What’s a blockchain wallet, and how does it work?

If you're new to crypto trading, chances are you've recognised the significance of a digital or blockchain wallet when it comes to storing, managing, and safeguarding your crypto assets. But what precisely is a wallet, and how does it ensure the security of your cryptocurrencies?

Let's explore the core principles behind blockchain wallets, their functionality, and the various types of wallets accessible in the market.

Blockchain wallet explained

A blockchain wallet serves as a digital vault for securely storing your cryptocurrencies and other digital assets. Since cryptocurrencies exist as unique forms of assets on the blockchain through cryptographic methods, they cannot be held in a conventional bank account. Hence the importance of blockchain storage becomes paramount, providing a platform for the safekeeping and trading of crypto.

Unlike traditional wallets, crypto wallets do not store physical currency or rely on centralised institutions. Instead, they harness the power of distributed ledger technology (DLT), which establishes a decentralised system for recording all transactions across a network of computers in a secure and transparent manner.

However, it's important to note that a wallet does not directly store cryptocurrencies. Rather, its purpose is to safeguard the private key associated with your crypto assets. This aspect often proves to be the most perplexing for beginners trying to grasp the concept of digital wallets.

Now, let's delve into how these virtual wallets function and ensure the security of assets through private keys.

How does a blockchain wallet work?

To understand how wallets function, it is essential to grasp the various components of storage involved. These components primarily include a public key and a private key. Think of the public key as analogous to your bank account number. Your blockchain wallet address is derived from this key, and you can freely share it with others to enable them to send cryptocurrency to your address.

A public key or address's primary purpose is to indicate your assets' specific location on the blockchain ledger.

Conversely, the private key is akin to the password for your account, comprising a 256-bit number consisting of 64 digits and alphabets. This key grants access to your assets on the blockchain. Given its significance, it is crucial to protect the private key diligently, as anyone who gains access to it could manipulate your crypto.

Consequently, a wallet secures your cryptocurrency by safeguarding the private key, which grants access to your assets.

The different types of blockchain wallets

Blockchain wallets can mainly be categorised in two ways; the first is based on their warmness, and the second one is their custody. Now, let’s find out what the warmth and custody of crypto storage refer to.  

1. Warmness: Hot vs. cold wallets

The warmness of a crypto wallet refers to the ratio between the convenience and security of a wallet. The main feature that decides convenience and level of security is the availability of the internet. Based on this, crypto storage is divided into hot and cold. 

When cryptocurrency storage is always connected to the internet, it will be referred to as a hot or software wallet. These wallets make trading cryptocurrencies easy, as you can access your assets from anywhere. Some examples of hot wallets include MetaMask, Trust, and Coinbase Wallet. 

In comparison, there are cold wallets, which are hardware storage devices for keeping digital wallets. These devices can work offline, which makes them less vulnerable to cyberattacks. Some of the best cold crypto wallet options include Ledger Nano X, Trezor Model T, and Safepal 1. 

2. Custody: Custodial vs. non-custodial wallets

The second categorisation of cryptocurrency storage is based on custody. The custody of cryptocurrencies refers to the actual ownership and control over the assets. Typically they fall into two types that are; custodial and non-custodial wallets. 

A custodial wallet is usually offered by the cryptocurrency exchange or brokerage itself. These wallets are simple to use and let you start with crypto trading easily. However, the control and custody of your assets remain with the provider.

On the other hand, there are non-custodial wallets that enable greater control over your assets. You are responsible for protecting the private key and can trade your assets anytime. For an example of the differences between custodial and non-custodial wallets, compare the Coinbase.com storage with the Coinbase Wallet. 

Is a blockchain wallet safe?

A blockchain wallet is widely regarded as a secure method for storing and managing digital assets. DLT introduces a range of security measures that inherently safeguard against tampering and fraud. However, it's crucial to acknowledge that different digital wallets provide differing levels of security and convenience. Consequently, selecting a wallet option that meets your specific requirements is vital.

To ensure optimal security, it is recommended to consider the "hotness" or "coldness" of the storage. Incorporating both types of wallets into your strategy allows you to maintain security while keeping up with your daily trades. Additionally, implementing security measures such as setting up two-factor authentication (2FA), exercising caution with unknown sources, regularly backing up your wallet, and updating the wallet software can significantly enhance security.

By adhering to these practices, you can further bolster the security of your digital assets and fortify your overall wallet protection.