By Collins Brown, CEO & Co-Founder of MARKET Protocol
A lot of people think of their cryptocurrency wallet as merely a digitized version of a real wallet that is used for storing funds. However, it doesn’t actually store cryptocurrencies. Rather, it saves a pair of public and private keys that grant access to one’s digital belongings. In a nutshell, a public key is a string of alphanumeric characters that serves as an address that others can use to send you cryptocurrencies. Likewise, your private key is what allows you to send money to others. You basically use these two keys to sign off ownership of your coins. There isn’t a physical exchange, mind you. The transfer of funds is simply recorded on the blockchain ledger with the difference of the balance in the sender’s and recipient’s wallet.
Remember: You cannot compromise on the safety of your keys; if you do, it’ll lead to a tearful goodbye to your digital assets. It is imperative to keep them safe. Always have backups.
Unlike real-world wallets that store your change and old receipts, cryptocurrency wallets do much more than that. These wallets enable users to interact with the blockchain, to send and receive funds, keep track of the remaining total, and some even have swapping features to convert cryptocurrencies for another. Hence, they act as an interface to the blockchain ledger.
Like cryptocurrencies, wallets are pseudonymous in nature as well. (However, since wallet addresses are stored on the public blockchain, there is a theoretical possibility to reverse engineer the identities of wallet holders.)
Ever since Bitcoin came into the limelight, a number of cryptocurrencies have sprouted up. Instead of using different wallets for different coins, many wallets support a multi-coin/ multi-currency option. They can therefore store a variety of altcoins, mitigating the need to hold separate wallets for each one. (No single wallet stores all cryptocurrencies).
As is the case with cryptocurrencies, there has also been a surge in the number of wallet services being offered today. Each comes with its own level of security and convenience of access. The best wallet for you depends on your requirements and your practices.
Often called a full node/full client wallet, cryptocurrencies also offer their own official ‘’core wallets.’’ These wallets are quite secure, stable and also able to make backups (which is, we reiterate, extremely important). Examples of core wallets include Bitcoin Core Wallet, Litecoin Core, and Ethereum Wallet, to name a few. However, since they download the entire blockchain, with data containing about every historical transaction, core wallets are heavy and slow. Other types of wallets fall under a broad categorization of hot and cold storage.
At its simplest, hot storage refers to wallets that are connected to the Internet. This type of storage is largely typified by software wallets, which in turn can be broken into four distinct categories. Hot storage has the advantage of providing quick and easy access to one’s cryptos. Some software wallets also support access through multiple devices, so cryptocurrencies can be easily be carried around.
As convenient and user-friendly as they are, hot wallets are also the riskiest to use; they have a high susceptibility to hacking attacks and theft. Often private keys are stored online and are controlled by a third-party, increasing vulnerability. In addition to this, if your device gets damaged or misplaced, the wallet is lost as well. It is therefore advisable to use hot wallets, just like you use your real-world wallet: Store only a small amount of money for day-to-day spending.
As mentioned before, software wallets include the following:
- Web/ Exchange-based/ Cloud Wallets
This is a web-based wallet and is often hosted by exchanges themselves. Since you have instant access to your wallet, web wallets are a very fast way to complete transactions. Creating a wallet is super easy and can be accessed from any device or server with an internet connection. Some online wallets can also manage multiple currencies and even swap one currency to another.
Some online wallets are also called custodial wallets because private keys are saved on third-party servers — a feature that heightens the security risk. Since exchange-based wallets have had instances of shutting down or being hacked, it is imperative not to store all your assets on these wallets. Online wallets are ideal for small amounts of cryptocurrencies only. Make sure to use reputable exchanges, and to enable two-factor authentication to add an extra layer of protection. You can also spread your cryptocurrencies on a variety of exchanges to diversify your assets. Coinbase is one such popular example of an exchange-based custodial wallet, while blockchain.info is an online wallet for Bitcoin.
- Desktop Wallets
Desktop wallets are software programs installed on a computer/laptop and accessed directly from that device. The keys are stored on the hard drive and offer much better security. Two examples of desktop wallets are Exodus (which has a great interface and supports multiple currencies)and Jaxx (good privacy and security and feature-rich).
A desktop wallet is still prone to malware, keyloggers, and hacks. Loss or damage to the device also causes your wallet to be inaccessible. To be on the safe side, you could opt to use a dedicated device (for example, an old laptop), or partition your desktop for digital assets. Another important point is to stay safe online! Avoid using public Wi-Fi connections, clicking unknown/phishing links, and downloading suspicious files. Last but not the least, install a really good version of an anti-virus software and firewall.
- Mobile Wallets
These wallets run as an app on both Android and iOS devices. It brings portability, ease, and practicality to serve as a great option for those actively trading or using cryptocurrencies. Mobile wallets also have a number of features such as storing keys to allow for payments on the fly, or instantly transferring funds through near-field communication. Mobile wallets are lightweight because they are only a subset of the blockchain ledger and, therefore, they work with Simplified Payment Verification (SPV) technology.
Again, mobile wallets can be compromised if damaged, misplaced, hacked, or infected with malware or keyloggers. Remember to tighten your security like Fort Knox. Breadwallet, Mycelium, Coinomi, Electrum and Copay are a few examples of mobile wallets.
- Multi-Signature Wallets
Multi-signature (or multisig) wallet, as the name suggests, requires more than one signature to authorize and complete a transaction — just like a shared bank account. This division of keys is ideal for use by businesses and families, creates more security, and acts as a backup in case you lose your key.
The term ‘cold storage’ denotes storing cryptocurrencies on wallets not connected to the internet, and these are comprised of hardware and paper wallets. Cold storage is similar to a safety deposit box or vault, or a savings account. They are best utilized for long-term storage of large sums of cryptocurrencies.
As improved security and reliability is, cold storage has a few shortcomings as well (theft,
environmental damage and human error), so it is advisable to be diligent about such
- Hardware Wallets
Hardware wallets are dedicated wallet devices, often in the form of a USB stick. Just plug it in to an internet-enabled device to transfer assets. Even though transactions are made online, the keys are stored offline. Thus, hardware wallets are one of the most secure methods of storing cryptocurrencies, in addition to being portable. Some hardware wallets come equipped with an OLED screen for displaying and verifying important details, while other features can also include the ability to be restored using seed phrases in case of damage, loss or malfunction of the device. Ledger Nano Sand Trezor are great options (among many others!) for a hardware wallet.
- Paper Wallets
A paper wallet is one of the easiest and safest types of wallets, and is basically a QR-coded printout of the access keys. These can be generated via programs that randomly generate the private and public keys. But, as it’s simply a piece of fragile paper, make sure to keep it safe from environmental destruction, thievery and human error.
Your wallet is only as secure as your practices. As a rule of thumb, make multiple encrypted backups of access keys and seed phrases. Use reputable wallet services and make sure to employ updated software with the latest security enhancements. Implementation of extra layers of security protocols, two-factor authentication, and long and lengthy passwords help to dissuade potential attacks from hackers. Remember the golden rule: store just a small amount on hot wallets, keep the rest tucked away safely in cold storage.
- Future ways of handling custody of crypto
We have previously discussed all the ways of storing crypto and issues associated with keeping your funds on exchanges, but there are many potential problems that might arise as a result of the fact that keeping custody over your funds in a sovereign way for many non-tech savvy participants might be an extremely complicated process.
But why do we take ownership of the tokens in the first place?
Cryptocurrency market participants are currently mostly owning coins and tokens in order to get exposure to their price movement. Many of the digital assets sold as utility tokens still require the development of the associated platforms and the ones that can be used for a certain utility at this point in time, lack a proper hedging mechanism.
Due to the aforementioned factors, it is very important to enable the price exposure to digital assets without having to take ownership of them. That’s why decentralized derivatives were created. These types of contracts do not need to directly exchange asset A for asset B to be exposed to it, so there is no risk from issues associated with transactions. But you still need a safe and trustless mechanism for custody of asset A and settlement with the other side of the trade.
- The solution: smart contracts.
All funds that are traded using these type of contracts are deposited into the smart contract collateral pool which is connected to another smart contract that holds any remaining funds that are not traded.
In order for crypto assets to be used for the specific purpose they are created for, besides having a platform built that would require them as a payment or participation mechanism, we need a “tool” that would help us keep their valuation more stable. For example, if you’re using Siacoin to pay for cloud storage, you want to be sure that the value you are getting for your money is better than traditional services, which is highly dependent on the actual price of the token. Besides the hedging, derivatives are contracts that represent a good price discovery mechanism, that can help decouple token utility from market volatility.
For the cryptocurrency markets to evolve and reach a higher level of mass adoption, we need to build safe and trustless frameworks for custody and trading of assets, and also empower participants that want to consume the utility of tokens and associated platforms with a way to achieve higher price stability.
Bio: Collins Brown is the CEO & co-founder of decentralized trading derivatives platform, MARKET Protocol. Previously he was a traditional financial trader and cryptocurrency hedge fund manager.