As DeFi moves to the forefront of innovation and adoption the understanding of How Crypto Wallet works is essential as crypto wallets have gained even more adoption because of their ability to store, swap, send and receive cryptocurrencies.
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What is a Crypto Wallet?
Crypto wallets store, send and receive cryptocurrencies while providing an easy-to-use interface to manage crypto balances. They support cryptocurrency transfers through the blockchain. Some wallets even allow users to perform certain actions with their crypto assets such as Interacting with decentralized applications (DApps) to enable swapping and more.
It is important to remember that coins displayed in your crypto wallet are just mere figures. The real funds reside in the Blockchain. Hence cryptocurrency transactions do not represent just the ‘sending’ of coins from your wallet to someone else’s.
When you are sending tokens, you are actually using your private key to sign the transaction and broadcast it to the blockchain network. The network will then include your transaction to reflect the updated balance in your address and the recipients.
A crypto wallet consists of two key pairs: private keys and public keys. A key is a long string of random, unpredictable characters. A public key is derived from the private key and serves as the address used to send crypto to the wallet.
It acts like your bank account number and can be shared widely, your private key is like your bank account PIN and should be kept secret. In public-key cryptography, every public key is paired with one corresponding private key. Together, they are used to encrypt and decrypt data.
How Crypto Wallet works
Blockchain is a distributed ledger technology that stores data in blocks. These are records of all transactions, the balances held at any given address, and who holds the key to those balances. Your coins on the other hand reside on the blockchain and the wallet protocol allows you to interact with the balances held on that blockchain.
The wallet itself stores addresses and allows its owners to move coins elsewhere while also letting others see the balance held at any given address with the public key.
While most Crypto wallets allow users to send, receive, and store crypto, some crypto wallets have additional features like swapping between tokens, staking tokens for a fixed return paid out to users, as well as access to DApps (decentralized applications) built on various networks.
Here are the general steps to sending and receiving funds using a crypto wallet:
To Receive Funds
You need to retrieve an address (i.e. your public key) from your wallet. Open the wallet if your tokens are not displayed on the home page, you can click on the wallet tab and click on one of the listed tokens then you’ll see two buttons send and receive. Click on the receive button to obtain your wallet address I.e your public key. Then copy the alphanumeric address and share it with the person who wants to send you crypto.
To Send Funds
You need the address of the receiving wallet. Locate the Send feature in your wallet and enter the address of the wallet you intend to send coins to. Select the amount of crypto you’d like to send, and click “Confirm.” You can consider sending a small test transaction before sending large amounts of crypto. Note that sending coins requires a fee that will be paid to miners in exchange for processing the transaction.
How Crypto Wallet works: Why Crypto Wallet is important
As with any type of currency, cryptocurrency can be accumulated and used for any number of different purposes and transactions. Crypto wallets serve a foundational role in enabling cryptocurrency to be functionally useful for individuals and organizations, much like a bank account is foundational for fiat currencies.
Crypto wallets are needed for several critical things that help to enable the practical utility of cryptocurrency. Some of the reasons why crypto wallets are needed include:
Cryptocurrency Management
Crypto wallets provide users with the ability to monitor a balance for cryptocurrency assets.
Transactions
Sending and receiving cryptocurrency payments is a key feature of Crypto wallets and one of the main reasons they are required.
Connection to decentralized apps (dApps).
In order to connect and interact with Web 3.0 DApps, a crypto wallet is required.
Username identities.
A blockchain is used to store all cryptocurrencies. A cryptocurrency wallet allows transactions to take place using a username that is linked to a public key address on a blockchain.
Key management.
On the blockchain, cryptocurrency exists as a public key address. A cryptocurrency wallet allows users to manage their private encryption keys, which are used to access a given address and enable a transaction.
Hot vs Cold Wallet
As an investor, the selection of a crypto wallet can be quite confusing especially if you’re new to Crypto wallets. if you buy any amount of Crypto you’ll have to choose between storing/holding it in a Hot or Cold wallet, or using a combination of both. The right type of wallet for you depends on your security preferences, and how easily accessible you need your funds to be.
Let’s find out what suits you!
What are Hot and Cold wallets?
Hot wallets
A “hot wallet” is a cryptocurrency wallet that is always connected to the internet and cryptocurrency network. They could be vulnerable to online attacks, which could lead to stolen funds. With hot wallets, you can trade conveniently. Its convenience and ease of use help to facilitate trade when interacting with centralized exchanges. Examples of hot wallets include exchange wallets like Coinbase, software wallets like Exodus, etc.
LEARN MORE: CRYPTO HOT WALLETS: HOW TO KEEP HOT WALLETS SAFE
Cold wallets
A cold wallet is typically not connected to the internet, so while it may be more secure, it’s less convenient. A cold wallet, also originally known as cold storage, because of its offline accessibility, helps protect the wallet from unauthorized access, cyber hacks, and other vulnerabilities that a system connected to the internet is susceptible to. Examples of the cold wallet include Ledger Nano X, Trezor Model T, etc.
LEARN MORE: CRYPTO COLD STORAGE EXPLAINED: WHAT IS IT? HOW IT WORKS
How Crypto Wallet works: A Combination of Both
When dealing with crypto wallets, you want to strike a balance between the accessibility of a hot wallet, and the peace of mind and security of a cold wallet, or employ both. When trading on a centralized exchange, you’ll need to use a “hot wallet” due to its convenience and ease of use in carrying out trades, whereas “cold wallets” are used to keep custody of your funds and when you want to invest in a cryptocurrency and hold it for an extended period of time.
Below is a detailed comparison of Hot vs Cold wallets.
| Comparison | Hot wallet | Cold wallet |
|---|---|---|
| User experience | Because they are already connected to the internet, hot wallets tend to be the most convenient for users. | There is no additional step of connecting the wallet online in order to facilitate a transfer of tokens. |
| Security | Because they are connected to the internet, they could potentially be vulnerable to hacking. | They can’t be accessed online, but they require security measures to keep them from getting damaged, lost or stolen. |
| Ease of Use | Hot wallets are easily accessible as the wallet is already internet-connected. | Cold wallets require an extra step to connect online through USB, Wi-Fi or QR code. |
| convenience | Hot wallets are convenient to access and use for trading. | Cold wallets are better suited for long-term storage. |
How Crypto Wallet works: Crypto Wallet vs Exchange
Cryptocurrency wallets and exchanges are two important tools that allow this revolutionary digital industry to function properly. The key difference between a crypto wallet and an exchange is that the wallet’s main purpose is to safe-keep your digital assets, while the exchange is there to facilitate trading from one coin to another.
Since exchanges are there to conveniently trade cryptocurrency, storing your cryptocurrency there might be convenient for a short period of time. However, it is highly recommendable to ultimately transfer funds to a wallet where the user is responsible for securing, backing up, and managing his/her own funds.
This is where knowing the difference between a crypto wallet and an exchange comes in handy. With a wallet, you maintain full control over the use and transfer of funds. You decide when and where to transfer your cryptocurrencies, and you keep hold of all the necessary passwords and private keys.
On the other hand, when your digital funds are kept in an exchange account, sometimes referred to as an exchange wallet, you hand out part of that overall control to the platform.
For more information about exchanges, you can check out this article on How Centralized exchange works
Is Crypto Wallet Safe?
Wallet safety is essential, as cryptocurrencies have become high-value targets for hackers due to the transparency of blockchain technology.
Some safeguards to using a crypto wallet include encrypting the wallet with a strong password, or your fingerprint, enabling two-factor authentication for exchanges, and storing any large amounts you have offline in cold wallets.
How Crypto Wallet works: Conclusion
Storing cryptocurrency, like any valuable asset, necessitates a personal decision about how to best safeguard it while striking the right balance between functionality and security.
Those who prefer to keep personal custody of their own cryptocurrency are increasingly storing funds in cold wallets.
Those who use a crypto exchange wallet to store the majority of their funds must use an exchange with a good reputation for security and adhere to its security recommendations.
