How Do Cryptocurrency Wallets Work?
Buying cryptocurrency in NZ through us is very easy, but what about storing your chosen coin? In this brief overview, we will dissect the ‘cryptocurrency wallet’, compare the different types of crypto wallets, showcase your storage options and then finally provide a recommendation on the safest way to stash your assets.
What is a cryptocurrency wallet?
As you probably guessed, yes, a crypto wallet is somewhere you store your crypto. These wallets come in various shapes and sizes, and range from moderately safe to virtually bulletproof. When you create a wallet address you generate a pair of keys. These keys are known as your public key and your private key, which are essential to use your wallet to send and receive your chosen crypto.
The public key is used to create a wallet address that you can give to anyone so that they know where to send you crypto. So if Harry has 2 Bitcoin and he wants to send it to Alan; Alan will give Harry his wallet address. The wallet address is created by a technical process known as ‘hashing’ the public key. Hashing basically means creating a cryptographically verifiable address that is linked to the public key. Bitcoin wallet addresses usually look something like this: 3MC225JdvawP2zqWyQ4RUAk5B5hTZxdmf5
At the same time a private key is generated upon wallet creation. The private key is what allows an individual to access their cryptocurrency. The private key is a long string of numbers and letters generated when you create your wallet. In the case of Bitcoin, it will look something like this: 5Jh4yhYWF9sVjLbHVnCUsanagkdmXewihSsuKUvdhiobcT5diw9
Think of your private key as your P.I.N number to your bank account. It must be kept completely safe and away from prying eyes.
Hot wallets v. cold wallets
Hot wallet: A hot wallet is considered any wallet that has a connection to the internet.
Cold wallet: A cold wallet is considered any wallet that has no connection to the internet. E.G saved on a USB stick in your drawer or printed on a piece of paper.
What is safer?
It is safer to store your cryptocurrency on a cold wallet wherever possible. This makes it impossible for someone to access your encrypted private key without physically having access to the wallet itself. The only downside is that as cold wallets are not connected to the internet you can’t easily send or spend your crypto. If you are wanting to make frequent transactions it is a trade-off between speed and security.
We have a guide on setting up a cold storage system using KeePass, which is a very secure and easy way to set up your cold wallets.
Hardware wallets vs Software wallets
A hardware wallet is a special type of crypto wallet that stores the user’s private keys in a secure offline hardware device. An example of this would be a USB wallet like the Trezor or the Ledger Nano S. In simple terms, the private key to your wallet is stored on the hardware wallet, which gives you access to your funds when required. As mentioned above, a hardware wallet is a type of ‘cold’ wallet which is the safest option for storing your crypto.
A software wallet works exactly the same as a hardware wallet, however instead of storing your encrypted private key on a device, it will store it on a secure server, hidden behind a passphrase that you use to login with. Most people also use 2FA with a mobile device to double login security. An example of this would be a cold software wallet like Exodus. Exodus is a great all-round wallet option – you can read more in our review of the Exodus wallet.
A web wallet is a wallet that is stored inside a website such as an exchange like Binance or Kiwicoin. Storing assets on exchanges or web wallets are necessary for people trading through exchanges, but an unnecessary risk to others who just want to hodl. Issues with web wallets are that you do not hold the private keys to your wallet – the exchange does. So you are handing over some trust that they will do the right thing by you.
In 2014, Mt Gox, a Japan-based exchange that at the time handled 70% of all bitcoin transactions, was hacked. (When we say hacked, Bitcoin itself wasn’t hacked, passwords to access the private keys of the exchange were stolen, allowing the hackers access to their wallets). This resulted in their users and personal business accounts losing about 740,000 bitcoins (6% of all bitcoin in existence). That equated to 780 million dollars at the time of the heist, as was the equivalent to 5.6 billion NZD at the market’s all-time high.
There a several ways that the security of your assets can be compromised when stored on an exchange:
- Your computer is hacked or your lose your password.
- Your exchange’s remote server is hacked.
- Your exchange goes bankrupt.
- The FBI or other authorities seize the exchange servers.
- There is a software bug in your wallet.
- An unauthorised person accesses your smartphone or computer while you are logged in.
A paper wallet is another type of ‘cold’ wallet because it is stored offline and keeps your private key safe so you can access your crypto when required. To spend the Bitcoin on your paper wallet, you need to open up a hot wallet and ‘sweep’ the address to move the coins from the paper wallet into the new wallet.
Storing a private key on a paper is quite secure but extremely inconvenient in use. Moreover, you will have to enter your private key in one of the wallet types described above to make a transaction.
So what wallet should I use?
The best wallet for you will depend on how much crypto you are storing, how accessible you want it to be, and your own preferences e.g. whether you feel safer with something stored physically or electronically.
Our top three picks for the best crypto wallets are:
1. A high-quality cold hardware wallet like a Ledger Nano, is an excellent option for long term storage. Make sure that you safely store your passphrase, and then even if you lose the physical device you can simply re-install your old wallets on a new Nano. Phew! You can browse the Ledger shop here.
2. If you want to use a hot wallet for frequent sending and management of your portfolio, take a look at Exodus – free a multi-currency wallet that can be found here.
3. Or if you want both cheap and safe, go DIY with our guide to setting up your own cold storage system.
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