[ELM] What are Wallets & Their Types?
A crypto wallet is a medium to access your cryptocurrencies, tokens, and other digital assets. This article elaborates on the crypto wallet, their working, and their types. Each wallet type has benefits and risks; therefore, the user must be fully aware of them before using them.
Introduction To Crypto Wallets
Crypto wallets make your private keys safe and accessible by storing them. It is an application that serves as a cryptocurrency wallet and is similar to an application found on a smartphone or computer. However, you can also have a physical device that runs wallet software. A wallet is called so because it functions similarly to a wallet in which cash and cards are stored.
Another analogy for a blockchain wallet is a bank account. A bank account facilitates the user to receive and send fiat currency. Similarly, a wallet acts as a medium to receive and send cryptocurrencies. Furthermore, a crypto wallet allows additional features like token-swapping, staking, liquidity pools, etc.
The function of a crypto wallet is to enable us to send and receive cryptocurrencies. Like a hard wallet, it stores the passkeys to sign bitcoin transactions and provides the interface via which you may access your cryptocurrency. However, it should be noted that the wallet doesn't store cryptocurrencies but only provides access to them. This is because cryptocurrencies live on their native blockchain networks.
The wallet service provider maintains the wallet and, in return, charges a small fee to the user for each transaction. Therefore, before choosing a wallet, it is essential to understand the risks involved in different wallets and how to keep them safe. For example, suppose the service provider is unreliable; better for users to stay away.
How Do Wallets Work?
Each blockchain wallet has a private and a public key. The keys are essential for operating a blockchain wallet. Your keys validate your ownership of your digital currency and allow you to conduct transactions. Therefore, you need to keep them safe and hidden. Else you lose access to your assets if you lose your private keys.
The private key of a wallet is your access to your wallet. It is like a secret code to your wallet. If anyone gets your private key, they can log in to your wallet and may transact assets through it.
The public key acts like an address to the wallet. Consider it akin to your home address to reach you or your email id to send an email to you. A public key connects the wallet to the blockchain for transactions.
A private key generates the public key and address. However, the blockchain's security protocol requires a unique wallet address for each transaction. Therefore, developing a new address for each transaction becomes a cumbersome task for the blockchain network. This is where a seed phrase comes into the picture. A seed phrase is a 12-24 long random words string with a hidden code to generate a key for each transaction.
Types of Wallets
The three main types of wallets are hardware, online & paper wallets.
A hardware wallet is a small device that can be used to store cryptocurrency offline. These devices are available for $100-200 and are the size of a USB. It is a type of cold wallet as it keeps the keys offline. As a result, it has lesser exposure to the risk of hacking and online attacks. Also, they can hold multiple currencies at a time.
A hardware wallet interacts with the blockchain network when connected to the computer with an internet connection. The interaction happens via a web-based interface, a company-created app, or a separate software wallet.
One of the drawbacks of a hardware wallet is that it needs to be handled and carried out carefully.
Online wallets or software wallets only operate via an active internet connection, hence they are a type of hot wallet. It is a computer or a mobile app that can be accessed easily but they usually carry a single currency only. The hot wallets are prone to hacking and phishing.
When using an online wallet, it is important to have regular backups as it reduces the risk of losing private keys in case of a hard-drive crash or a web browser crash.
Paper wallets are yet another option for storing your private keys. However, the creation and use of paper wallets have a high risk of user error. Thus, rendering them unsuitable for holding any significant amount of cryptocurrency. Therefore, it is advisable to avoid them.