What is a Cryptocurrency wallet, and How does it work?

April 22, 2022

Welcome to Soldex academy, your number one source for crypto and DeFi education. In this article, we will reveal what a cryptocurrency wallet is, how it works, and the different types of wallets we have. However, we will start with what a cryptocurrency wallet is not. Contrary to popular opinion, a cryptocurrency wallet is not a wallet where you store your crypto assets.A wallet ordinarily means something that stores money, right?

Well, in cryptocurrency, a wallet doesn’t store your currency. Your crypto assets never leave or enter your wallet; they don’t get stored in any single location. They exist on the blockchain. When a person sends you crypto assets, there’s no exchange of coins; what happens is that the person signs off ownership of their coin to your wallet. The transaction is signified by a change in balance in your crypto wallet. To understand a cryptocurrency wallet, you’d have to compare it to a keychain rather than a conventional wallet. Now let’s explain what a crypto wallet is. A crypto wallet is a tool you can use to interact with the blockchain network.

How do crypto wallets work?

Just like we said, crypto wallets don’t store your crypto assets; they only provide keys and addresses you need to interact with the blockchain. Let’s explain this using a real-life example. Imagine you want to send money to your friend, Bella, in Mexico but don’t want to go through the traditional finance medium like PayPal or Western Union because of their insane rates. So you buy some SOL and ask your friend to set up a crypto wallet so she can receive the assets. She creates a crypto wallet to receive the payments from you. Her wallet will generate different pairs of public and private keys and different blockchain addresses. But for the sake of this illustration, we’d consider just a single blockchain address and a pair of keys.

Her wallet generates a public key and a private key.

Her public key is used to generate a new SOL address.

This is the address that she sends you.

You then send SOL to her wallet.

Remember that the coins are not literally transferred from a wallet to another. What happens is that you sign off your ownership of the coins to her. Then a change in the balance of SOL in both your wallet and hers signifies a successful transaction. Bella can only access her funds using her private keys. So even if she loses her phone or computer, she can simply use her private keys to access her coins on a new device. Bella can also use her private keys to recover her public keys and blockchain addresses. However, if anyone gets to know Bella’s private keys, they’d be able to take her assets. The private key is the most important part of a crypto wallet and should be kept safe and private. So Bella uses her public key to generate crypto addresses to receive money from her friends. But she uses her private key to access and monitor her funds.

Note that different cryptocurrencies have different address structures. A bitcoin address is different from a Solana address which is different from an Ethereum address. So a wallet is basically a tool that provides you with public and private keys to interact with the blockchain. Also, note that most crypto wallets make use of a seed phrase. A seed phrase works like a master key that unlocks other private and public keys. A seed phrase gives access to all other keys and addresses in a wallet. So instead of safeguarding her multiple private keys, Bella only needs to safeguard her seed phrase.

Types of Crypto wallets=

Now that we’ve learned how Crypto wallets work, let’s consider the different types of crypto wallets and how they work. A crypto wallet can either be software, hardware, or paper.

Software wallet

A software wallet is an online-based wallet. It can either be:

–     A web wallet

–     A desktop wallet or

–     A mobile wallet

With a web wallet, you can easily communicate with the blockchain through your browser. So you don’t need to download or install any software or app on your PC. A Desktop wallet is an app or software you must download on your PC to interact with the blockchain. A mobile wallet is similar to a desktop wallet. The only difference is the apps are optimized for just mobile devices. Desktop and mobile wallets are generally safer than web wallets.

Centralized exchanges like Binance or Kucoin are software wallets. Your public and private keys are stored on the servers of these exchanges. These exchanges let you access your wallet through your account on their server. Technically, they’re in control of your public and private keys. Now it’s important to know that Software wallets are the least secure cryptocurrency wallets. This is because they are connected to the internet, so there’s a risk of being hacked by scammers. However, software wallets are convenient for frequent users and traders because funds are quickly accessible and they’re easy to set up.

Hardware wallet

Another type of crypto wallet is a hardware wallet. A hard wallet is basically a USB stick that stores your private and public keys. They have no connection to the internet, so there’s no risk of being hacked or scammed. You can simply plug them into any available PC, input your seed phrase and password, and perform your transactions. When you’re done, you unplug them. Hardware wallets are much safer than software wallets and are convenient for long-term investors.

Paper wallet

The last type of wallet is the paper wallet. This wallet is simply a paper with your public and private keys, usually as a QR code physically written on it. You can generate and print a paper wallet and then transfer funds by typing in the keys or scanning the QR code. A paper wallet is the most secured type of crypto wallet; however, it has a major disadvantage. A paper wallet is only suitable for sending the entire balance of your crypto asset all at once. So its use is discouraged. There’s also the risk of losing the paper.

Another important factor to note is crypto wallets can either be hot or cold. A hot wallet is any crypto wallet that is connected to the internet, like software wallets. A cold wallet or cold storage is any crypto wallet that uses a physical medium to store public and private keys. They have no connection to the internet. Examples are hardware and paper wallets. In conclusion, most crypto wallets are software wallets because of their convenience; however, cold wallets like hardware and paper wallets are the most reliable forms of crypto wallets. Each wallet type has its pros and cons, so it is necessary to understand how they work before adopting each one.

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