What is a crypto wallet and what does it do?

Like a physical wallet, a digital wallet can hold your currency, in this case, cryptocurrency. And since your digital currency exists nowhere but in the decentralized electronic network that manages and tracks it, your digital wallet must be able to interact with that network.

While experts use the term “wallet” to describe what secures your crypto assets, it might be more accurate to think of it as a (heavily fortified) address to which your money is accounted. So in a crypto’s distributed ledger – like a long-running receipt of all the transactions in the currency – a wallet says “Any assets directed to this address belong to the owner of this wallet.”

In a general sense, you couldn’t have crypto coins without a wallet. There’s simply no place to put your cash. So even exchanges such as Coinbase and payment apps such as CashApp and PayPal provide a basic wallet for transactions, even if it doesn’t meet the needs of heavy users.

And there are differences between investing in crypto, where the exchange moves and holds the asset, and actually transacting in a cryptocurrency, where a wallet is needed to send and receive money. In the former, the onus to maintain the asset remains with the custodian, while a specialized wallet gives the end user the ability – and the responsibility – to safeguard the asset.

Advantages of Crypto Wallets

A digital wallet gives you a place to collect payments and acts as a place to store your payment keys so that you can send crypto coins to others. In this first regard, it’s similar to other digital wallets such as CashApp, PayPal, or Venmo, which you may already use for regular currency.

A specialized wallet allows users to take possession of coins themselves. In this sense, holding a wallet at an exchange could be likened to keeping your money at a bank, whereas having your own specialized wallet would be like locking down your currency in your own possession.

What separates the specialized payment wallets listed above from more basic ones is a higher level of security and other features that appeal to users with greater demands (or fear). These wallets are not controlled by a third party and so are not subject to the same large-scale threats, such as mass hacking and fraudulent custodians who abscond with their client’s assets.

This setup means that you – and you alone – may be responsible for maintaining your holdings. Many see this as an advantageous feature since you needn’t rely on a third party for custody.

Disadvantages of Crypto Wallets

But the lack of a third party is a knife that cuts both ways, at least when it comes to accessibility.

Again, the wallet metaphor is useful, at least partly: If you drop your real-life wallet, the money may simply disappear, perhaps due to a thief. In the case of a crypto wallet, you may lose the wallet itself, which may be a physical object, or you may lose your wallet’s password, rendering your ownership of the stored currency moot. Either way, you may ultimately lose your crypto.

If you’re using a hardware wallet, it could be subject to physical issues, such as degradation or potentially the destruction or incapacitation of the device via some other means.

A crypto wallet, depending on what kind, may create further problems, in terms of friction, in actually using your cryptocurrency. Some wallets may not be able to transact with certain kinds of coins, while others may be literally offline – making coins near-impervious to electronic theft, but also useless as a means of exchange, though they can later be shifted to a wallet for use.

Some wallets, such as mobile wallets, are better for actual payments on the go, while others, like desktop wallets, are decidedly less amenable to paying for merchandise when you’re out.

And finally, there’s the issue of convenience when it comes to payments. Anything that hinders the payment process beyond the swipe or tap of a credit card may make a wallet less useful.

What types of crypto wallets are available?

Broadly speaking, crypto wallets come in two broad categories: hardware wallets, or cold wallets, and software wallets, or hot wallets.

Hardware wallets

A hardware wallet is a wallet that relies on a physical device to secure your cryptocurrency. In the physical sense, it’s closer to a real wallet and looks something like a USB thumb drive. It contains the cryptocurrency keys that allow you to transact in the currency, effectively to own it.

The main advantage of this wallet is that it is not connected to, or rather can be disconnected from, the internet. So without a connection, your coins are not easily subject to electronic theft. But they’re still vulnerable – to loss of the wallet, to physical theft, and loss of the password. When you need to move money, you can plug in the wallet to your computer and transact.

So a hardware wallet is designed really for safekeeping and less for transactions, and thus it’s called a cold wallet. Popular makers of hardware wallets include Trezor T and Ledger Nano X.

Software wallets

In contrast, a software wallet relies on software to secure your cryptocurrency. Software wallets are less secure generally than hardware wallets because they’re connected to the internet. But they’re also meant to be used, as you go about paying for things, so they’re called hot wallets. As you would for a physical wallet, you might want to carry only what you intend to spend.

Bottom line

The world of cryptocurrency and Bitcoin is new and wild. As you’re looking for a digital wallet, make sure you’re clear on what you want. With potentially a lot of money at stake, you want to feel confident in whatever solution you choose, and more importantly, it has to meet your needs.