Cryptocurrency wallets are what we use to access our cryptocurrency. There are two types of wallets: “hot” wallets and “cold” wallets. A hot wallet is a software wallet that is always connected to the internet for easier access while a cold wallet is a hardware wallet that can be kept offline for added security. Some hot wallets are also termed as “custodial” wallets and are used for keeping cryptocurrency easily accessible for trading on exchanges.
What are crypto wallets and how do they work?
When it comes to storing your cryptocurrencies, there are a number of options to choose from. While active crypto traders often choose to keep their money on exchanges, there are also digital wallets that can be used when you want to move your assets, link to decentralized applications (dApps) and to store them more securely.
But “storing” digital assets in crypto wallets isn’t exactly the same way as storing money in a physical wallet. If your physical wallet can store actual cash inside it, your digital wallet stores your private and public keys that are linked to your data on the blockchain and which allows you to engage in transactions.
On the internet, a user is assigned a public and private key. Both of these keys are necessary to validate and authenticate any kind of crypto transaction. Most users however, never really encounter or “see” their public and private keys as they are strings of encrypted code that are meant to be read by computers.
A public key is like your public persona on the internet. Other users will need your public key in order to send you crypto. Think of your public key as a username or handle which is what other people’s computers use to be able to identify you within the network. In fact, your public key is what your wallet address is generated from. Simply put, a wallet address is just a compressed version of your full public key.
Meanwhile, a private key is an identifier that only you have access to. It functions a lot like a PIN number or password that gives you access to your wallet.
Since a private key is a complex computer code that is very difficult to memorize, users are typically given something called a “seed phrase” which consists of a string of 12 or more randomly generated words which acts as a more readable password with the private key encrypted within it.
Keep your private keys safe
It is important to note that losing your private key means losing access to your crypto wallet, which is why seed phrases are supposed to be kept under tight lock and key and must never be shared with anyone. Losing your seed phrase means you will never be able to withdraw or use the money stored in your account–permanently. This is why a popular saying in the crypto world is, “Not your keys, not your crypto” since possession of private keys means full access to your assets.
When you leave your money in exchanges, your assets are kept in custodial wallets. Through custodial wallets, users give the exchange platform control over their private keys so that the user’s job is merely to initiate the sending and receiving of payments. This is why for your own protection, it is very important to only use exchanges which can be trusted with your private keys, and which are licensed and regulated by authorities such as Philippine Digital Asset Exchange (PDAX).
If you prefer keeping your crypto outside of exchanges however, you have the option of using either hot or cold wallets.
What is a hot wallet?
A hot wallet is designed to allow you to easily access your tokens by being always connected to the internet. Since hot wallets are always online, users are able to transact at their own convenience.
Hot wallets are software applications or browser extensions that can directly be linked with cryptocurrency websites and dApps such as play-to-earn (P2E) games. Hot wallets are very convenient to set up. After installing the wallet extension, users only have to import their wallet with their seed phrase to be able to access their crypto right away.
Many users make use of hot wallets for purchasing and trading tokens and moving them from one exchange to another. They can also be used to store digital assets such as NFTs.
However, one major drawback of hot wallets is that since they are always online, they become enticing targets for cyberattacks. Hot wallets can be compromised by malware and private keys can be stolen by hackers through phishing scams such as by visiting fake sites or clicking malicious links.
As such, most people don’t place large sums of crypto in a single hot wallet. It’s the same principle as not bringing all of your cash with you whenever you go out so that in case your wallet gets lost or stolen, you don’t end up losing all your assets. For added safety, assets are usually spread out across multiple wallets, or better yet–are kept in a cold wallet instead.
It’s worth noting that not all hot wallets are created equal and that some wallets are better suited for certain tokens than others. Though there are wallets that are compatible with many blockchain networks and token standards, you should always make sure that you are using the correct wallet for the correct cryptocurrency.
For example, a wallet like MetaMask is mostly used for ERC-20 (Ethereum) tokens while a wallet like Phantom is only compatible with Solana-based tokens.
What is a cold wallet?
Cold wallets are considered to be more secure than hot wallets because they are kept offline and are only connected to the internet once you need to make a transaction. And since a cold wallet is offline, there is no way for a hacker to be able to steal your private keys.
There are two types of cold wallets: hardware wallets and paper wallets. Hardware wallets usually come in the form of a USB storage device and are the more popular option. To use a hardware wallet, users only need to plug it into their laptop or desktop computer and unlock it with their PIN.
Most hardware wallets are also flexible as they are designed to be compatible with most major blockchains and can hold thousands of different altcoins. Some of the most popular cold wallet manufacturers like Trezor and Ledger are known for this feature.
Furthermore, losing your hardware wallet doesn’t automatically mean you lose your assets. Hardware wallets also come with recovery phrases so that you can still access your funds by simply inputting your phrase in a replacement wallet.
On the other hand, paper wallets are printed pieces of paper with a QR code containing your keys that can be accessed on any device that can read the code. To create a paper wallet, users have to make use of a private key generator. This software will then print out the public and private keys along with a QR code onto a piece of paper.
While this is secure in the sense that printed paper is completely impossible to hack. Users seldom use this method as paper can easily be lost, misplaced or destroyed.
Since both types of wallets have their share of pros and cons, your choice of wallet should depend more on your trading habits. If you are more interested in short-term trading that requires you to actively engage in transactions, the convenience of a hot wallet might be better for you.
But if you are more of a long-term investor than a trader, then a cold wallet might be the better option for safeguarding your assets and your private keys.
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DISCLAIMER: The statements in this article do not constitute financial advice. PDAX does not guarantee the technical and financial integrity of the digital asset and its ecosystem. Any and all trading involving the digital asset is subject to the user’s risk and discretion and must be done after adequate and in-depth research and analysis.
PDAX is a BSP-licensed exchange where you can trade Bitcoin, Ethereum, and other cryptocurrencies directly using PHP!
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