Table of Contents
- Bitcoin wallets generate and store a users keys, allowing them to easily send and receive bitcoin, track their transaction history, and check their balances.
- Wallets come in the form of hardware devices, software applications, and online, custodial services.
- Hot wallets connect to the internet, offering easy access. They should be used to store small amounts for spending.
- Cold wallets offer greater security by staying isolated from other devices and the internet. They should secure larger balances that do not need frequent access.
Introduction To Bitcoin Wallets
What Is a Bitcoin Wallet?
A Bitcoin wallet is a device or service allowing a user to secure and manage their Bitcoin. There are many different types of wallets but are all responsible for two things:
- Store the user’s public and private keys. A public key is used to receive payments while a private key is used to send payments
- Facilitate transactions, i.e. the receiving and sending of bitcoin
All bitcoin is recorded on Bitcoin’s blockchain. A wallet does not physically or digitally store a user’s bitcoin, but stores a user’s combination of private keys and public keys allowing the user to transact on the Bitcoin network and check their balances. //: # (TODO: uncomment this link when private key article is published.)
What Are The Different Types of Bitcoin Wallets?
Wallets are divided by two defining characteristics: whether they are a hot wallet vs. cold storage, and whether they are custodial vs. non-custodial. Choosing a wallet will depend on how often a user plans to move bitcoin and requires making a trade-off between security and convenience.
Custodial vs. Non-Custodial
A wallet being custodial means that the user’s private keys are held by a third party, such as an exchange. The third party has full control over the user’s funds while the user only has the permission to send and receive bitcoin. In other words, the user cannot perform a transaction without the third party’s permission.
A wallet being non-custodial means that the user has full control over their funds and the associated private keys. In this scenario, a user is their own bank.
A hot wallet is perhaps the most convenient wallet used and includes web, mobile and desktop wallets. Its key feature is that it is always connected to the internet and allows a user to send and receive on demand.
Keeping a large amount of bitcoin in a hot wallet is considered a poor security practice by many. By being connected to the internet, the wallet is vulnerable to attack by hackers or malware. This is true of any device with an internet connection. However, not all users want to personally hold responsibility for the security of their keys. In a case like this, using a hot wallet with a custodian, like an exchange or Bitcoin custodial service, is the most secure solution.
Exchanges will often keep a small amount of bitcoin in a hot wallet in order to offer immediate withdrawals to its clients, while keeping the majority of its bitcoin offline in cold storage.
Unlike hot wallets, cold wallets generate and store a user’s private keys in an offline environment. Because they are never connected to the internet, the threat of an attacker gaining digital access to a user’s keys is significantly reduced. The only way an attacker can access your private keys is through physical means.
However, cold storage is not without its drawbacks. Because it is a non-custodial solution, i.e. the user does not allow a third party to hold control over their keys, the user is completely responsible for the security of those keys. If their device is stolen and they lose their seed phrase for example, they have no third party to lay a claim with. In contrast, with a custodial wallet like a web wallet used on an exchange, funds can still be recovered if a user loses their device or password. This is similar to any other web service where a user’s account is backed up in a company’s database and can be recovered. For a user not familiar with bitcoin technology, or even someone who is but would prefer a third party to be liable for their funds, a custodial hot wallet is often the best solution.
The most commonly used form of cold storage is a hardware wallet.
A hardware wallet is a small, portable device, that keeps a user’s keys isolated from the internet at all times. To transact, a computer and the manufacturer’s application are required in order to keep the private keys offline.
Some advantages to using a hardware wallet include:
- Hardware wallets are immune to digital attacks to which a system that is connected to the internet is susceptible.
- A hardware wallet ensures that a user’s private key is never given to a third-party wallet provider or software that could be vulnerable to a virus attack or theft.
- Hardware wallet software is often open source. This allows users to validate the entire operation of their device.
What if I lose my hardware wallet? Wallet software will generate a seed phrase, in the form of a list of words, and instruct the user to write it down on paper. As long as a user stores a copy of their seed phrase in a safe place, they will be able to restore their wallet on another device.