What is a crypto wallet (cryptocurrency wallet)?
A crypto wallet (cryptocurrency wallet) is software or hardware that enables users to store and use cryptocurrency.
With cryptocurrency, there's no tangible currency, no paper money to place within a physical wallet or purse. Cryptocurrency exists on the blockchain, and there's no physical manifestation that a user touches. But there's still a need for individuals and organizations to understand ownership of cryptocurrency assets and to be able to know how much is held, much like a bank account provides a bank balance.
A crypto wallet provides a way for users to validate an account balance to provide visibility into how much cryptocurrency the user owns. A crypto wallet enables users to send and receive cryptocurrency transactions -- an approach that's similar in concept to how a traditional bank account enables users to conduct transactions. For many users, a crypto wallet is a primary mechanism for managing cryptocurrency balances.
Why are crypto wallets important?
As with any type of currency, cryptocurrency can be accumulated and used for any number of different purposes and transactions. Crypto wallets serve a foundational role in enabling crypto assets and cryptocurrency to be functionally useful for individuals and organizations, much like a bank account is foundational for fiat currency.
Crypto wallets are needed for several critical things that help to enable the practical utility of cryptocurrency, including the following:
- Management of cryptocurrency. Crypto wallets provide users with the ability to monitor a balance for cryptocurrency assets.
- Transactions. Sending and receiving cryptocurrency payments is an important feature of crypto wallets.
- Connection to decentralized apps (dApps). A crypto wallet is required to connect and interact with Web 3.0 dApps.
- Username identities. All cryptocurrencies are stored on a blockchain. A crypto wallet enables transactions with a username that can be associated with a public key address on a blockchain.
- Key management. Functionally, cryptocurrency exists on the blockchain as a public key address. A crypto wallet helps users manage the private encryption keys used to access a given address and enable a transaction.
How do crypto wallets work?
With a physical wallet, individuals can hold fiat currency or bank and credit cards, which enable access to funds. A crypto wallet doesn't hold cryptocurrency, but rather holds the privileged credentials needed in the form of private keys to access the blockchain for a given cryptocurrency.
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With a traditional bank, users receive bank accounts with account numbers. With a cryptocurrency blockchain, the public key serves the same basic concept as the bank account number. Simply having a bank account number or a public key isn't enough to conduct a full set of transactions with an account.
Blockchain works with a public key infrastructure model for cryptography. A public key and private key are only supposed to be known by users that hold a given asset or cryptocurrency. Both keys are needed to access and transfer cryptocurrency. Just as a private personal identification number is used to access a bank account with a bank card, a private key is needed to access the asset on a blockchain.
Crypto wallets hold the user's private key and information, while public keys are located on the blockchain. With the combination of public and private keys, a crypto wallet can enable a secured operation to validate a balance and send or receive cryptocurrency transactions.
Types of crypto wallets
Crypto wallet users get to choose not just the service or vendor that supplies a crypto wallet, but the deployment approach as well.
There are functionally two core types of crypto wallets: hot wallets and cold wallets. Hot wallets are generally always on and connected to the internet, while cold wallets, sometimes also referred to as cold storage, are typically disconnected and only connect online as needed.
Within the category of cold wallets are two primary types:
- Hardware wallets. With a hardware-based crypto wallet, the private key for the user's cryptocurrency balance is stored on a physical medium, which is typically a USB drive. Because it's a secured device that isn't always connected, the hardware wallet ensures a form of isolation when the user pulls out the key.
- Paper wallets. A paper wallet is truly a low-tech solution, whereby the user writes down the public and private key information on a piece of paper.
Within the hot wallet category are three types:
- Online (web) wallets. Perhaps the most common and widely used form of crypto wallet is found in online services. With an online wallet, an online service such as a crypto exchange holds the user's public and private keys. Users access the wallet by logging in to the online service.
- Desktop wallets. With a desktop wallet, the cryptographic keys are stored in an application on a user's desktop system.
- Mobile wallets. A mobile app can be used to store a user's public and private keys for accessing and using cryptocurrency.
Custodial vs. noncustodial wallets
Crypto wallet types are either custodial or noncustodial. The fundamental difference between custodial and noncustodial wallets is control:
- Custodial wallets are crypto wallets in which the custody -- that is, the control and operations of the wallet -- is managed by a third party. That third party is typically the cryptocurrency exchange itself, where users buy and sell cryptocurrency tokens and other crypto assets. The custodial wallet provides users an easy on-ramp for holding crypto assets and is directly offered by a custodian or exchange.
- Noncustodial wallets are crypto wallets where the custody is held by the individual who has the private keys for the crypto assets on the blockchain and is responsible for securing them. Noncustodial wallets include paper wallets, as well software wallets, that are managed by users.
Crypto wallet pros and cons
There are numerous benefits to a crypto wallet and potential disadvantages, depending on the type of wallet being used.
The primary benefit for all types of crypto wallets is that they enable individuals and institutions to hold crypto assets and participate in the Web 3.0 economy. Simply put, without crypto wallets, it's hard to directly own and control crypto assets.
While crypto wallets are essential and critically important for Web 3.0 and cryptocurrency, there is some risk to custodial and noncustodial types of wallets. The greatest risk for all types of wallet is the potential for theft, fraud or cyber attack.
Noncustodial wallet pros
- enables users to directly control and hold crypto assets;
- provides direct and rapid access; and
- transactions are resistant to censorship or control by outside parties.
- complexities that users need to learn and understand;
- potential for user errors; and
- responsibility solely with the user.
- integrated into a service, enabling ease of access;
- ability to convert to fiat currency more easily; and
- managed by a provider.
- lack of complete user control;
- risk of censorship and blocked transactions;
- risk of bankruptcy or fraud on the provider side that could lead to loss; and
- supply chain risk if the custodian is the victim of a cyber attack.
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Examples of crypto wallets
There's no shortage of crypto wallets for users across every type of approach. For paper wallet users, the options include any type of paper, notebook, whiteboard or surface on which the user can write a series of numbers.
Examples of hardware wallets include the following:
- Ledger offers a series of different hardware wallet options, including the Nano S and Nano X devices.
- Trezor offers the entry-level Trezor Model One and the premium Trezor Model T hardware crypto wallets.
- SecuX has a growing portfolio of hardware wallets, including the V20, W20 and W10 devices.
- SafePal's primary product is the company's S1 hardware wallet, which is a low-cost option.
Examples of hot wallets include the following:
- Coinbase provides all three types of crypto wallets, including online, desktop and mobile options.
- Exodus provides desktop and mobile crypto wallet options that can also be integrated with the Trezor hardware wallet.
- Crypto.com provides a series of services to users as part of its exchange, including options for a crypto wallet with a web-based approach and a mobile app.
- MetaMask offers a mobile app, as well as a desktop crypto wallet that works as an extension on the Firefox web browser.
- Trust Wallet provides a popular mobile crypto wallet option and support for non-fungible tokens.
How to choose the best crypto wallet
The first choice of cryptocurrency wallet for new users is often an online wallet with the crypto exchange to buy and sell cryptocurrency. While that choice might be the easiest, it's not necessarily the best choice for all users. Consider the following when choosing the best crypto wallet:
- Cold versus hot. A hardware wallet offers a disconnected model for cryptocurrency access. A hardware wallet is a reasonable choice for those who are particularly risk-averse and concerned about the potential that an online service, desktop or mobile app could be hacked or about being the victim of ransomware or other attack. The challenge with a hardware wallet is that it's not always on or as easily accessible with online services, making it a bit more difficult to use.
- Security. For hot crypto wallets, security is a top priority. A user should choose a crypto wallet that has strong authentication capabilities, including multifactor authentication.
- Blockchain support. Users looking to use a specific cryptocurrency should make sure that the chosen crypto wallet technology supports the desired services.
- Integration and access. Beyond just specific cryptocurrency support, users should also check to see if the desired crypto exchange provides easy integration and support for the chosen crypto wallet technology.
Cryptocurrency inheritance and crypto wallets
When a person dies, any cryptocurrency they owned is treated as an asset. Cryptocurrency goes through probate like other assets before going to beneficiaries. The cryptocurrency needs to be listed in the estate plan and can be passed on to named beneficiaries when the owner dies.
But someone needs the crypto wallet's private key to open it and gain access. If the deceased doesn't leave the details of their private key, the cryptocurrency will be nearly impossible to access. If crypto wallets are not listed in a will or trust, they may never be found. There are a few options to ensure cryptocurrency is inherited, including the following:
- Provide the crypto wallet's passkey. These instructions can be included in the will, written down or verbally given to beneficiaries. There are some security risks, including theft, so consider adding a snapshot of all digital accounts to a secure program, such as a password manager.
- Move cryptocurrency to an exchange. Exchanges, such as Coinbase, provide a vault similar to a safe-deposit box to store a private key.
- Open a joint account. Exchanges also offer joint accounts to ensure a smooth transfer of inherited cryptocurrency to heirs.
- Establish a beneficiary with the exchange. The exchange handles accounts after the owner has died to ensure beneficiaries inherit the assets as determined by the previous owner.
- Open a trust account. Trust accounts avoid probate and designate how beneficiaries should inherit properties, including cryptocurrency. Include instructions in the trust on how to access the crypto wallet.
When going through a divorce process, parties should list cryptocurrency as assets and not income on financial disclosures. The value of cryptocurrency varies based on current exchange rates and can fluctuate significantly, which should be considered when determining the value. Dividing property during divorce varies by state, and typically, dividing cryptocurrency is similar to dividing any other assets among parties.