- What is a Crypto Wallet?
- Working of a Crypto Wallet
- Crypto Wallet Options
- Custodial Vs Non – Custodial Wallets
- Hot Wallet and Cold Wallets
- Hardware Wallet
- Multi-Sig and MPC Wallet
With the increasing awareness among the people about blockchain technology, more and more people are coming and exploring the industry. But one of the basic things one needs is the cryptocurrency to do any transaction on the blockchain or interact with the blockchain. This gives rise to the need for secure crypto storage solutions.
The widespread adoption of blockchain technology hinges on how easy and secure it is for users to manage their cryptocurrency wallets. Safeguarding digital assets has become increasingly important due to the recent industry development and the growing number of people entering the market. The security of a user’s cryptocurrency depends on how they choose to store them.
What is a Crypto Wallet?
A cryptocurrency wallet allows the users to interact with the blockchain network. They keep your private keys – the password that gives you access to your cryptocurrencies. Contrary to the wallets in the real world, the cryptocurrency wallets do not store the digital asset. The assets are stored on the blockchain. The wallets provide the users a gateway to interact with the assets stored on the blockchain. Using the wallets, the users can then check the account balance and make the necessary transactions.
It is kind of like a virtual wallet which is accessible on computers and smartphones. Similar to how we carry the money in a physical wallet, we use the crypto wallets to access the stored digital assets like NFTs, bitcoins and other tokens.
Working of a crypto wallet
Crypto wallets generate the information required for sending and receiving the cryptocurrencies through blockchain transactions. This involves using the cryptography concept of public key and private keys. We will talk about this in a bit. The wallet also generates an alphanumeric address using the public key and the private key to identify the correct wallet. This address gives the location on the blockchain where the coins can be received. Users can share this address and receive funds from other users.
To give some context about the public key and the private key, in the realm of cryptography, a key consists of a lengthy sequence of random and highly unpredictable characters. Public key is like a bank account number which can be shared with others whereas the private key acts like a bank account password. In cryptography, each public key has a matching private key. These pairs work together to perform the encryption and the decryption of the data. They ensure the security of our assets. The security and the privacy of your private key is of utmost importance.
Crypto Wallet Options
There exists a multitude of wallet options today to safeguard our digital assets. Each of them is uniquely oriented and is designed to cater to specific user profiles within the expansive decentralised network. Choosing the best wallet will depend on the users specific needs.
We have different bases on which the wallets are differentiated. On the basis of key-pair storage we have custodial and non-custodial wallets. On the basis of connectivity we have hot and cold wallets. On the basis of format we have mobile wallets, desktop wallets, hardware wallets and paper wallets. On the basis of the number of users in control we have multi-sig and MPC wallets.
Custodial Wallets Vs Non – Custodial Wallet
In the custodial wallets, the private key is stored with a third-party service provider (typically a cryptocurrency exchange). This means that the users effectively do not have full control over their wallets. Most of the web-based cryptocurrency wallets are categorized as custodial wallets. These are super convenient for newcomers to the crypto space as they are user-friendly and easy to use.
This arrangement requires the user to trust the service provider to securely store their tokens and implement robust security measures to prevent unauthorised access. The common security measures include the two factor authentication, email confirmation or biometric authentication. Many exchanges require the user to set up these security features before they initiate the transactions.
While using the non custodial wallets, users have the advantage of retaining complete control over their funds as the private key is stored locally on their device. Users need to write down and securely store a list of 12 randomly generated words (called as the seed phrase). This is the backup phrase which can be used in case the user loses the access to the device.
If the seed phrase is lost or compromised, the user will lose the access to their funds. Therefore it is strongly recommended to store the seed phrase in a highly secure location and avoid keeping a digital copy of it elsewhere. Users are themselves responsible for the protection of their own fund.
Hot Wallet and Cold Wallets
The main difference between the hot and cold wallets depends on their connection to the internet. Hot wallets are online and are connected to the internet. The private keys are stored and encrypted within the application, which is accessible online. Connectivity to the internet makes the wallets more readily accessible and easier for the user to trade and make the transactions. The downside to this type of wallets is that it is more vulnerable to potential hacking attempts; the computer network has hidden vulnerabilities that hackers or malware programs can exploit. Examples of hot wallets include web-based wallets, mobile wallets and desktop wallets.
On the other hand a cold wallet is not connected to the internet. They make use of “crypto-bridge” to receive transaction data offline, sign the transaction data and send the transaction data back through the crypto-bridge to broadcast the transaction online. It is inconvenient for most of the users, but it makes up for it by providing the extra security. They are offline and are less susceptible to online hacks. Examples of cold wallets include the hardware wallet, paper wallet.
These are Physical devices like USB sticks or hard drives. They are cold wallets, meaning isolated from the internet. Security is the highest priority of such wallets. Even the most powerful malware cannot sign a transaction on a hardware wallet to steal funds when the wallet is offline.
To initiate a transaction, a hardware wallet owner connects their device to a computer and uses a crypto bridge to transfer unsigned transaction data to the hardware wallet. The hardware wallet then signs this transaction data using its offline private keys and returns the signed data through the crypto bridge to be broadcasted online to the blockchain network.
To further enhance the security of the hardware wallets, they sometimes have a two-factor authentication or biometric authentication. These wallets are best suited for a risk averse person.
Multi-Sig and MPC Wallets
Single user wallets require the private key of only one user whereas the multi sig wallets require two or more private key signatures to authorise the transactions. Each authorised person will have one key and a sign-off requires the majority of keys. This makes the wallet more secure since if one key is lost to a malicious party, they still cannot make the transaction because the majority of the private keys are with the good person. This will also prevent the loss of wallet funds in case the private key of one person is lost, the funds can be recovered using another person’s key. This is a good option for hedge funds, exchanges and corporations.
MPC wallets use an off-chain cryptographic process called multi-party computation to break a wallet’s private key into multiple pieces and then give the key to different authorised users. They were essentially created to address the downside of multisig wallets. Once the contract is created, we cannot assign a more authorised number of users into the same wallet account. For a changing organisational team, this can prove to be a bottleneck. MPC allows for continually fractioning the private key and thereby allowing more people into the account as the organisational structure changes.
To ensure the safety of their funds, individuals must grasp the inner workings of their wallet accounts. These wallets rely on intricate processes involving record-keeping, connectivity, and cryptography to interact with the blockchain.
Wallets vary based on how they store private keys, connect to the internet, and authorise transactions, making it crucial for users to choose the one that aligns with their needs. However, there’s a tradeoff between convenience and security in current wallet options. Striking the right balance between these two factors is essential. In a decentralised system, it’s imperative to offer a variety of wallet options to cater to the diverse needs of users.