Crypto wallets serve as a digital gateway to interact with various blockchain networks and ensure the safety of your funds. In this blog post, we will delve into the different types of crypto wallets available, highlighting their advantages and disadvantages. Additionally, we will explore the future of crypto wallets and the potential advancements in this rapidly evolving field.
There are different types of crypto wallets, but they generally fall into a few different categories: hot wallets, cold wallets, software wallets, and hardware wallets. As you will see, these categories are not always mutually exclusive and there are convenience and security tradeoffs with each. Even though technically not a "wallet", we will also talk about how centralized exchanges fit into the conversation.
Hot Wallets
These are crypto wallets stored in a device that is always connected to the internet such as your mobile phone, laptop, etc. The reason they are called hot wallets is because by always being connected to the internet, they are ready to sign transactions at anytime and are usually the most convenient for everyday use. However, with increased convenience comes increased risk as it is easier for hackers to exploit vulnerabilities remotely through the internet without needing physical access to your computer or mobile phone. Most experts recommend that users only keep small amounts of crypto in hot wallets and that the bulk of assets are kept in a "cold wallet". We will explain cold wallets in more detail further down this post.
Different types of hot wallets include:
- Desktop Wallets: Desktop wallets are software applications installed on your personal computer. They provide users with complete control over their private keys, making them a secure option. However, they are susceptible to malware and viruses if proper security measures are not in place.
- Mobile Wallets: Mobile wallets are designed to run on smartphones or tablets, offering convenience and accessibility. They are user-friendly, making them suitable for everyday transactions. However, the security of mobile wallets depends on the security measures implemented on the device itself.
- Web Wallets (Browser Wallets): Web wallets, also known as browser wallets, are hosted on the cloud by third-party service providers. They can be accessed through a web browser from any device with an internet connection. Web wallets are convenient for regular transactions but pose a higher risk because the private keys are held by a third party. You rely on the security measures and trustworthiness of the service provider.
Cold Wallets
Also known as offline wallets, cold wallets store your cryptocurrency offline, disconnected from the internet. This isolation from online connectivity provides enhanced security and protection against hacking attempts, malware, and other online threats.
Cold wallets offer a higher level of security and are ideal for long-term storage of cryptocurrencies or for users who prioritize the utmost security of their funds. However, it's important to note that cold wallets may involve additional setup and technical knowledge compared to hot wallets, which offer more convenience for regular transactions.
Different types of cold wallets include:
- Paper Wallets: Paper wallets involve generating printouts or handwritten copies of your private and public keys. They are entirely offline, making them immune to hacking attempts. Paper wallets offer excellent security, as they are not susceptible to malware or online threats. However, they require caution and careful handling to ensure their security. Paper wallets are not suitable for frequent transactions due to the complexity of the process. The tradeoff between security and convenience is heavily skewed towards security but with reduced convenience. If not stored properly, they can also be vulnerable to loss or theft. Paper wallets were popular in the early years of crypto but eventually went out of favor once hardware wallets came into the market.
- Hardware Wallets: At the time of this writing, hardware wallets are the gold standard when it comes to crypto security. They are physical devices specifically designed to store cryptocurrency offline. They provide excellent security by isolating the private keys from internet-connected devices and offer a higher level of protection against malware and hacking attempts. They are typically equipped with secure elements, which are specialized chips designed to securely generate and store cryptographic keys. This hardware-level security ensures that the private keys never leave the device, mitigating the risk of exposure to malware or keyloggers. However, they are less convenient for everyday transactions since they require connecting to a computer or mobile device.
- Brain Wallets: A brain wallet enables users to generate private keys and corresponding public addresses using a personally memorable passphrase. The passphrase is used as the basis for creating a deterministic private key through a cryptographic hashing function. The resulting private key can be reproduced using the same passphrase. Brain wallets offer the advantage of memorability and complete control over funds, but they are vulnerable to brute-force attacks if weak passphrases are used. Since they only live in the user's memory, there is no way to recover it if the original owner forgets all or part of the passphrase.
Centralized Exchanges
While technically not crypto wallets, the majority of retail crypto buyers keep their funds on centralized exchanges such as Coinbase and Binance. This is also what is known as custodial services, because the centralized exchange is keeping custody of your crypto on your behalf.
When a user keeps their funds on a centralized exchange, they are trusting that the company will actually buy the crypto on the user's behalf, store it securely, and not invest it or put it to other uses without the customer's permission. As we saw with the recent failure of the FTX exchange, even reputable companies can be vulnerable bad decisions from bad actors, and the customers are the ones who pay the ultimate price.
While it is expected that government regulations will make it harder for centralized exchanges to defraud customers in the future, the best way to guarantee that your funds are safe is to hold them in custody yourself. Not your keys, not your crypto.
The Future of Crypto Wallets
Relatively speaking, crypto is still in its early stages of development. When it comes to crypto wallets, the primary tradeoffs are between security and convenience. Hardware wallets in their current form are unlikely to garner mass adoption from users who are not interested in learning the technical details and software wallets are not safe enough to secure large amounts of funds without risking permanent loss.
The future will likely bring solutions that leverage the convenience of software wallets with the security guarantees of hardware wallets in a user friendly package that most users can understand and adopt.
In the meantime, it is recommended that users do their own research before deciding the solution that best fit their needs and technical knowledge.