Getting to know the digital currency wallet
As we keep our fiat currencies and valuable assets in different wallets, bank accounts or funds, we should also keep cryptocurrencies in their appropriate wallets. A digital currency wallet is not such a complicated concept, but not being familiar with it can easily lead to the loss of your capital. So in this article we want to see what a digital currency wallet is and how it works. We also introduce the types of wallets and check the difference between hot and cold wallets
What is a digital currency wallet?
A digital currency wallet is simply a software or hardware that creates and stores private and public keys. This program connects with various blockchains so that users can send and receive all kinds of cryptocurrencies and control the amount of their digital assets. Don’t worry, we’ll explain about public and private keys and how wallets work in the next section.
Our first step to working with digital currencies is to have a wallet. There are different types of wallets that we should be familiar with and their differences. Some wallets are free and some require a fee. The lack of awareness and carelessness of users in connection with wallets is one of the main reasons for the loss or theft of cryptocurrencies.
The security of our cryptocurrencies is completely dependent on our knowledge and use of wallets. We need to be very aware of what wallet information we can share with others to receive cryptocurrency or interact with a decentralized application (dApp) and what information should never be disclosed.
How does a cryptocurrency wallet work?
The important thing to note is that your cryptocurrencies are not stored in wallets, but each digital currency is recorded in its own blockchain. Wallets are simply an interface to blockchain networks that allow users to view and manage their cryptocurrencies.
The movement of digital currencies is recorded as transactions on blockchains. When someone sends you Bitcoin or any other cryptocurrency, they are essentially signing the transfer of ownership of those tokens to your wallet address. This signature, which we call a digital signature, is created from the combination of the public and private keys of the sender. In the following, we introduce the most important elements of a wallet that help you better understand how it works.
Public and private keys
The process of creating a wallet starts with the creation of a pair of keys, which we call public key and private key. These keys are used to encrypt information and are in the form of a string of numbers and letters. Basically, first a private key is generated, an address is created from the private key using the mathematical functions of the public key, and finally from the public key. Note that this relationship is completely one-way and it is not possible to get from the address or public key to the private key.
Lesson is what we give others to send us crypto. People in blockchain networks are recognized by address and public key instead of identity information such as name and national code. Possessing the private key of an address also means owning the assets inside it. This means that anyone who has the Private Key is known as the owner of the wallet and can transfer its assets.
The address and public key can be considered similar to bank card numbers that we give to others to deposit money to us. The private key is the same as the password of the card, which no one but ourselves should be aware of. Your address is publicly registered on the blockchain and everyone can see it, but you must never allow anyone else to access your private key.
Also, if you lose your wallet for any reason (such as deleting the software) and want to use its backup copy, you must have the private key. Therefore, it is very important to keep the private keys in a safe place and have access to it.
Recovery phrase
We said that the form of public and private keys is a string of numbers and letters, so it is difficult to remember and write them down. In order to make it easy to store private keys, we are given a recovery phrase or Seed when creating a wallet. The recovery phrase is a number of English words that can be written down and used instead of the private key to recover the wallet. If someone other than us gets access to these phrases, they can empty our wallet.
Custodial or Non-Custodial
One of the important things you should pay attention to when it comes to wallets is custody versus non-custodial. A custodial wallet is said to be a third party (usually a platform or wallet provider) that has control over the private keys and maintains them. So basically, the control of all the assets inside the wallet is the responsibility of the third party.
On the other hand, in the Non-Custodial wallet, the private keys are in the hands of the user, and the wallet creation team does not have any access to the users’ Private Key. Therefore, it is clear that the responsibility of keeping the private key safe is the responsibility of the user. If you lose the private key or recovery phrase of a non-custodial wallet, there is no way to recover the assets inside it.
We recommend that you always keep your cryptocurrencies in a non-custodial wallet, and of course keep your private keys safe. When you use a custodial wallet, you give them control of your assets. So if they want, they can deny you access to your cryptocurrencies and you will lose your capital.
Types of digital currency wallets
There are different types of wallets that provide access to your digital currency in different ways. There is a general classification that divides wallets into two categories: hot wallet and cold wallet. The main difference between these two categories is that warm wallets usually have a permanent connection to the Internet, but cold wallets only connect to the Internet when we want to use it.
Hot wallets are much easier to use and are more suitable for daily use and connecting to DeFi platforms, but these wallets are also less secure and more prone to hacking. On the opposite side, we have cold wallets, which are largely immune to the risk of hacking and are suitable for long-term storage of cryptocurrencies, or holding. Cold wallets are more physical, and perhaps this is the closest thing to experiencing the feeling of owning cryptocurrencies.
Warm wallets can be divided into three categories: mobile, desktop and web. For cold wallets, there are two general categories of hardware wallets and paper wallets.
Desktop wallet
A desktop wallet is a software that is installed on a computer or laptop. So, to access your digital currency, you must have access to your computer. In these wallets, the private key is stored on your computer or laptop. The security of these wallets is good, just be careful that your computer is not hacked or infected and only connect your wallet to trusted apps.
Mobile wallet
These types of wallets run through an app on your phone and you can use them anywhere. In these wallets, private keys are stored encrypted on your mobile.
Web or online wallet
It is possible to use these types of wallets through all kinds of devices and from any place. Some web wallets are custodial, meaning you log into a site and use its wallet services. Some other online wallets are non-custodial and are installed as extensions on different browsers such as Brave, Safari and Google Chrome.
According to the nature of the system used, it can be said that in warm wallets, desktop wallets are more secure and web wallets are less secure.
Paper wallet or Paper Wallet
In paper wallets, the private and public key are printed on a piece of paper. In terms of network security, these wallets are at a very high level. But the nature of paper is vulnerable and someone can easily see your private key. We do not recommend using paper wallets except for special cases such as gift giving.
Hardware wallet
In a hardware wallet, as the name suggests, the private key is stored on a piece of hardware (usually similar to a USB flash drive). This device actually keeps your private keys in a safe and offline environment. However, you need to install software on your device (mobile phone or computer) to be able to use this type of wallet. All previous wallets are free, but you have to pay to get a hardware wallet. This cost is between 60 and 250 dollars according to the wallet model.
Introducing two concepts of multichain wallet and HD Wallet
Each blockchain network and the tokens on it follow a certain standard. Usually, to store the tokens of each network, dedicated wallets are developed that are single-chain and only the cryptocurrencies of the same network can be stored in it. But what will happen to someone who wants to keep several cryptocurrencies from different networks such as Bitcoin, Ethereum, Polkadata and Cardano?
Naturally, installing several different wallets does not leave a good user experience, and one cannot expect widespread adoption of cryptocurrencies. For this reason, wallets were created which are called multi-chain or multi-chain. Different cryptocurrencies from different networks can be stored in these wallets. By visiting the website of each of these wallets, we can find out what networks they support.
Another important issue for us is privacy. If we always use the same address for our various interactions, our identity may be identified after some time. HD wallets have special features that solve this problem. These wallets have a special mechanism that gives you a new address every time to receive cryptocurrency.
What wallets do cryptocurrency exchanges offer?
Another important pillar of the world of digital currencies are the exchanges that we use to trade and exchange cryptocurrencies. In a decentralized exchange, users use their personal wallet, but in a centralized exchange, we have to create a user account, and then the exchange provides us with the wallet of various cryptocurrencies.
The wallet that centralized exchanges give to users is a custodial warm wallet. This means that the exchange has complete control over the assets of all users. So, whenever he wants, he can block the user’s access to his cryptocurrencies for various reasons, including sanctions. In addition, if the exchange is closed suddenly (for any reason) or its site becomes unavailable, users will still not have access to their passwords.
I strongly recommend that you never keep your assets on centralized exchanges (even the most reputable ones).
Transfer the amount you want to exchange to the exchange and then return your assets to the wallet. If you are a trader, keep only the amount needed for your transactions in the exchange and use hot or cold wallets to store your principal.
How to choose the right wallet?
To choose the right wallet, you should pay attention to various factors. First you need to know what cryptocurrencies you want to hold, what networks these cryptocurrencies are on and which wallets support these networks. The next topic is your goal. If you intend to hold for the long term, a cold wallet is better; But if you constantly want to use different Defi programs, warm wallets, especially those that are installed on the browser, will be more useful to you.
Next is the value of your coins. The cost for hardware wallets to hold $100-$200 worth of cryptocurrency is not justified; But if the value of your property is high, it is better to use these wallets. Note that there are valid non-custodial warm wallets that are sufficiently secure if the user knows the necessary tips and uses them correctly. The best warm wallets include Metamsk, TrustWallet, Coinomi, MyEtherWallet, AtomicWallet, and Exodus, and the best hardware wallets include Ledger and Trezor.
