What is a cryptocurrency wallet and how does it work?

Blockchain / 10 Min Read
Axi Team / 01 Sep 2021

To securely store your crypto investments, you 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 you can trade assets with complete autonomy and security thanks to the innovative blockchain technology that cryptocurrencies are built on. But how do you keep your cryptocurrency secure like a bank would keep your cash safe? You need a cryptocurrency wallet!

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

What is a cryptocurrency wallet?

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

Think of it as a bank account for your crypto. 

Crypto wallets come in all shapes and sizes, from mobile wallets on your smartphone and online wallets you can access on the internet to hardware wallets that are physical devices similar to a USB stick. 

While some cryptocurrency wallets allow you only to hold one digital currency, such as bitcoin, others enable you to store all your 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 you to send and receive cryptocurrency, just like your postal address allows you to send and receive documents. 

Your cryptocurrency wallet address is essentially like your bank account number. You can share it with others to receive money into your wallet. 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. You use your crypto wallet to hold your funds, make and accept payments, and send money transfers. 

However, crypto wallets work differently than bank accounts. 

A cryptocurrency wallet has private and public keys. Once you create a wallet, you automatically receive a private-public key combination. The public key is the cryptocurrency wallet address you use to receive money, while your private key is more like a password that gives you access to your cryptocurrency. You should never share your private keys with anyone.

Think of your public key (i.e., your wallet address) as your bank account number you can share with others to receive payments and your private key as your PIN to access and use your bank account to make payments.

Public and private crypto walley keys

If someone wants to send cryptocurrency to you, you copy the public wallet address and send it to them. Once the transaction is completed on the sender’s end, you’ll see the cryptocurrency in your wallet within minutes (or sometimes seconds).

On most cryptocurrency exchanges, your public and private keys are managed for you, and the only thing available to you is a public address to receive cryptocurrencies.

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

The seed phrase is a list of random words that helps you access your wallet. 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 you access on your smartphone, or a web-based wallet you access in a browser. 

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

Cold wallet

Cold wallets are not connected to the internet, which inherently makes them safer as sneaky actors cannot access your 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 you can download onto your smartphone to manage your cryptocurrency on the go. 

Hardware wallets

Hardware wallets keep your private keys offline in a physical USB-like device. They provide 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, you plug it into an internet-enabled computer, type in the password, and perform a transaction. Once you are done, you unplug it again, and your crypto rests securely offline.

Ledger hardware wallet USD-like device

Web wallets

Web wallets, as the name suggests, are crypto wallets that you can use on the web. You can easily access them from any computer connected to the internet from any location. Although web wallets are convenient to use, your 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 your private keys and allow you to use your wallet whenever you are on your computer. 

While they are typically not as user-friendly as mobile wallets, they come with an added level of security, provided you practice basic cybersecurity measures, such as installing anti-virus software on your device. 

Paper wallet

A paper wallet is a printed piece of paper with your 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

You need to check to see how secure the wallet you intend to use is. Cold wallets (i.e., hardware and paper wallets) are considered the most secure, but you 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 you intend to use because each wallet has different security measures in place. 

Ease of Use

You should evaluate how easy it is to use the cryptocurrency wallet. If you are a complete newcomer to the crypto space, you are probably better off downloading a reputable mobile wallet, like Trust Wallet, onto your smartphone instead of setting up an advanced desktop or hardware wallet. You should also ensure that the wallet is compatible with the blockchain network you want 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 you hold in cryptocurrency, choosing a crypto wallet that comes with privacy features is a smart move. Avoid wallets that require personal information from you 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 you to store, send, and receive digital currencies and assets, giving you complete control of your digital funds. 

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

Lastly, you need a crypto wallet to take part in the broader crypto ecosystem. For example, if you want to create, mint, and sell non-fungible tokens (NFTs) you 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 you use.

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

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

Should you keep crypto on an exchange or wallet?

Mobile exchange cryptocurrency wallet

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

However, unless you are actively trading, you should always store your 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, you should only use exchanges to trade and then withdraw your funds to a personal wallet once you’ve completed your 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 you could choose from. To make the choice easier for you, 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. You 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, you can spend your cryptocurrency in games, stake tokens in applications, trade on decentralised exchanges, and more. 

Metamask is available as an extension for your 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 you to safely store your 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 you have to buy. You can order online from the Ledger store and get it delivered to your doorstep.

How to set up a crypto wallet?

Now, let’s take a look at how to set up a crypto wallet. To help you 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".

In the following steps, you will get a twelve-word recovery phrase, which is what you will need to recover your funds when you can’t access the app. You can’t change or recover your 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 you complete the wallet creation process, ensure you have stored the recovery phrase in the order you are shown. The app will request you to re-enter it to ensure you noted it down. Once you’ve verified the recovery phrase on the app, your Trust Wallet app is ready to use.

To fund it with crypto, you can 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 your Trust Wallet.

How to set up Ledger Nano S wallet

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

Step 1: Connect the Ledger Nano S to your 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, you will have to add a PIN code. You can 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 your pin code. You will also be required to re-verify the code.

Thereafter, your 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 your funds. Use the Ledger button to toggle between each word of the recovery phrase and then store it safely so you are able to regain access to your 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.

While some wallets charge a small transaction fee when you make a payment using your wallet, most crypto wallets only require you 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 do you cash out your crypto wallet?

To cash out your bitcoin (or other cryptocurrencies) from your wallet, you will need to send the funds to a digital asset exchange or peer-to-peer trading platform.

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

Once you have created an account, you simply send your crypto from your personal wallet to your exchange wallet and proceed to sell your crypto for fiat currency. 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 you to buy, sell and store multiple cryptocurrencies.

Multi-currency wallets, like Trust Wallet and Ledger, make it easier to manage your digital assets as you 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 your 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 you 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. 

We hope that this article will help you on your journey to buying, owning, and trading cryptocurrencies. You can start trading cryptocurrency CFDs with Axi today.

 

 

 

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.

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