Just as you might store physical money in a wallet that you carry around, digital currencies use digital wallets for storage and payments.
Whether you want to speculate on bitcoin’s value, or need a place from where to send and receive coins, here’s all you need to know about bitcoin wallets and how they work.
Remember that cryptocurrencies are speculative investments where all your capital is at risk, meaning you might lose all your money.
Cryptocurrencies are unregulated in the UK and you will have no recourse to compensation if something goes wrong.
What’s in a bitcoin wallet?
The most important thing to note is that cryptocurrencies such as bitcoin are not actually ‘contained’ within crypto wallets. The ‘coins’ themselves are kept on the blockchain.
Remember, there is no physical representation of a bitcoin - they exist only as numbers on a screen. A bitcoin wallet thus contains the public and private keys to your bitcoin holdings, both of which are needed to carry out transactions.
A public key is best likened to a bank account number. On its own, it does not provide access to the assets in your wallet.
A private key is essentially a password in the form of a long string of letters and numbers that you keep secret. If someone gained access to both your private and public keys, they’d be able to spend your bitcoins or transfer them to other accounts without your permission.
Your wallet address is also a unique, alphanumeric string. It’s actually a ‘hashed’ version of your public key. Hashing is when you put data of any size into a hashing algorithm to produce an almost-unique alphanumeric string of text.
Since a public key is a very long string of text, hashing it makes it shorter and more shareable, which is why it’s used to create your bitcoin address.
To send bitcoins from your wallet, you simply log in, enter the recipient’s wallet address and input how much you want to send. To receive bitcoins, you simply share your wallet address.
Types of wallet
Wallets can be ‘hot’ or ‘cold’ and either ‘hosted’ or ‘non-custodial’. Here’s a look at the differences between the different types.
Hot wallets are those where your public and private keys are stored online, either with a crypto exchange like Coinbase, or a specialist provider. They’re known as ‘hot’ because they can be hacked over the internet, and indeed have been in the past.
Hot wallets can be either hosted or non-custodial. The former are wallets provided by an exchange (the place where you buy your crypto), for free. Providers of hosted wallets usually keep your private keys safe for you, which can save you lots of headaches if you forget the password to your account since the provider will be able to help.
Non-custodial hot wallets aren’t offered by exchanges and are managed entirely by you. This means you alone keep your private key. If you were to lose it, you’d be locked out of your holdings.
Cold wallets, sometimes referred to as hardware wallets, are physical storage devices that aren’t connected to the internet, but connect to a computer via USB.
Your private and public keys are stored within a cold wallet, and they’re safer from hackers as there’s no direct connection between their computers and your storage device. However, malware can be used to access cold wallets once they’re connected to a computer.
There’s no provider to offer support if you lose the recovery phrase necessary to access your cold wallet, so you wouldn’t be able to get your public and private keys - effectively locking you out of your bitcoin holdings.
You can also download wallets to your smartphone or desktop computer, but they’ll only be as secure as the virus and malware protection you have installed.
Choosing a wallet
When choosing a wallet, you should consider the level of security you’re comfortable with, the price you’re willing to pay for storage, and how much responsibility you want to take for your private keys.
Whether you’re looking at a cold wallet, a non-custodial hot wallet or a hosted hot wallet, it’s worth looking at customer ratings and reviews, particularly what people say about a provider’s customer service.