Cryptocurrency Wallets are programs that give access to the details of your digital currency transactions and holdings located on the blockchain.
It is important to understand that you are 100% in control and therefore responsible for your wallet and the contents it has access to.
The blockchain is a ledger of transactions that eliminates the need for a trust medium (ie bank) as a go between. The transactions are transparent and display the public address key of both parties.
Anyone can access the transaction records. If you would like to see this happening in real time click here on the current unconfirmed transactions in Ethereum Explorer.
Each type of coin tends to have its own type of address. Therefore it is vital that you use a wallet that is compatible with the coin you are sending to that wallet. If you were sending bitcoin you would need a bitcoin capable wallet. Ethereum to an ethereum capable wallet and so forth.
- I transfer some Australian Dollars (AUD) from my bank to an exchange like Independent Reserve.
- I use the exchange to buy some Ethereum (ETH).
- I transfer my ETH to my software wallet Exodus after selecting the Ethereum address in the wallet to do so.
With cryptocurrency wallets like Exodus you can deal with many types of coin, which is why we like it as a beginners wallet. Where a wallet like My Ether Wallet (MEW) deals only with ETH and ERC-20.
The keys to the vault
A wallet does not hold any currency itself but it does hold the keys. There are two keys, one public and one private. The keys are created mathematically in pairs.
In the case of Ethereum and Bitcoin the algorithm to generate this key pair is called an Elliptical Curve Digital Signature Algorithm.
It is mathematically easy to generate the public key from the private key but very, very difficult to reverse.
The public key is your wallet address, like a bank account number. Anyone can send currency to this wallet address.
With this key you can access the currency stored on the blockchain referenced by this wallet. Anyone with this key has complete control of the currency addressed by this wallet.
It goes without saying that this private key should be kept completely secure. Furthermore, it should always be accessible to the owner of the currency. If it is forgotten the coin tied to it is lost.
A seed phrase is generally provided to you by the wallet provider. This can enable you to recover your private key in the event of losing a wallet password or log in.
The common seed phrase used is a series of 12-24 words from a dictionary written in sequence. The words are chosen carefully so that they are simple and hard to misspell.
Who holds the keys to your wallet?
It is useful to think about who holds and controls your keys. If your currency is being held on an exchange, then that exchange has the control of your keys, therefore control of your currency.
This can be less than useful if an exchange is hacked. This has happened periodically with EXMO being a recent example.
Also, if your currency is held in an exchange’s wallet, if that exchange goes offline then you can do nothing with your assets.
This typically happens when there is a bear market and people are trying to quit their position in the currency. The exchanges servers get overloaded and the whole thing shuts down. If your crypto is in there then you just have to ride it out.
That is why non-exchange personal wallets are useful. You have control, not a third party. If one exchange gets overloaded and shuts down you are free to go and use an exchange that is still online.
Types of Wallet
There are a plethora of wallet terms which can be confusing at first. Cloud wallets are almost always hot wallets whereas some software wallets can be hot and cold wallets (not simultaneously) and so on. Read on for a breakdown.
Running Hot and Cold
It has always been the case in cybersecurity that the biggest security issue is the internet itself.
A hot wallet is a wallet that you use when connected to the internet. Therefore by the very nature of that connection it is a data security risk because both keys, public and private are stored online.
Coins kept on an exchange can be considered as hot wallets.
Hot wallets are convenient. They are fast, you can use them readily and with a minimum of fuss.
On the downside there comes the risk of hacks and data breaches. Many seasoned investors only keep a small amount in hot wallets and store the majority of their holdings in cold wallets
Cloud, Software, Hardware and Paper Wallets
Cloud wallets are wallets stored online and therefore by definition ‘hot’ wallets. These cryptocurrency wallets are generally not under your full control ie. the wallet provider holds the private key on your behalf.
There are many forms of cloud wallets, dedicated wallets like MetaMask and the wallets where your coin is kept on an exchange.
Software wallets are programs or apps like Exodus, installed on your computer or mobile device.
Software cryptocurrency wallets are typically hot wallets but some have a hardware storage capability which makes them cold wallets in this mode.
Hardware cryptocurrency wallets are cold wallets. A hardware wallet can resemble a USB stick or have their own designs such as Trezor. It is in fact a very simple computer. In its simplicity comes very few opportunities for a third party hacker to exploit any vulnerabilities.
Hardware wallets are designed to do one thing and one thing only, hold your private keys safe. These generally plug into your computer’s USB port. Some manufacturers are developing the ability to connect via Bluetooth but the technology is not perfected yet.
Paper wallets are also cryptocurrency cold wallets. It is very simple. Write the private key down on a piece of paper and stash it somewhere safe.
Some have had their keys stamped or engraved into a metal plate and other more creative ideas.
Other methods include printing the code, going to a site and making a scannable QR code or just taking a photo with your phone. A quick observation on doing this, all those practices defeat the purpose of a cold wallet. Each one of these methods expose vulnerabilities to your private key unnecessarily and should be avoided.
Mobile and Desktop Wallets
Mobile cryptocurrency wallets are variously cloud/software wallets, some of which can be accessed offline. They are of course portable, convenient and usually user friendly.
One mobile wallet is the native Ethereum wallet My Ether Wallet (MEW).
Desktop wallets are typically software cryptocurrency wallets, again, some of these can be accessed offline.
The buck stops with you in the cryptoverse. If you are careless with your passwords and seed phrases, no one will be there to compensate you for any losses you may incur.
With good research, understanding of the rules of the game (which is likely the reason you are reading this article) and some self discipline you can be pretty secure in this space.
People who really know cyber security will say their products are “pretty good” as they know nothing is 100% secure. Nothing! So when you see someone advertising a product that boasts 100% security, it should raise an eyebrow.
Check out the number of websites that have been hacked or had data breaches for example at Have I been Pwned.
Single Factor Authentication (SFA)
A single factor authentication requires only one layer of security such as a password, pass phrase or pin.
Two Factor Authentication (2FA)
Two Factor Authentication requires an extra layer by requiring a second method on top of the SFA such as a fingerprint, face scan, sent SMS or security token like Google Authenticator.
It is always a good idea to go at least with 2FA.
See our article on Two Factor Authentication.
Multi Factor Authentication (MFA)
As the name implies Multi Factor Authentication involves more layers of identification.
If you think a six digit password will make the grade, then think again. It is advisable to use passwords that are at least 12 digits long.
This site in the link is out of date now but throw a six digit password into this calculator and see how long it suggests it will take to crack it by brute force.
So how do you keep track of all those long random passwords? That is where a password manager may help.
Password Managers or Keepers
A password manager has the ability to store multiple passwords in an encrypted database secured by one master password or phrase. They generally have the ability to generate strong passwords. There are many available both paid and free.
Password managers are also built into browsers like Brave, Chrome and Firefox which can be useful as they can autofill passwords for you online.
Another password manager could be that little black book hidden in a locked drawer in your desk.
It is useful to consider password managers in terms of “hot” and “cold” like wallets. Ones exposed online would be hot and those remote from the internet as cold.
An encrypted offline free password manager. KeePass
See our article on KeePass in Password Manager.
The key takeaways:
- Ensure the wallet you are using is capable of accepting the currency you are sending to it.
- Take extreme care with your seed phrase wherever you decide to keep it.
- Keep currency in wallets you do not control only for the amount of time you need them.
- Similarly keep currency in hot wallets only for the amount of time you need them.
- Hardware wallets are a must if you intend to do some serious cryptocurrency investing.
- Be diligent about your passwords.
and follow the two rules:
- Never tell anyone your seed phrase.
- See rule 1.
This is general knowledge only, not advice.
DYOR – Do Your Own Research
Photo Credits John Salvino | UnSplash