If you’re new to trading crypto, you might think the answer is obvious: a crypto wallet is where traders store cryptocurrencies. In fact, coins and tokens are not stored in wallets—they’re stored on the cryptocurrency’s blockchain. In this article, we’ll take a closer look at what cryptocurrency wallets are for, their core functionality, and the types of crypto wallets traders use to manage cryptocurrencies.
What Is a Crypto Wallet?
At their most basic, crypto wallets are databases for storing cryptographic keys that allow you to transact with the coins you own. The simplest possible wallet is just a piece of paper printed with cryptographic keys. Paper wallets are often used as a backup, but they’re not very convenient for trading cryptocurrencies, so it’s more usual to use an app or device that handles key storage and provides an interface for sending and receiving cryptocurrencies.
Modern crypto wallets offer a wide range of features that may include:
Generating and storing cryptographic keys.
Supporting a variety of cryptocurrency coins and tokens.
Sending and receiving cryptocurrencies.
Generating and scanning QR codes for easy cryptocurrency transactions.
Tracking and displaying information about cryptocurrency holdings.
Displaying exchange rate charts, crypto prices, and other data useful to traders.
How Are Coins Stored In A Crypto Wallet?
As we said earlier, coins are not stored in crypto wallets. Crypto wallets store cryptographic keys. To explain how these keys let you send and receive coins, let’s take a step back and think about how cryptocurrencies and blockchains work. Cryptocurrency blockchains are ledgers that maintain a record of the transactions that send coins from one blockchain address to another.
Blockchain addresses are strings of alphanumeric characters derived from a public key. Public keys are mathematically paired with private keys. The math is complex, but the upshot is that when someone sends coins to a blockchain address, only the holder of the associated private key can use it to sign future transactions with those coins.
You can think of the address as a bank account and the private key as a password that lets you use the funds it contains. That’s why it’s so important to keep your private keys secret. If someone gets hold of a private key, they can take control of all cryptocurrency sent to addresses derived from the public key.
In the very early days of cryptocurrencies, it was not unusual to use a single key pair for large volumes of transactions. But that quickly became inconvenient and potentially risky. The modern best practice is to use fresh private keys—and therefore fresh public keys and addresses—for transactions. A wallet helps traders by handling the generation and management of key pairs. Key management happens under the hood, and the wallet presents a user-friendly interface so traders don’t have to worry about the underlying complexities of sending and receiving cryptocurrencies.
How Do I Send Crypto With A Crypto Wallet
The exact steps for sending cryptocurrency differ depending on the wallet. However, the process is fundamentally similar:
The recipient’s wallet generates an address. Addresses are just a string of letters and numbers derived from a public key.
The recipient copies the address and sends it to you. Alternatively, their wallet produces a QR code which you scan with a mobile device.
You click “Send Bitcoin” or similar in your crypto wallet.
You enter the address and the amount of crypto you want to send. Most wallets will tell you the equivalent value in other currencies.
You may be able to choose a transaction fee. Transaction fees are a way of paying the network for carrying out the transaction. Higher fees result in faster transactions.
You confirm the transaction, and the wallet communicates with the blockchain, transferring the coins to the chosen address. Transactions are irreversible, so be sure that you enter the correct address.
What is a Crypto Wallet Seed?
A seed is a random number or string of words used to derive your wallet’s private keys. When you first set up a crypto wallet, it will usually present you with a list of words you are expected to record somewhere—write it down on paper or save it in a secure text file. It will look something like this, although it may have a different number of words:
dial almost garbage gather resist high engine hawk tunnel sand way idle
This is called a seed phrase or seed recovery phrase. Seed phrases can regenerate your wallet’s keys if you lose or delete the wallet. You can take an empty wallet, enter the seed phrase, and it will regenerate the private keys and give you access to your cryptocurrency. Another way of saying the same thing: a seed phrase allows anyone who has it to spend your crypto. Seed phrases are a useful backup and recovery tool, but care should be taken to ensure they don’t fall into the wrong hands.
If you’re only interested in using a crypto wallet, that’s all you need to know about seed phrases. But they are the tip of an interesting iceberg that explains how modern crypto wallets work. At the beginning of the crypto era, wallets created randomly generated, unrelated private keys. That worked, but as the wallet created fresh keys for transactions, each one needed to be backed up in a secure location. This type of wallet—called a nondeterministic wallet—quickly fell out of favor. No one liked having to carefully back up hundreds of private keys. People often didn’t back up and so they lost access to their cryptocurrencies when they misplaced or accidentally deleted a wallet.
The alternative—a deterministic wallet—uses a different method to create private keys. The wallet generates a random number, breaks it into chunks, and maps the chunks to a word list, creating a mnemonic phrase. The mnemonic is then used to generate a seed, and the seed is used to generate the private keys. We’re skipping over a lot of math here, but the important point is that this process is deterministic, which means it can be repeated.
If you start with the same seed phrase, you will always end up with the same set of private keys. Just as important, it’s impossible to move in the other direction. You can’t generate the seed even if you know one or more private keys derived from it. So, you can back up your wallet and all of its private keys with a simple list of words.
What Happens When You Move Crypto To A Wallet?
From the perspective of a crypto wallet user, a transaction looks as if the crypto moves from one wallet to another. You enter an address and hit send. Your crypto balance goes down. The recipient’s balance eventually goes up. However, if you’ve read the previous sections, you’ll realize crypto doesn’t move between wallets.
What happens is that you initiate a transaction on the wallet and it implements that transaction on the blockchain, signing it with a private key in your wallet—the key linked to the address containing the coins. The transaction moves the coins to the recipient’s address, which is linked to a private key in their wallet. They now have control of the coins.
Both wallets can work out which crypto on the blockchain is linked to addresses under their user’s control, so it increases or decreases the displayed balance accordingly.
What Are The Types of Crypto Wallet?
All crypto wallets store keys, but there are many different types, each of which has benefits and drawbacks.
Hot Wallets vs. Cold Wallets
A hot wallet is a crypto wallet that is connected to the internet. An internet connection allows the wallet to send and receive cryptocurrency and access price and trading information. A cold wallet is not connected to the internet. Cold wallets are useful for long-term storage and for protecting crypto from the risks associated with network connectivity. To use the crypto in a cold wallet, the user will usually connect it to the network or transfer the crypto to a hot wallet.
Software Wallets
Except for paper wallets, all crypto wallets include software. However, many wallets are designed to run as software on non-dedicated devices. For example, you might run a software wallet on your laptop or phone. Software wallets are convenient, inexpensive or free, and easy to install.
One potential downside of software wallets is that they depend on the security of the machine on which they are installed. If your laptop or phone is compromised, your wallet is at risk. Most software wallets are installed on devices with an always-on internet connection, which may also increase risk.
Hardware Wallets
Hardware wallets are USB or Bluetooth devices dedicated to running a crypto wallet. There are many designs, but they often require the user to press a button or physically authenticate before the wallet will sign a transaction. Hardware wallets do not have a network connection and are particularly useful for long-term storage of crypto you don’t intend to trade with immediately.
Exchange Wallets
An exchange wallet is a crypto wallet hosted by a cryptocurrency exchange. When you buy cryptocurrencies via an exchange, the private keys used in the transaction are stored in an exchange wallet. You can also transfer crypto to an exchange wallet when you want to sell it.
Exchange wallets like those provided by Bittrex are convenient for cryptocurrency traders: you can access your crypto by signing into your exchange account, and you don’t have to worry about installing software or managing a hardware device.
Cryptocurrency exchanges typically store most of their users’ crypto in cold wallets, holding only a portion in hot wallets for daily withdrawals and trading.
Mobile Crypto Wallet Apps
Mobile crypto wallet apps are a convenient way to manage your crypto from a device you always have with you. The Bittrex cryptocurrency app combines a secure and convenient software wallet with industry-leading crypto trading features. Users can trade with any of the crypto and fiat currency trading pairs supported by the Bittrex platform.
Custodial vs. Non-Custodial Wallets
The main difference between a custodial wallet and a non-custodial wallet is who has control of the private keys. In a non-custodial wallet, the private keys are in your possession and you control them. Hardware wallets and many software wallets fall into this category.
In contrast, with custodial wallets, the keys are ultimately controlled by a third party. Web-based wallets, including exchange wallets, are usually custodial wallets. Custodial wallets are often more convenient and easy to use. You don’t have to worry about storing and managing the keys, and key security is the custodian’s responsibility.
However, before using a custodial wallet, you should satisfy yourself that the operator is reputable, trustworthy, and has the expertise and experience to securely look after your private keys.
Does Crypto Gain Value in a Wallet?
This is a commonly asked question, but it’s based on a misconception. There is no relationship between the value of a cryptocurrency and the wallet you use to store private keys. A cryptocurrency’s value is determined by supply and demand in a marketplace, just like other assets. The market doesn’t know or care where your crypto is stored, so it will continue to gain or lose value regardless of the wallet you use.
How Do I Set Up a Crypto Wallet?
You can store and manage crypto keys with any of the options we’ve discussed here. But if you want to start trading cryptocurrency today, create a Bittrex account. Our secure crypto wallets are convenient and easy to use and let you access a huge range of crypto trading markets.
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