Find out which digital wallet is the best option for storing your bitcoin or other altcoins.
If you’re interested in using cryptocurrencies like bitcoin or Ether, whether you want to pay with the coins or simply want to keep the coins as an investment, you’re going to need a wallet. While these digital, software wallets might seem like regular wallets at first glance, there is a lot to learn about them: how they work, the different types and, most importantly, how to keep them safe.
Even if you’re completely new to cryptocurrencies, this guide will teach you everything you need to know. We’ll also cover some of the more common aspects of cryptocurrencies and altcoins to help you understand all there is to know about this important and often overlooked aspect of the technology that’s taking the world by storm.
What is a wallet? And how does it work?
Cryptocurrency wallets, (or wallets for short), are pieces of software that give you access to any cryptocurrency (such as bitcoin or Ether) that you own. But first things first...
Your coins are not stored in your wallet.
The name is a bit of a misnomer. In fact, your coins are not stored in the wallet at all. The coins do not technically exist anywhere as they do not have any physical form (hence the name digital currency). What your wallet can do is connect and analyse the blockchain, which allows you to transfer and receive money to and from other users of that blockchain and check out your coin balance. Some wallets have other features, such as checking live exchange rates to your fiat currency of choice, or maintaining various coin balances from different blockchains, but we’ll cover these in later sections.
Originally developed by Satoshi Nakamoto, the inventor of bitcoin, the blockchain is the beautiful technology underlying all cryptocurrencies and altcoins on the market today. In essence, the blockchain is a database of transactions. Each verified transaction is stored on a “block”, a file containing multiple transactions. When a block is full, a new block is created and chained to the previous block. In bitcoin, a transaction is an exchange of bitcoin, but other platforms like Ethereum are using the blockchain to store many different types of data, and all the transactions are shared and replicated throughout the various users of the blockchain.
So you’ll never find data stored in a single location, and if users want to double check the data they can ask any of the other nodes for their data and confirm that the transaction really did take place.
Data added to the blockchain, described as immutable, cannot be deleted and cannot be changed.
Wallets do not actually contain any coins. The blockchain contains all the transactions that have been made since the initialisation of the blockchain, and through those transactions the wallet can figure out how many coins you have.
For example, Alice sends Bob 0.001 BTC. Once verified and added to the blockchain, the transaction can then be used by Alice’s wallet to show a reduction of 0.001 BTC from her balance, and by Bob’s wallet to show an addition of 0.001 BTC.
All wallets have a record of this transaction. All transactions on the blockchain are public so all users on the blockchain can confirm that the bitcoin changed hands.
How do coin transactions work?
Inside every wallet, the two most important pieces of data are the public key and a private key. This is how most of today’s secure transactions work (for example, when you enter https:// into your browser to check out products from a merchant website). It makes sense that cryptocurrencies have adopted this method.
The public and private keys come together when it’s time to transfer coins from one user to the other. In the example above, Bob gives Alice his public key, which Alice uses with her wallet to send the money. Meanwhile, on the blockchain, Bob’s private key is used to match the public key of the recipient of these bitcoins and, once they match, the transaction is added onto a block and appended to the blockchain. With that transaction validated, the money appears in Bob’s wallet.
This is why keeping your wallet secure and taking steps to ensure that your private key is never lost is of utmost importance. Without it, all your coins will be lost.
The 5 different types of crypto wallets
As we’ve just covered, wallets are little more than a way to store two keys, one public address and one extremely important private key. Various companies have developed not only software but different types of real-world wallets to hold these keys, providing different levels of security and ease-of-use.
The most common types of wallet out there, desktop wallets, are downloaded and installed on your computer. Easy to install and maintain, most are available for Windows, Linux and Mac, although there are some limited to a particular OS. Most, if not all cryptocurrencies offer a desktop wallet specifically designed for their coin.
Desktop wallets provide a very high level of security since they’re accessible only from the machine on which they’re installed. The biggest disadvantage is that they also rely on you to keep your computer secure and free of malware. So antivirus and antimalware software, a strong firewall and a common sense approach to security are required to keep your coins safe and sound.
Most desktop wallets will provide you with a long string of words upon installation. These words map with your private key so it’s important to store them somewhere safe in case your computer dies or you need to format the operating system and re-install your desktop wallet.
Online wallets (most often owned by exchanges but sometimes owned by third-party organisations) run on the cloud and are the easiest to set up and use. Some only require an email address and a password, although the more secure ones, require other verification like scans of your passport or ID.
The biggest advantages to online wallets are that they cannot be lost and that they’re accessible from any computer with an Internet connection. Businesses keeping online wallets for users also often have servers that are far more secure than the average user’s computer.
However, being online is unfortunately also their biggest disadvantage. Because some businesses maintain the wallets of thousands of users, they are the biggest targets for hackers. After all, why would a hacker attack your wallet when it can attack thousands at once?
Additionally, some online wallets will take a percentage (or flat) fee for every transaction you carry out, which could quickly eat into your balance (or profits, if you’re an investor) unless you’re careful.
Similar to desktop wallets, but running as an app on your smartphone, wallets enjoy most of the same advantages and disadvantages of regular, desktop wallets.
Smartphone wallets are often simpler and easier to use compared to their desktop counterparts, and include the ability to scan other wallet addresses for faster transactions.
You will need to be extra careful about losing your smartphone, though, because anyone who has access to your device might also have access to your funds.
Also very similar to desktop wallets, hardware wallets add another layer of security by keeping the private key on a USB stick. Apart from added security, hardware wallets allow the user to plug the USB stick into any computer, log in, transact and unplug.
The biggest disadvantage here is that if you lose the USB stick, you lose your private key, so you’ll need to be extra careful about keeping the stick safe.
Paper wallets take the concept of entirely offline keys used for hardware wallets to the next logical step: simply print out your public and private keys and use that printout as your wallet. That we are allowed to keep paper wallets is a testament to the power of the blockchain transaction.
As secure as they are, paper wallets are also the most complex wallets to use as they require both the paper and a desktop (or software) wallet to work and should only be used by the most advanced users who want the highest level of security possible.
To transfer money to a paper wallet, you use a software wallet (any of the above mentioned) to send money to the public key printed on the sheet of paper. Most often, this is printed as a QR code for easy scanning. To transfer money from the paper wallet to someone else, you would first need to transfer money to a software wallet (by manually entering the private key into the software), and then transfer money from the software wallet to the recipient as usual.
Sending and receiving coins with your wallet
Wallets are not only the gateway to checking your available balance, they also allow you to send and receive cryptocurrency. Wallets vary from one to another in how they handle the sending and receiving of currency, but the general process remains the same.
How to send currency to other users
First, you will need a wallet address (the recipient’s public key). These addresses are given in one of three ways:
- A long alphanumeric string (numbers and letters)
- A QR code (for smartphone wallets)
- A URL-like web link (clickable, opens your wallet automatically)
Once the address is entered into the wallet, you will be asked to enter an amount of currency to send. Once you’ve entered the amount, click your wallet’s version of a send button.
The recipient will immediately be notified of the transaction.
How to receive currency
Receiving coins is even easier than sending them. However, wallets vary greatly in the way this is done: some will provide you with a fixed public address, some will give you a new address for every transaction, and most will provide a combination of the two.
Whichever system your wallet uses, you will have to provide a public key in one of the formats listed in the previous section to the sender, along with how much money you’re asking for. Once sent you should receive a notification of the transaction.
Depending on the blockchain in use, the transaction might take some time to be verified because for most blockchains a miner needs to confirm and add the transaction to the blockchain. This might be anywhere between a few seconds to ten minutes (or longer) depending on the cryptocurrency being used.
Keeping your wallet secure
Your wallet might not contain your actual coins, but it’s the gateway to those funds. Coins are sent to a public + private key combination, and if that combination is lost (by, say, accidentally uninstalling your desktop wallet) you will never be able to match those transactions to yourself, and all your digital currency will be lost.
So how do you make sure you keep your coins? By keeping your wallets secure.
Employ standard best practices
Wallets are built to be secure. They are almost completely unhackable and the weakest link is most often the user. So make sure to follow standard security best practices when using a computer on which you have a desktop wallet installed, or when accessing an online/smartphone wallet:
- Always use strong usernames and passwords
- Install antivirus and antimalware software (and keep them up-to-date)
- Set up a secure firewall
- Never install software developed by companies you don’t trust
- Only use verified and trusted wallets
- Update your wallet software as soon as possible
- Double-check your public address when giving it to users sending you money
- Double-check your recipient’s public address when sending money
- If accessing an online wallet, make sure the address is secure (https://)
- Never access online wallets from public Wi-Fi
If you’re using a desktop, smartphone or online wallet, and follow these best practices, your coins should stay safe.
While these wallets enjoy a higher level of security by their nature, they still require the use of digital software (desktop/smartphone/online) and so these best practices should still always be observed.
Keep a backup
Most people nowadays backup their vacation photos, their texts, their documents, their game saves. Keeping a backup of your wallet is no different. Most desktop wallets will let you define a backup folder upon installation. Every time you are done transacting, you should always save a copy of the backup folder onto a USB stick in case something happens to your computer.
This will let you recover your wallet as it will contain your private key.
Backups should always be done on an offline medium. Keeping your wallet’s backup on the cloud could lead to disaster if that backup service provider is hacked.
Additionally, if your wallet provides you with a mnemonic key (as discussed in an earlier section) you should keep a copy (or two or three copies) of that key just in case.
Finally, make sure to keep a copy of your usernames and passwords in a secure location just in case it’s been a while since you last accessed your wallet (after all, you should be using a password so strong you can barely even remember with regular use).
Always use the best wallets
Some wallets require only a username and password to access. Other wallets have two-factor authentication or require a PIN code generator to access. The more security layers a wallet provides the better. It might make it a hassle to access and transfer funds quickly, but wouldn’t you rather take a while longer to access your wallet than lose everything because you were using a wallet with weak authentication?
Used by the most secure and trustworthy wallets, two-factor authentication requires a regular username and password combination and another authentication method. This is often a PIN code that is sent to your smartphone as an SMS and is different every time you log in. This means that an attacker needs to know your username and password, and also has to be in possession of your phone.
Some wallets also require the use of a secondary app installed on your smartphone that generates these PIN codes for you, again adding another layer of security.
Where to go from here
Hopefully, this guide has provided you with some much needed information on what wallets are, what they do and how to use them, and how to keep the money in them secure.
Your next course of action depends on where you are on the cryptocurrency adventure. If you have yet to decide on a cryptocurrency to invest in, check out some of the guides on our website for more information. If you’ve already decided on a favourite coin, we suggest downloading its developers’ desktop wallet and giving it a spin. Once you’ve played around with that wallet for a bit, revisit this guide and give some other type of wallet a try.
If you keep it safe, your wallet will become your next best friend.
Read our wallet reviews
Frequently asked questions
Do I need a wallet for every currency I own?
Which wallet should I get?
Image sources: Shutterstock