At the simplest level, a cryptocurrency wallet is a digital wallet that is dedicated to securely storing and managing digital assets — including cryptocurrencies (such as Bitcoin and Ethereum) and (more recently) non-fungible tokens or NFTs.
The vast majority of crypto wallets in existence are software wallets — often referred to as ‘hot wallets’ because they run on devices that are connected to the net (such as smartphones and laptops). Hardware wallets, on the other hand, are designed to keep your crypto in ‘cold storage’ (i.e. offline) — so as to maintain a permanent firewall between your crypto and all online threat vectors (such as hackers and the malicious exploits they deploy).
Each cryptocurrency held within a given wallet (such as ETH, BTC, etc.) has both a public key (the equivalent of a bank account number) and a private key — known only to the wallet-holder (or rather to the wallet itself). Cryptocurrency wallets are essentially devices for securely storing these private keys — both away from prying eyes and so you don’t lose them by storing them insecurely.
From a user’s perspective, crypto wallets therefore contain the pass-codes they need to get access to their crypto holdings. If they lose the pass-codes, they lose their crypto. In reality, the user doesn’t ever have to deal with the individual private keys. Instead, they have to record and keep safe (offline) a seed phrase that is set up when initiating the wallet — and which can subsequently be used to recover the wallet in the event of the loss, theft or damage of the device on which the wallet resides.
Put simply: with varying degrees of security, crypto wallets act as a platform for users to safely store, send, receive and manage their crypto. There are various different types of wallet depending on specific applications and blockchain protocols (including both software wallets and hardware wallets) but all crypto wallets fulfill the same basic function of storing a user’s public and private keys (equivalent to account numbers and access codes) for the cryptocurrencies they hold. As such, crypto wallets represent a vital layer of infrastructure in the emerging crypto economy. Indeed, without crypto wallets, a crypto-based economy could not exist.
In recent years, popular software wallets such as MetaMask and Trust Wallet have become gateway devices for users to access the world of web3. Such wallets enable users to access decentralized applications (dApps), and through them entirely new domains such as decentralized finance (DeFi); to participate in denentralized organisations (DAOs); to collect and trade non-fungible tokens (NFTs); to access blockchain gaming platforms (e.g. GameFi); to seamlessly trade crypto on dedicated trading platforms in much the same way as people trade stocks and shares; and to buy and sell in-world assets, goods, and services in the metaverse (amongst other use cases).
THE IMPORTANCE OF CUSTODY
It’s important to note that cryptocurrency wallets also fall into two distinct categories in terms of ownership/sovereignty:
CUSTODIAL WALLETS
A custodial wallet is a wallet where a third-party (such as an exchange or service provider) holds the private keys on behalf of the user. The user therefore does not have to worry about keeping the keys safe but also does not have full control over their crypto — since they rely on the third party to secure and manage their assets.
This is a centralized format which arguably runs counter to the prevailing ethos behind crypto — namely the elimination of the need for trusted third-parties in financial transactions. The FTX collapse is a reminder that this centralized format represents a significant — and often unquantifiable — risk. However, the issue is further complicated by the fact that some institutional investors require institutional-grade crypto-custody solutions — which may only be provided by specialized third-parties.
One example of this would be the company Bitcoin Suisse, which offers institutional clients and high-net-worth individuals with military-grade custody for their Bitcoin holdings — all running on “banking grade” servers; ring-fenced from the outside world, with an independent power supply and buried deep within a vault at a secret location in the Alps.
NON-CUSTODIAL WALLETS
A non-custodial wallet is a wallet where the owner of the digital asset holds the private keys — bestowing them with complete control and ownership over their funds. Non-custodial wallets (such as MetaMask and Trust Wallet) are capable of offering greater security, privacy and censorship resistance; since the user does not have to rely on any third parties to manage their assets.
However, non-custodial (or self-custody) wallets also require the user to take a much greater degree of personal responsibility in terms of keeping their assets safe — since losing access to a wallet’s seed phrase (or getting hacked when you’re using a ‘hot wallet’ connected to the net) can result in you losing all crypto held in the wallet.
It is estimated that 4 million Bitcoins (out of the approximately 19 million in circulation) have been permanently lost — primarily because of people losing access to their private keys. These kinds of non-custodial solutions may therefore be ideal for recreational applications like experimenting with NFTs, or for the more serious retail investor prepared to do the research and put a solid system in place from the outset, but they are not suitable for many institutions — since they present a single, human point of failure.
Multisig wallets are another non-custodial option; which (as the name suggests) require multiple signatories before any crypto transaction can be executed. Self-managed multisig wallets may be a viable solution for a lot of mid-range institutional investors (including modest family offices, etc.).
In summary, the key difference between custodial and non-custodial wallets is who holds the private keys and who has control over the assets stored in the wallet. Custodial issues can arise in both individual and institutional settings, but there are some key differences between the two, including the fact that institutions may face additional regulatory and compliance requirements, making it important for them to have secure and reliable custodial solutions in place.
USER EXPERIENCE (UI/UX)
Since crypto wallets are essentially the main control surface that people have to use if they want to get personally involved in crypto, it must be said that many of the early wallets leave much to be desired in terms of the general user experience and user interface (UI/UX).
MetaMask, for example — which provided early access to the Ethereum ecosystem and therefore had a prime-mover advantage — has always felt to me like something built on a machine running Windows ’98. In other words, when compared to the sophisticated kinds of apps we are already used to using on our smartphones, many crypto wallets feel extremely clunky, impenetrably complicated and just plain awkward to use for the non-geek — a bit like the early days of the world wide web.
Indeed, the UI/UX of cryptocurrency wallets in general is regarded by many crypto insiders as the primary factor holding back greater adoption (more important even than the lack of regulation) — since the average user simply isn’t prepared to invest resources into learning how to use something so complicated, messy and poorly designed from the outset.
DeFi, for example, will not be ready for prime-time until the UI/UX is sorted. It’s difficult to understand why this problem has persisted for as long as it has. But it’s a safe bet that sooner or later, the digital wallet interface will become much more seamless and integrated into our lives — and (one would hope) about as straightforward as using a smartphone already is for making electronic payments (e.g. over ApplePay).
THE EVOLUTION OF HARDWARE WALLETS
Hardware wallets, which provide the safer form of ‘cold storage’ for digital assets such as cryptocurrencies and NFTs, are evolving rapidly. Hardware wallet manufacturers such as Ledger are introducing the next generation of devices, which resemble smartphone-type devices. With a bigger form factor, superior UI/UX, and touchscreens, these devices can be used to sign-off on online transactions without compromising the operational integrity of the device or the safety of the underlying private keys they secure. Once these devices become mainstream, self-custody as a general practice will have significantly fewer pain points.
Similarly, Solana announced last year that they will “change everything” in 2023 by launching their new Sage mobile phone, running the Solana Mobile Stack SDK, which will be the first time a smartphone has full hardware-based crypto and web3 compatibility. So, the evolution of hardware wallets (and perhaps even their convergence with smartphones) is coming on in leaps and bounds.
SUMMARY & KEY TAKEAWAYS
- Cryptocurrency wallets are digital wallets for securely storing and managing digital assets, including cryptocurrencies and NFTs;
- Most crypto wallets are software wallets (referred to as “hot wallets”) that run on devices connected to the internet, whilst hardware wallets are designed for ‘cold storage’ to protect from online threats;
- Crypto wallets store private keys — which are the equivalent of access codes — to access crypto holdings;
- Crypto wallets allow users to participate in a decentralized economy, enabling peer-to-peer transactions without the need for financial intermediaries;
- Crypto wallets can be either custodial or non-custodial;
- Custodial wallets are managed by a third party and do not give the user full control over their crypto, whilst non-custodial wallets give the user complete control but require greater personal responsibility;
- Non-custodial solutions may be ideal for recreational use or serious retail investors, but present a single point of failure and are therefore not suitable for many institutions;
- Multisig wallets are another potentially non-custodial option that requires multiple signatories for a crypto transaction to be executed;
- Crypto wallets are increasingly used for additional use cases related to web3, including accessing decentralized applications (dApps), participating in decentralized organizations (DAOs), collecting NFTs, trading crypto, and buying and selling in-world assets (in the metaverse).
FINAL POINTERS
Considerations: When choosing a cryptocurrency wallet, consider factors such as security, ease of use, compatibility with the cryptocurrencies you want to hold, and the reputation of the wallet provider.
Security: Keep your seed phrase (which is the key to unlocking your wallet) safe and secure (and most importantly offline) — and be cautious of phishing scams or other security risks when using your cryptocurrency wallet.
Responsibility: Remember that you are solely responsible for the security of your funds in a non-custodial cryptocurrency wallet, so it’s important to be well-informed and take necessary precautions.
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