a QR-code or a string of text and numbers - which represent your address. Transferring Bitcoin or any other currency to your paper cryptocurrency wallets is accomplished by the transfer of funds from your software wallet to the public address as indicated on your paper wallet. Alternatively, if you want to withdraw or spend currency, all you need to do is transfer funds from your paper wallet to your software wallet. This process is often referred to as 'sweeping' and can either be done manually by entering your private keys or by scanning the QR code on the paper wallet.
When it comes to cryptocurrencies, you can take any number of assets with you on a mobile cryptocurrency wallet and store the rest safely on (multiple) other locations.
Remember that all third-party exchange accounts are linked to online ‘hot’ wallets, as mentioned before. You do not own the keys to your online exchange account and are always at risk of losing direct access.
In addition to the above, you might also want to have a small portion on a mobile wallet to be able to take with you for easy access and liquidity purposes.
Ultimately, it is up to the end-user to determine their own acceptable level of risk in terms of their investment. This usually depends on the invested amount and the need for the investor to access these funds on short notice. Take some time to assess your requirements and only then decide on the most suitable wallet(s) for you.