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How do cryptocurrency wallets work?

How safe is my cryptocurrency wallet?

Who doesn’t wish their wallet was full of Bitcoin? But even if it is, how safe is a cryptocurrency wallet?

Introduction

So, you’ve recently acquired some new cryptocurrency that you’ve stored in your cryptocurrency wallet. If you’re new to this space, you’ll likely have doubts regarding the security of your wallet. Through this guide, a breakdown will be provided to help you better understand how safe your cryptocurrency wallet is and whether or not your wallet is at risk.

Firstly, let’s evaluate what a cryptocurrency wallet is, before we arrive at a decision on how safe they are. It’s important to break down the different types since each one has its own benefits and drawbacks which make them either more or less suitable to your needs.

If you’ve never heard of a cryptocurrency wallet, in overly simple terms, it is a place where you ‘store’ your cryptocurrency. Though this is in the event that you only intend to hold on to it for a short while; for longer durations, you would do well to switch to a ‘cold wallet.’ A cold wallet just refers to an offline storage where you can keep your private keys securely.

A cryptocurrency wallet can be software; in this event, the wallet isn’t a physical, concrete item. One example of this is an ‘electronic’ wallet. A cryptocurrency ‘wallet’ in effect is no more than a metaphor; it is a simplistic way to think about it despite the cryptocurrency not actually being stored there.

Instead, public addresses are associated with transactions that have been added to the blockchain. Because of this, the wallet can then display the balances for you. From a more technical view point, they serve to store private keys, view balances, and create and sign outgoing transactions.

Electronic/software wallets

Electronic wallets can be either downloadable software or possibly hosted on a cloud-based service. A downloadable software wallet would live on your computer/device and facilitate transactions. Hosted wallets more often than not focus on user-friendly interfaces, but while they look aesthetically pleasing, you are placing trust in a third party to hold your private keys.

There are other types of software wallets, such as one where you might install it directly to your computer/device that grants you, the user, security over your keys. This is naturally safer than trusting a third party with your private keys, but you then have to make periodic backups. If you don’t and your computer/device is compromised or simply stops working, you would lose all of your cryptocurrency. Don’t forget that you can still be hacked with this type of wallet.

Hardware/offline wallets

However, not every cryptocurrency wallet is software based; as stated earlier, cold wallets are typically safer. Another type of cryptocurrency wallet could be as archaic as a piece of paper with a QR code split into two, with each piece hidden in a different location. As you could imagine, it would be a lot easier for a hacker to hack into your software-based wallet than get their hands on the two torn pieces of paper. But, if you lost the paper, or even just one half of it, you would find yourself in an unfavourable situation without access to your cryptocurrency wallet.

Another type of wallet is a hardware wallet. These are usually small devices that can, if needed, connect to the internet to engage in transactions. Hardware wallets are incredibly secure because they function offline, meaning they can’t be hacked unless you connect one to the internet. For instance, if you plugged it into a computer/device and suddenly that device became compromised, all you would have to do is unplug it straight away. Whilst they excel for being nearly unhackable, you have to be careful not to lose them or have them stolen.

Which type of wallet is the best?

Now that several types of cryptocurrency wallets have been discussed, each with their benefits and drawbacks, it should be becoming clearer that the safety of your cryptocurrency wallet is dependent on two factors:

  • Which type of wallet you choose to secure your cryptocurrency
  • How smartly you go about ensuring their protection

By far the safest option available is a hardware wallet because you begin to minimise the risk that your wallet can be hacked by an external party. But by no means does this guarantee that your cryptocurrency is entirely safe; you must take care to look after the hardware wallet and not lose or damage it. A way to minimalise heartbreak if this occurs would be to make a reliable backup of the keys, such as on multiple hardware wallets each hidden somewhere different but equally safe.

Serious investors in cryptocurrency may adopt an approach where they utilise more than one wallet. For example, they may have a cold wallet stored for their capital, but then own a spending wallet in which they may trade with or keep a spending balance in the interest of liquidity.

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