What is a cryptocurrency wallet and how does it work?

Publish Date 01 Sep 2021
Blockchain / 10 Min Read
Alex Lielacher / Last Update 24 May 2022

To securely store the crypto investments, traders will need a cryptocurrency wallet.

Cryptocurrencies are changing the world. They allow for decentralised transactions to take place without the need of a middleman like banks, PayPal, or Visa. Now traders can trade assets with complete autonomy and security thanks to the innovative blockchain technology that cryptocurrencies are built on. But how do they keep cryptocurrency secure like a bank would keep cash safe? This is where a cryptocurrency wallet is needed!

In this beginner’s guide, traders will learn what crypto wallets are, how they work, what types of wallets exist, and how to set up the first wallet. Jump to each section here:

What is a cryptocurrency wallet?

A cryptocurrency wallet is software that allows a person to store, send, and receive cryptocurrency. 

Think of it as a bank account for crypto. 

Crypto wallets come in all shapes and sizes, from mobile wallets on smartphones and online wallets that users can access on the Internet to hardware wallets that are physical devices similar to a USB stick.

While some cryptocurrency wallets allow traders only to hold one digital currency, such as Bitcoin, others enable bitcoin holders to store all digital assets in one place.

Cartoon cryptocurrency wallet

What is a cryptocurrency wallet address?

Every crypto wallet comes with a cryptocurrency wallet address. Wallet addresses are composed of letters and numbers, and each address is unique.  

Like the word “address” suggests, a cryptocurrency address enables users to send and receive cryptocurrency, just like a postal address is able to send and receive documents. 

Bitcoin wallet holders can share it with others. Wallet addresses can also be used to track transactions on a public blockchain explorer, similar to searching a database.  

How do cryptocurrency wallets work?

A cryptocurrency wallet plays the same role as a personal bank account but for digital currency. Using the crypto wallet to hold funds, make and accept payments, and send money. 

However, crypto wallets work differently than bank accounts.  

A cryptocurrency wallet has private and public keys. Once wallet holders create a wallet, a private-public key combination will send to the wallet holder automatically. The public key is the cryptocurrency wallet address that use to receive money, while the private key is more like a password that gives access to cryptocurrency. But please notice that never share private keys with anyone. 

The public key (i.e., cryptocurrency wallet address) is similar to a bank account number that can be shared with others, and the private key is a PIN to access the wallet, similar to a PIN for your bank account. These two keys enable a user to make or receive payments.

Public and private crypto walley keys

If someone wants to send cryptocurrency, they only need to copy the public wallet address and send it to the sender. Once the transaction is completed on the sender’s end, the receiver will see the cryptocurrency reflected in the wallet within minutes (or sometimes seconds).

On most cryptocurrency exchanges, public and private keys are managed for traders and the only thing the traders need to worry about is a public address to receive cryptocurrencies.  

Most personal crypto wallet providers, like MetaMask or Trust Wallet, give investors complete ownership of private and public keys, typically by providing a recovery phrase (also known as the seed phrase) to ensure that investors can regain access to their wallet should any technical issues arise.  

The recovery phrase is a list of random words that helps users access their wallets. It’s important to write the seed phrase down and ensure not to share it with anyone.

Seed phrase example

Example of using a cryptocurrency wallet

Alice wants to send bitcoin to her friend Bob. Both are avid cryptocurrency users and store their crypto in the popular mobile wallet, Trust Wallet.

To receive the bitcoin, Bob sends Alice his public bitcoin wallet address via WhatsApp. She copies the address and opens Trust Wallet on her smartphone. There, she opens her bitcoin wallet and pastes the wallet address into the recipient bar.

Next, she puts in the amount of bitcoin she wants to send to Bob and then confirms the transaction. 

Bob will receive his bitcoin within around 20 minutes in his mobile wallet. He can view the transaction on a public blockchain explorer in real-time.

Recommended reading: What is cryptocurrency trading?

Types of crypto wallets

There are several different cryptocurrency wallet options, each with its own level of user-friendliness and security. 

Crypto wallets fall under two categories: hot wallets and cold wallets

Hot wallet

A hot wallet is a crypto wallet that is connected to the Internet. It could be an online wallet on a cryptocurrency exchange, a mobile wallet that can be accessed via a smartphone, or a web-based wallet that users can access in a browser.

Hot wallets can be custodial or non-custodial. A custodial wallet provider holds private keys, which means users have to trust the wallet providers to keep funds safe. A non-custodial wallet lets the users have complete control over funds as only the wallet holder has full access of the wallet. While the latter is more secure, it also comes with the responsibility of keeping the private keys safe by securely backing up the wallet.

Cold wallet

Cold wallets are not connected to the internet, which inherently makes them safer as sneaky actors cannot gain access to another users coins online. Hardware wallets and paper wallets fall under this category. While cold wallets are more secure than hot wallets, they are more complicated to set up and use. 

Now, let’s take a closer look at the different types of crypto wallets in these categories:

Mobile wallets

Arguably the most popular crypto wallets for newcomers are mobile wallets. A mobile crypto wallet is a mobile application that traders can download to their smartphones to manage their cryptocurrency.

Hardware wallets

Hardware wallets keep private keys offline in a physical USB-like device, which provides a high level of security but are typically more complex to use for beginners. Additionally, they come with a cost, while software wallets are typically free.  

To use a hardware wallet to make a transaction, plug it into an Internet-enabled computer, type in the password, and perform a transaction. Once done, unplug the device, and the crypto rests securely offline.  

Ledger hardware wallet USD-like device

Web wallets

Web wallets, as the name suggests, are crypto wallets that traders can use on the web, which are easily accessed from any computer connected to the internet from any location. Although web wallets are convenient to use, private keys are managed online and can be vulnerable to cyber theft.

Desktop wallets

Desktop wallets are downloaded and used on a desktop or laptop computer. These wallets offer significant security for the private keys and allow traders to access the wallet anytime and anywhere. 

While desktop wallets are typically not as user-friendly as mobile wallets, the wallets are able to provide an added level of security, provided the user practices basic cybersecurity measures, such as installing anti-virus software. 

Paper wallet

A paper wallet is a printed piece of paper with the private and public keys on it. Since they are entirely removed from the internet, they are a secure offline storage option. 

However, securely storing a piece of paper with a potentially large sum of money on them can be challenging and stressful for newcomers. As a result, hardware wallets are considered the more user-friendly cold storage option.

How to choose a crypto wallet?

There are several things to look for when selecting a cryptocurrency wallet. Here are the essential things to consider when choosing a crypto wallet:

Security

Please check how secure the wallet that the traders intend to use is. Cold wallets (i.e., hardware and paper wallets) are considered the most secure, but traders will need to understand how to protect a physical wallet, which can be challenging for newcomers. Desktop and mobile wallets can also offer a high degree of security. Still, it’s essential to research the wallet before starting use because each wallet has different security measures in place. 

Ease of Use

Kindly evaluate how easy it is to use the cryptocurrency wallet. If the trader is a complete newcomer to the crypto space, they should be better off downloading a reputable mobile wallet, like Trust Wallet, onto the smartphone instead of setting up an advanced desktop or hardware wallet.  Also, ensure the wallet is compatible with the blockchain network the trader wants to transact on. Not all cryptocurrency wallets support multiple blockchains.

Recovery Process

Another point of consideration would be the type of backup provided by the wallet. The simpler a wallet recovery process (typically via a 12 to 24-word recovery phrase), the better.

Privacy

To avoid suspicious actors finding out how much wealth the trader holds in cryptocurrency, choosing a crypto wallet that comes with privacy features is a smart move. Avoid wallets that require personal information beyond an email address.

Reputation

The reputation of a wallet service provider is essential. Avoid wallets that have had security breaches in the past.

Why are crypto wallets so important?

Cryptocurrency wallets allow users to store, send, and receive digital currencies and assets, giving complete control to the user of their digital funds.

Crypto wallets also keep a record of holdings on the blockchain, which traders access with the wallet's private keys. The private keys show the ownership of digital money and allow owners to spend it. Losing private keys means losing money, so keep them secure. 

Lastly, traders need a crypto wallet to take part in the broader crypto ecosystem. For example, if a users wants to create, mint, and sell non-fungible tokens (NFTs) or use one of the many decentralised finance options, they will need a wallet to sign transactions.

Are cryptocurrency wallets secure?

Cryptocurrency wallets are generally secure. However, safety and security vary widely depending on the type of wallet that traders use.  

When using a non-custodial cryptocurrency wallet, traders are in control of the private keys and security is guaranteed as long as they never share the keys with anyone else.  

In the case where the private keys are managed by a third party, wallet holders have to rely on the reputation and security measures of the cryptocurrency wallet company. If they decide to use such a third-party service, do research to understand how they protect their users.  

Should traders keep crypto on an exchange or wallet?

Mobile exchange cryptocurrency wallet

Crypto exchanges are regarded as one of the least secure places to store cryptocurrencies. The only crypto users who hold funds on an exchange are typically traders who are actively day trading the market. That way, users don’t need to send funds to and from exchanges every time they want to place a trade.  

However, unless traders are actively trading, users should always store funds in a secure crypto wallet, not on an exchange.

Exchanges have a long history of security breaches and hacks that have led to billions of dollars in stolen funds. As a result, investors should only use exchanges to trade and then withdraw funds to a personal wallet once traders have completed the trading for the day, something that seasoned day traders do to securely store their funds overnight.  

Best crypto wallets

There are hundreds of cryptocurrency wallets to choose from. To make the choice easier, we have listed three of the most popular and secure crypto wallets in the market.

Trust Wallet

Trust Wallet is a multi-currency crypto mobile wallet owned by the leading digital asset exchange, Binance. Users can use Trust Wallet to store, send, and receive 160,000+ digital currencies and tokens, making it one of the best wallets for new crypto users who want to hold a range of digital assets.

Trust Wallet is used by more than 10 million people and is available on the Google Play Store and App Store.

Metamask 

Metamask is arguably the most popular Ethereum wallet on the market. The wallet can be used to connect to and interact with DApps operating on the Ethereum blockchain. Since 2020, MetaMask can also be used to hold Binance Smart Chain (BSC) tokens and to interact with BSC DApps. 

Through connecting to Metamask, a trader can spend their cryptocurrency in games, stake tokens in applications, trade on decentralised exchanges, and more. 

Metamask is available as an extension for Chrome, Firefox, Brave, and Edge browsers, and also comes with a mobile app.

Ledger

Ledger is one of the most recommended hardware wallets in the market. It’s a USB-like physical crypto wallet that enables users to safely store their cryptocurrencies offline. The French company boasts a range of different hardware wallet products, including Ledger Nano S, Ledger Nano X, and the Ledger Family Pack S.

Since it’s a hardware wallet, it’s a physical product that needs to be bought. Traders can order online from the Ledger store and get it delivered straight to their doorstep.

How to set up a crypto wallet?

Now, let’s take a look at how to set up a crypto wallet. To help traders get started, we have created step-by-step guides for Trust Wallet and Ledger.

How to set up Trust Wallet

Step 1: Visit the Trust Wallet website.

Step 2: Download and install the app (available for iOS and Android). 

Step 3: Open the Trust Wallet app and click on "Create a new wallet". 

Traders will get a twelve-word recovery phrase, which is what is needed to recover funds when users are not able to access the app. Users are not able to change or recover the twelve-word phrase once it's lost or forgotten. Ensure never to share it with anyone, and to keep it in a safe place. 

Step 4: Before completing the wallet creation process, ensure stored the recovery phrase in the order are shown. The app will request users to re-enter it to ensure the phrase has been noted down. Once verified the recovery phrase on the app, the Trust Wallet app is ready to use.  

To fund it with crypto, buy a range of digital currencies using a credit or debit card directly in the app or send crypto from another wallet or exchange to the Trust Wallet.  

How to set up Ledger Nano S wallet

To set up a Ledger Nano S, traders need the physical Ledger wallet, a computer, and the Ledger Live application downloaded and installed on their computer.

Step 1: Connect the Ledger Nano S to a computer with the provided USB cable. The device should display a ‘Welcome to Ledger Nano S’ message.

Step 2: Follow the on-screen instructions to set up the device.

Step 3: Then, users will have to add a PIN code. Press the right or left button to type the first digit of the PIN code and use both buttons to type in the remaining digits. Use the checkmark and press both buttons to confirm the pin code. Users will also be required to re-verify the code.

Thereafter, a 24-word recovery phrase will be shown word by word on the Ledger Nano S screen. Just like Trust Wallet, this recovery phrase is the only way to recover funds. Use the Ledger button to toggle between each word of the recovery phrase and then store it safely so access can be regained to the wallet.

How much does it cost to use a crypto wallet?

Most crypto wallets are free to download and use. Only hardware wallets have to be purchased and typically cost between $100 and $200 (USD?).  

While some wallets charge a small transaction fee when making a payment by the wallet, most crypto wallets only require to cover the blockchain transaction fee when making a crypto transaction. 

Blockchain transaction fees differ from chain to chain and can range from a few cents to tens of dollars.  

How to cash out from a crypto wallet?

To cash out bitcoin (or other cryptocurrencies) from the wallet, users will need to send the funds to a digital asset exchange, peer-to-peer trading platform, or a trusted individual who will send the fiat currency in exchange for crypto.  

To cash out crypto using an exchange or a peer-to-peer marketplace.  First, set up an account on one of these platforms, which may also include completing an identity verification process.  

Once users have created an account, simply send crypto from a personal wallet to an exchange wallet and proceed to sell crypto for fiat currency.  

If users want to sell crypto to some trusty third party, the sender can send the money while sending the cryptocurrency to the person’s wallet. Ensure to get cash first, though. There’s no way to reverse a crypto transaction.

To learn more, check out our page on how to trade cryptocurrency CFDs.

Can I store all my cryptocurrencies in the same wallet?

There are numerous crypto wallets that allow users to buy, sell and store multiple cryptocurrencies.

Multi-currency wallets, like Trust Wallet and Ledger, make it easier to manage digital assets as users can store them all in one place.  

Crypto wallet scams

Finally, every new crypto user needs to be aware of wallet scams.

Crypto wallet scams are schemes devised by cybercriminals to steal funds. The way it works is that scammers develop and upload fraudulent crypto wallet software onto an app store and then wait for inexperienced users to download them to store their crypto. 

Once funds have been deposited into a fraudulent wallet app, the scammers will steal them as they have coded the app in a way that allows them to siphon off funds without their victims noticing.

Before downloading or using any cryptocurrency wallet, make sure to download a reputable wallet from the verified wallet provider. The easiest way to do that is to download the app from the company’s official website. 

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We hope that this article will help on the journey to buying, owning, and trading cryptocurrencies. Start trading cryptocurrency CFDs with Axi today.



Alex Lielacher

Cryptocurrency Content Contributor

Alex Lielacher is a ‘banker-turned-bitcoiner’ who exchanged the bond trading desk for a laptop in a co-working space to provide engaging and educational content for leading companies in the blockchain technology space.

 

 

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

Cryptocurrencies (such as Bitcoin) are extremely volatile and can move or jump in price with no apparent reason due to lack of liquidity and ad hoc news. There is little or no fundamental reasoning behind its pricing and as such trading CFDs in cryptocurrencies poses a significant risk to clients. For any Cryptocurrency CFDs that we limit to Monday – Friday trading, it is important to note that the underlying market will continue to trade over the weekend, meaning there could be a significant price change between Close of Business on Friday and open for business on Monday. Therefore, these symbols should be traded by clients with sufficient experience to  understand that, subject to negative balance protection (where available), they risk losing all their investment, or more, in a  short period of  time, and only a very  small part of their portfolio should be allocated.


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