What Is a Cryptocurrency Wallet?

How Do Crypto Wallets Work?

There's a lot of jargon in the cryptocurrency world. So, before diving deeper into how cryptocurrency wallets work, let's decipher some of the key terms:

• Blockchain: The foundational technology behind most cryptocurrencies. A blockchain is a decentralized public ledger that records all transactions on computers around the world. Each cryptocurrency operates on its own blockchain.
• Private key: A randomly generated string of numbers and letters that gives you control over your cryptocurrency on the blockchain. Think of it as the master password—you need it to send or spend your crypto.
• Public key: A code derived from your private key that works like an account number. It's used to generate your cryptocurrency address.
• Cryptocurrency address: Created from your public key, this is what you share with others to receive cryptocurrency. Anyone can look up an address on the blockchain to see its transaction history, but they can't access the funds without the private key.
• Seed phrase: A series of 12 or 24 randomly generated words that serves as a backup for your wallet. If you lose access to your wallet, your seed phrase allows you to recover your private keys and regain control of your cryptocurrency. Keep it secure: Anyone with your seed phrase has complete access to your crypto.
• Transaction fees: Small amounts of cryptocurrency you pay to complete transactions on the blockchain. Also called gas fees on some networks, these fees compensate the validators who process and confirm your transaction. Fees vary based on network congestion and transaction complexity.

While the cryptocurrency itself lives on the blockchain, your wallet stores the private and public keys needed to control it and the addresses needed to receive it. In some cases, you can have multiple addresses in a single wallet, similar to carrying multiple credit cards or keys.

Learn more: Cryptocurrency Slang Terms to Know Before You Invest

Types of Crypto Wallets

You'll need a cryptocurrency wallet to own Bitcoin, Ethereum or other cryptocurrencies. However, there are several types of wallets available, each with different security and convenience trade-offs.

Wallets are broadly classified as "hot" if they're connected to the internet or "cold" if they're stored offline. Hot wallets offer more convenience for frequent transactions, while cold wallets provide stronger protection against online threats like hacking.

Custodial Wallets

Many people start with custodial wallets, where a third party—typically a cryptocurrency exchange—holds and manages your private keys on your behalf. When you create an account on an exchange like Coinbase or Kraken, the platform automatically sets up a custodial wallet for you.

With custodial wallets, you access your crypto by logging in with a username and password, similar to online banking. You don't need to manage your own private keys, which makes these wallets beginner-friendly. However, you're trusting the exchange to secure your assets.

The main risk is if the exchange is hacked, goes bankrupt or engages in fraud, you could lose access to your cryptocurrency. Many reputable exchanges mitigate this risk by carrying insurance and storing the majority of customer funds in cold storage.

Software Wallets

Software wallets are applications you download to your computer or mobile device. Unlike custodial wallets, you control your own private keys with software wallets.

These non-custodial wallets give you full ownership and control of your crypto. You're not relying on a third party, which eliminates the risk of an exchange failing. However, you're also fully responsible for securing your private keys and seed phrase.

The downside is that if your device is infected with malware, hackers could potentially steal your keys. Additionally, if you lose your device or forget your seed phrase, there's no customer service team to help you recover your funds. In other words, your crypto could be gone permanently.

Hardware Wallets

Hardware wallets store your private keys on a physical device, such as a USB drive. These cold wallets keep your keys offline, making them highly resistant to online hacking attempts.

To make a transaction, you connect the hardware wallet to your computer or phone, but your private keys never leave the device. Many hardware wallet providers offer companion apps that make it easy to manage your crypto while keeping your keys secure.

Hardware wallets are considered one of the most secure options for storing cryptocurrency, especially for larger amounts that you don't need to access frequently.

Paper Wallets

With a paper wallet, your private key and public address are printed on paper, often as QR codes. This creates a completely offline storage method.

However, paper wallets have fallen out of favor because they're vulnerable to physical damage, loss or theft. If the paper is destroyed or the ink fades, your cryptocurrency becomes inaccessible. Most crypto users have moved to more secure and practical options like hardware wallets.

How to Get a Crypto Wallet

The source for your crypto wallet depends on which type you choose. Here's where to find each option:

• Custodial wallets: These are available through cryptocurrency exchanges like Coinbase, Gemini and Kraken. They're often best for beginners who want a simple, familiar interface similar to online banking.
• Software wallets: Popular options include MetaMask, which supports Ethereum and Ethereum-based tokens, and Exodus, which supports multiple cryptocurrencies. These wallets are generally free to download and use. A few exchanges also offer standalone software wallets separate from their custodial exchange wallets.
• Hardware wallets: These physical devices must be purchased from the manufacturer or an authorized retailer. Leading brands include Ledger and Trezor, with devices typically costing $50 to $200—essentially a one-time investment for enhanced security.

When choosing where to get your wallet, consider factors like cost, ease of use and how much control you want over your private keys.

Learn more: How to Start Investing in Cryptocurrency: Beginner's Guide

Frequently Asked Questions

Keep Your Keys Safe

There's a popular phrase in the cryptocurrency world: "Not your keys, not your coins." Whoever controls the private key controls the cryptocurrency. Never share your private key or seed phrase with anyone, even if they claim to be from customer support or promise free coins—these are always scams. Legitimate companies will never ask for your private key.

If someone steals your private key, they can transfer all your funds, and there's typically no way to recover them. Similarly, if you lose your key or seed phrase, you may lose access to your cryptocurrency permanently. Store your seed phrase somewhere secure, like a fireproof safe, and never save it digitally where it could be hacked.