A crypto wallet is what you need if you want to store and send cryptocurrencies. There are different types of crypto wallets. Being aware of the differences between them is important because they have far reaching implications in terms of security and usability, which are often ignored by people who are new to the crypto space. In this post we want to educate about these differences.
Let's start with non-custodial wallets.
The most defining characteristic of a non-custodial wallet is that users have full control over their funds. No one, not even the company providing the wallet can access users funds!
In short, a non-custodial wallet is a tool that lets users directly interact with a blockchain network. Contrary to traditional digital wallets, they don’t truly store the funds of the user. In reality, users funds are stored on the blockchain and the wallet merely provides an interface and software for the user to communicate with the blockchain.
Upon installation a wallet generates one or more pairs of public and private keys, allowing users to send and receive funds. The funds are then tied to that particular address and when the user wants to send crypto to someone, the wallet uses the private key to sign the transaction and broadcast it to the network, where it’s validated through a process called mining. The signature also provides the mathematical proof that the transaction comes from the owner of the wallet.
Wallets are just an interface that display the account balance and let users initiate transactions but critically the wallet provider can’t access the users funds. This means that if you lose the private key (or seed phrase) associated with your account, the wallet provider won’t be able to help and you’ll lose all your funds.
UPDATE: There are new technologies emerging allowing users to recover their wallet in case of loss while remaining non-custodial. If you're interest to read more on these new technologies read our article on smart-contract wallets.
Non-custodial wallets share the characteristic that only the user can access the funds but they can still come in different forms and shapes.
A Desktop wallet is a piece of software you download and execute locally on your computer. When you install the app, the software will generate a private key and store it locally on your computer, in a dedicated file. It's important to understand that the key will not be stored on the wallet provider's server, that's why they don't have access to your funds.
Typically, the wallet will allow you to choose a password to encrypt the private key. This makes for an additional security layer as anyone trying to move funds will need to know the password. We recommend exporting your private key in case you lose your computer so you can regain access to your funds on other devices.
Electrum a Desktop Wallet for Bitcoin
They work similarly than their desktop counterparts but are designed specifically for smartphones. Among other things, this means that they are convenient for quick everyday payments, making use of QR-codes for instance to share payment information more easily with others. Moreover, they can use security measures from the smartphone’s operating system like FaceID or TouchID which makes your wallet more secure.
Hardware wallets are a subset of non-custodial wallets. Instead of storing your private key on your mobile device, the private key is generated and stored in a small physical device that is specifically built to protect it from hackers. Having the key on a physical device is deemed more secure by some experts, because the device is not connected to the internet and hence less prone to an attack. Hardware devices are used in combination with a wallet interface provided by the manufacturer. To make a transaction, the hardware wallet is typically connected to a computer through the USB port and can then sign transactions through a secure local connection without exposing the keys to the internet. The most well known hardware wallets are Ledger, Trezor, KeepKey, BitBox and Coldcard.
A Ledger Nano X
As opposed to non-custodial wallets, custodial wallets hold crypto funds on behalf of their clients. This means that your funds are not tied to a blockchain address under your control. Instead, the wallet provider holds all funds and is responsible for securing them. Because they store the funds for you, they are often compared to banks and like banks, are also regulated financial companies. Among other things, that means they have to verify the identity of their users, restrict their services in certain countries or even censor certain payments to comply with authorities. You will also notice a custodial wallet from the fact that you will not receive a private key when installing the app.
Custodial wallets are convenient for beginners but they don’t give the financial sovereignty that cryptocurrency can uniquely provide.
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