How Do the Different Types of Crypto Wallets Work?

Aug 21, 2022, 6:56PM
4 min, 51 sec READ
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Crypto wallets allow you to receive, store and send your digital money by storing the keys that point to your assets on the blockchain.

A crypto wallet is a software-based or digital device that enables users to access cryptocurrencies. Digital currency is unlike fiat, where you keep the notes and coins in your pocket and can see your balance in each currency online. It is only available in a digital format and must be kept in a way that it can be recognized by other stakeholders in the marketplace.

Unlike your traditional wallet, a cryptocurrency wallet does not store your crypto assets. Instead, it stores the credentials of the assets, called private keys. These keys give you access to the assets held on the blockchain.

What You Can Do with a Crypto Wallet

A crypto wallet can send, receive, and pay accounts. You only need to have the recipient's wallet to send all payments with crypto. On the other hand, you need to give the sender your wallet address to receive cash from them:

  • Store crypto: Most crypto wallets allow you to store different types of coins in one place. If you transact with different coins, you do not have to open a wallet for each one.
  • Create a digital vault where you are the only one with access.
  • This allows you to interact with web3 applications that allow you to lend money and borrow against the crypto assets that you hold.
  • Sell, buy and store any NFT
  • Earn coins from any of the crypto rewards accounts that you may be working with.

Crypto Wallets – How do they Work?

There are three parts to the crypto wallet, including a private key, a public key, and a public address to receive your assets. Whenever you are sending crypto, you must sign in with a private key and then confirm the transaction. When you confirm the transaction, you sign the transaction. The digital signature becomes the unique fingerprint used to confirm the transaction. It also proves that the transaction has come from the legitimate owner of the wallet and cannot be tampered with on the way.

Differentiating between Public and Private Keys

All crypto wallets start with a private key. This key is long and randomized and contains a string of numbers and letters. The key can be a mnemonic phrase or the QR code. The wallet uses this key to generate a public key by encrypting it. It is easy to verify if a public key matches a private one. However, you cannot reverse-engineer the keys to determine the codes for either the public key or the private one.

This technology is called "trapdoor" encryption. It is one-way encryption that allows crypto wallet users to share their addresses with anyone without worrying that someone may have a look at their private key and access their cash illegally.

In addition, the public key then undergoes a mathematics function that compresses it to an address that would receive cash. The receiving address is usually in the form of QR codes created by secure QR code generators or a shorter string of numbers and letters. This is where your senders put the money. One private key can generate several public keys, each with its own address. You can then use each to ask for money from different people.

The requirement of generating keys is not a requirement every time you want to buy or receive cash. It is generally stored in the app and does not require your involvement in any way.

Are Crypto Wallets Secure?

Yes, crypto wallets are secure as long as you take the right steps to prevent access. These wallets rely on cryptography, the science behind protecting data using codes and puzzles called ciphers. When you sign a transaction using your private key, the blockchain network is able to check and determine that the details are correct without disclosing the privacy of the information.

Crypto wallets can manage the keys for you so that there is a lower risk of losing the information. However, remember that anyone with access to the private key can access your cash and move it away. Therefore, it is important to keep the key private.

Types of Crypto Wallets

There are two types of crypto wallets: custodial and non-custodial.

Custodial Wallets

Custodial wallets are also called trading accounts. They are a means of trusting your private key with a third-party provider such as a crypto exchange. It offers an easier method of accessing and transacting with your crypto, especially for beginners.

These wallets cannot access decentralized finance or web 3 applications. However, they are more familiar with users who make investments with custodians. These custodians apply identification methods like Know Your Customer and Anti-Money Laundering systems.

Non-Custodial Wallets

These wallets are also called "private key" wallets. They give you full control over the private and public keys. In essence, the holder is their own bank and can do anything they wish with their cash. They can also use the wallet to access decentralized finance or web3 applications.

It is unfortunate that there are no ways to determine that anyone operating the non-custodial account is being operated by the person who owns it. Besides, it is also possible to lose private keys by losing the wallet details or through an online scam, which could lead to a loss of funds.

Pick the crypto wallet that meets your needs. If you are just getting started, go for a custodial one as it has a better user experience and additional security measures.

You can use any of the crypto wallets to transact online. Many of the e-commerce platforms today accept many of the leading digital currencies. Several gambling platforms also accept this type of currency. If you wish to start gambling on such platforms, check out the crypto gambling guide for more information.

Disclaimer: information contained herein is provided without considering your personal circumstances, therefore should not be construed as financial advice, investment recommendation or an offer of, or solicitation for, any transactions in cryptocurrencies.