When Bitcoin's developer, Satoshi Nakamoto who owned the first crypto wallet became successful in sending American software developer and second crypto wallet owner Hal Finney, 10 Bitcoin as a test, the cryptocurrency craze kicked off.
That was back in 2009. Today, there are a huge number of users in the crypto world, whose numbers are still expanding to this day.
However, as with any bright development, obstacles are bound to grow. This year kicked off with a series of wallet hacks where many crypto users lost millions of funds and never recovered them. One famous example is of founder of Proof, Kevin Rose, who lost over $1 million worth of NFTs to a wallet compromise in January.
There are several other examples if you search the net but we will leave it at that. Today, let’s understand what exactly crypto wallets are, why are they important and how exactly are they secure.
Basically, a cryptocurrency wallet is an application that performs as a wallet, but for your cryptocurrency. Instead of holding physical currencies, like cash or credit cards, it stores the passkeys one uses to sign for their cryptocurrency transactions and provides the interface that allows them access to one’s crypto.
Cryptocurrency wallets are software applications that enable one to store and use cryptocurrency through computers or mobile devices such as phones or tablets.
In order to access the blockchain network for the cryptocurrency one is using, an internet connection is required.
What makes cryptocurrency wallets so different is that, unlike physical currencies, cryptocurrencies are not actually ‘stored’ anywhere. In reality, they are small chunks of data that are stored and scattered all over a database. The crypto wallet seeks out all of these chunks associated with the user’s public address and sums up the amount for them in the app's interface.
Through these applications, one can easily send or receive cryptocurrency from one’s wallet using different kinds of methods.
Just like any other currency, cryptocurrency can be accumulated and used for several different purposes and transactions. What a crypto wallet does is serve a fundamental role in enabling crypto assets and cryptocurrency to be functionally useful for their users –be it individuals or organizations, similar to how a bank account is foundational for Fiat money.
Crypto wallets help to enable the practical utility of cryptocurrency, such as:
Users are provided with the ability to monitor a balance for their cryptocurrency assets.
One important feature of crypto wallets is sending and receiving cryptocurrency payments.
As cryptocurrencies are stored on a blockchain, a crypto wallet allows transactions with a username that can be linked with a public key address on a blockchain.
As we know, there are two main types of wallets- custodial and noncustodial.
A custodial wallet is hosted by a third party that stores your keys for you while in noncustodial wallets a user is responsible for one’s own keys.
Aside from the main, there are two subcategories of wallets- hot and cold. The difference between the both is simple. A hot wallet has a connection to the internet or to a device that has a connection, while a cold wallet has none. Lastly, there are three other subcategories software, hardware, and paper. And each one is considered either a hot or cold wallet.
Therefore, one can have a noncustodial software hot wallet, a custodial hardware cold wallet or a noncustodial hardware cold or hot wallet. These are some of the most common types.
Now that we know about the types of crypto wallets there are let’s look into their safety risks:
Perhaps the biggest risk when it comes to custodial wallets is vulnerability to exchange hacks and the custodian becoming bankrupt. Though experienced exchanges will usually hold most of their coins in cold storage, have complicated measures, and use complex firewalls, they are still not immune to attack.
In 2019, through an orchestrated attack using scams and viruses against the popular Binance exchange, hackers stole $40 million of Bitcoin. Moreover, as seen with centralized finance lending platforms and exchanges such as Voyager, and FTX, these institutions may freeze accounts and withdrawals if they face liquidity issues. Yes, relying on third parties is easy, however, it has its own risks.
Non-custodial wallets usually have fewer backup and recovery options than custodial wallets. This is so because the user is solely responsible for backing up and recovering their crypto wallet.
The biggest risk in a non-custodial wallet is perhaps that since the security depends entirely upon the user themselves, people as they regularly fall victim to phishing scams, end up losing many assets from their crypto wallet.
Between 2019 and 2020, it was found that hackers stole over $22 million of Bitcoin from Electrum wallets by sending users fake messages.
Yes, money has now evolved to crypto, and perhaps is the new currency now. However, one should still be careful in choosing the type of crypto wallet that they will be using in the future.