How are cryptocurrency wallets structured?

Safe Cryptocurrency Storage

Buying cryptocurrency isn't enough, it's important to learn how to store it properly so it doesn't fall into the hands of hackers or scammers. Safe storage of cryptocurrency is a key aspect to protecting your digital assets.

One of the main and most effective ways to protect your assets is to spread them across different wallets - diversification. By spreading your assets across different wallets, you can keep yourself as safe as possible. This approach is comparable to opening several bank cards in different institutions: in case something happens to one account (it was blocked, you lost your card or someone stole it), you realize that you will not be left without funds, as you have several cards at your disposal.

When someone fraudulently gets to the wallets that hold assets, the user understandably has a desire to save at least something. Distributing assets to different addresses will help the user, even in the event of a hacker attack, to save some of their funds and not be left on the fence at all. Cold wallets are considered to be the safest - we will talk more about them in the following sections, but even if you have a cold wallet, it is still recommended to keep not all your funds and assets on it.

Any cryptocurrency wallet is software that interacts with various blockchains (Bitcoin, Ethereum, and others). This interaction allows the user to create a public address in the blockchain (it can be called something like an account) and make transactions with one click. The cryptocurrency wallet acts as a buffer between the user and the blockchain.

For a proper understanding of how cryptocurrencies work, let's separate the concepts.

There are cryptocurrencies, which we talked about above. They allow you to interact with the blockchain and your assets in it.

There is the cryptocurrency wallet, which is part of the blockchain itself (your account).

Many people have a big misconception that a wallet installed on their phone or computer stores your crypto-assets. It doesn't. Your crypto-assets are stored inside the blockchain. An installed wallet stores data that allows you to access the "true" crypto-purse (your account) and perform various transactions via the blockchain.

The reliability of a "true" blockchain crypto-purse is based on cryptography. The principle on which most such wallets are built uses three things: a private (private) key, a public (public) key, and a public address.

Every time you send cryptocurrency from your wallet, it must use a private (public) key to "sign" or validate the transaction. This signature is similar to your fingerprint, unique to each person and their private key. This allows you to prove that the transaction comes from the legitimate owner of the wallet and has not been tampered with.

Now let's pay attention to the presented scheme.

The private key is used to create the public key in the encryption process. The peculiarity of the encryption method does not allow a reverse transition. That is, you can get the public key from the private key, but the public key cannot be used to decrypt the private key.

This approach allows you to share the public key without worrying that someone can get the private key and steal the cryptoassets.

When creating any cryptocurrency wallet, your journey starts exactly with creating a private key. 

Very often, a mnemonic phrase (seed phrase) is used to make the private key easy to remember (and it is quite complex). The private key is converted into 12-24 Latin words.

The public key is subjected to a mathematical function that "compresses" it into a public address.

From a single private key, multiple public keys can be generated, each with its own public address.

The public address is the identifier of the user on the blockchain network. It is the classic address that you use to send cryptocurrency to someone or have it transferred to you.

Custodial (exchange) - wallets created by centralized exchanges. In essence, it is a virtual wallet, which is created by the exchange for transactions. Funds are stored in the central wallet of the exchange, so you are not the true owner of the asset. As long as the asset is on the exchange - it is not yours, because you do not own the private key. We talked about it earlier.

Pros: they are free, very easy to use. You register and can fully use the wallet. You do not need to store a private key, as exchanger does it for you. To regain access you need to write to support and reset the data you used in the KYC procedure.

Disadvantages: you do not control your funds, if for some reason exchange decides to block your funds, you will not get access to them anymore. De-anonymization of identity, at the moment almost on all acceptable for work exchangers need to pass KYC-procedure - confirmation of identity. The risk of hacking the main wallet of the exchange.

Hot (software) - software that allows you to manage your crypto-assets. Such wallets are most suitable for people who regularly use cryptocurrencies (transfers, speculation). Software wallets are divided into desktop wallets (Exodus), web wallets (Metamask) and mobile wallets (Trust Wallet).

Such wallets are called hot wallets because they are connected to the Internet. Transactions of such wallets are authorized immediately on the device. Cracking occurs when connecting to the internet. The wallet's mnemonic phrase/private key is also at risk.

Pros: free, fairly easy to use, but not as custodial solutions. You have full control over your funds since the private key is with you. Anonymous enough, you don't need to pass KYC, but as the crypto market develops, such applications collect more and more different personal data: ip addresses, geo-location, device type and so on.

Cons: vulnerable to hacking as they are used on regular personal computers, in addition people don't really care about the security of their personal computer. It is necessary to keep the private key and the seed phrase carefully, since a loss can lead to loss of access to the wallet, or to the theft of assets.

Hardware (cold) - These are electronic devices that consist of a processor, touchpad and display. These devices generate public and private keys and store them. To process a transaction on such a device, you need to connect it to a computer using USB or Bluetooth (Trezor, Ledger, SafePal).

A cold wallet does not connect to the Internet. The risk of introducing a virus that will steal your recovery keys is minimized. Your keys are stored in the safest possible environment - only on this device.

The main difference between a hot wallet and a cold wallet is that in a hot wallet all the actions take place on it, while a cold wallet only signs your transactions and transmits them to the network thanks to the connection with a device that is connected to the network.

They are notable for this, although you can see the balance of your wallet in your application on your phone, but you can not make a transaction without a hardware wallet, so you should not be afraid that you will lose your phone, someone will find it before you and steal the crypto, or some virus will steal the keys.

Pros: this is the safest way to store cryptocurrencies. Private keys are under full control. Just like with hot wallets, they are anonymous, you don't need to go through KYC.
Minuses: they are fee-based. The cost of popular products starts at $50, you also need to consider the cost and delivery time by mail. Most wallets support only one network - ERC20. At the moment, depending on the load, the transaction fee can be quite biting, you need to take this into account. It can be difficult for beginners to understand the interface of cold wallets. Since it is a physical device, it can be lost, broken and so on. You will have to order a new one.

Hot cryptocurrency wallets

Hot cryptocurrency wallets are a type of wallet that is connected to the internet. This means that you can access your funds and make transactions anytime and anywhere.

Hot wallets are convenient for everyday transactions such as buying goods or services, exchanging cryptocurrency. A hot wallet can be compared to your wallet that you always carry with you. Due to the fact that such wallets are always connected to the internet, you have instant access to your accounts.

Hot wallets include: web wallets, mobile wallets, and exchange accounts.
Web wallets are cloud-based platforms that can be accessed using a web browser. As an example, you can take the ShapeShift website, or the MetaMask browser extension.

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They're convenient and always on hand, but a constant internet connection can make them vulnerable to hackers, especially if your key is only stored on a website. We'll talk more about this in the next section.

Mobile wallets are apps designed to manage your crypto assets. They are very convenient, because you always have access to them, and in general it is more convenient to enter the application on your phone than to take out your laptop every time and open a browser extension. An interesting example of a mobile wallet can be the Ukrainian project Trustee Plus.

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Exchange wallets are also hot: these are wallets that are given to the user when using a crypto exchange. They are directly linked and owned by your account. While convenient for trading, they do not provide you with private keys, as all your funds are permanently stored on the platform and are PRIVATE to the exchange.

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Advantages and disadvantages of hot wallets

Advantages of hot wallets:

• Constant availability: cryptois always "at hand". You have constant access to your assets, and in case of emergency you can perform any action with them in a matter of seconds.
• Speed of transaction processing. To transfer crypto to another address you need to press just a couple of buttons, and it will not take more than a minute of your time.
• Support as much crypto as exchanges, and sometimes even more. Wallets have reached parity with exchanges in terms of the number of supported assets. This means you'll always have the ability to interact with almost any asset - and do so at high speed.
• Trader Convenience. If you are a trader and constantly follow the markets, then of course hot, and especially exchange accounts, will be a priority for you. Only if you have funds in your exchange or other hot wallets will you be able to open a trade.
• Price. Of course, among the advantages of hot wallets should be their price. What kind of price you may ask - that's right! They are absolutely free, which can't be said about cold wallets.

Disadvantages of hot wallets:

• Hackable. By default, hot wallets aren't secure, especially if your connection isn't secure or you're working over public Wi-Fi. They are vulnerable to hacking and cyberattacks. Hackers are constantly looking for vulnerabilities in online wallets, and a successful intrusion can result in loss of assets. Such wallets always remain online, making them at risk of hacker attacks.
• Hot exchange wallets are not yours. You will not be given a cid from such a wallet, reliability is relative. This means that you cannot access your funds if the hot wallet company goes bankrupt or is hacked. As was the case, for example, with the FTX exchange after its collapse: the exchange's website simply went down and people couldn't do anything with their funds.

Popular hot wallets

MetaMask

MetaMask is one of the most famous and popular hot wallets, used by more than 30 million people worldwide. It comes in the form of a mobile app for iOS and Android, and has its own browser extension for Firefox, Google Chrome, and Opera.

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Supports connection of cold wallets from Ledger, Trezor and Lattice.

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Metamask also provides the ability to purchase cryptocurrency directly within the app. In addition, the wallet includes a built-in browser, allowing the user to interact with various blockchain applications. By the way, according to statistics, more than 70% of Metamask users use the application exactly for working with DeFi projects - that is, not for storing cryptocurrency, but for daily work with it.

Metamask advantages:

• Support for all EVM networks
• Built-in browser with its own add-on store
• Simplicity, convenience and free of charge
• Ability to buy and exchange cryptocurrencies inside the wallet
• Support for NFT, Wrapped tokens and all "additional" standards
• Mobile and PC version

Metamask Disadvantages:

• All EVM networks need to be connected manually and through add-ons, which can be tricky for beginners

Metamask is considered the hot wallet standard - it has few drawbacks, a long development history and good support from the team. Read more about MetaMask in this piece.

TrustWallet is the main competitor of Metamask. Another handy hot wallet, which in many ways may be even easier to use for beginners. It is a multi-currency wallet that allows you to store and exchange a variety of cryptocurrencies including Bitcoin, Ethereum, XRP and hundreds more. It is in no way inferior to Metamask.

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Until recently, TrustWallet existed exclusively as a smartphone app, but not so long ago there was a browser extension that absolutely everyone can download.

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Benefits of TrustWallet:

• Trust Wallet supports over 500 cryptocurrencies and tokens
• Through Trust Wallet you can run dApps that run on different blockchains
• Easy and native addition of cryptocurrencies
• Built-in browser, NFT support, mobile and PC version
• Login via Face ID, Touch ID and login validation via 2FA

TrustWallet Disadvantages:

• Higher risk of losing assets if your device is compromised
• Support for a limited number of cryptocurrencies

These two wallets are the most popular among hot wallets. Of course, there are more options besides them, but these can definitely be classified as the most reliable and convenient to use.

Cold wallets

Cold wallets (or "hardwar wallets") are physical devices specifically designed to safely store cryptocurrency.

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These wallets offer a high level of security as they operate offline without connecting to the internet when you don't need to perform transactions. Cold wallets are suitable for storing large amounts of cryptocurrency that you want to keep safe. They are also suitable for storing cryptocurrency that you don't plan to use on a day-to-day basis. These wallets are most effective for long-term investments and storing significant amounts.

Advantages and disadvantages of cold wallets

Advantages of cold wallets:

• High level of protection against hacking: the essence of such wallets is that they store cryptocurrency offline and off the network and internet. Since they are not connected to the network, hackers have no access to your funds. Such cold crypto wallets are the safest and most secure option for long-term asset storage.
• Autonomy: crypto will remain safe even if the wallet manufacturer disappears from the market. The operation of a cold wallet does not depend on external circumstances. Your funds will remain untouched even if the company closes down.
• Complete control: when you use a cold wallet, you physically control your private keys. This means that unless you lose the wallet or it is stolen from you, no one can get the funds out of there but you.

Minuses of cold wallets:

• Every transfer requires the wallet to be connected: unlike hot wallets, cold wallets only require a network connection for transactions. This can be inconvenient for those who prefer instant access to their funds. Their offline mode requires additional time to connect to a computer. For those who actively trade or move their cryptocurrency assets frequently, using a cold wallet may be less convenient.
• Access to your funds if you lose your wallet: the cid-phrase is stored inside a chip on the wallet and can be retrieved from there if hacked.

Cost: cold wallets cost money, which adds an additional cost to users. This additional financial burden may not be appealing to all users, given the availability of free alternatives. The average price for a cryptocurrency wallet is $100.

Popular cold wallets for storing crypto

Ledger is a French company with a focus on developing hardware wallets for storing cryptocurrencies. The company was founded in 2014 by a group of crypto security experts - Eric Larcheveque and Thomas Francet along with the founders of BTChip and ChronoCoin.

Ledger produces two main products:

• Ledger Nano X is a hardware wallet with support for 1500+ cryptocurrencies and tokens. It has a touchscreen and supports Bluetooth, allowing you to connect to your computer or mobile device without the need for a cable.
• Ledger Nano S is a simpler hardware wallet that supports 1000+ cryptocurrencies and tokens. It connects via USB port and does not support Bluetooth.

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• Ledger wallets are considered one of the most secure wallets in the world due to the use of two key technologies: the Secure Element chip, which stores your private keys offline.
• Ledger Livesoftware, which allows you to manage your cryptocurrencies and make transactions.

Additional security measures:

• Setting up PIN and two-factor authentication by phone number, with in-app code entry.

To use Ledger Nano, you need to install the official smartphone app. Ledger is one of the market leaders in hardware wallets for storing cryptocurrencies, trusted by more than 3 million users.

One of Ledger's main competitors are cold wallets from Czech company Trezor. Trezor specializes in developing hardware wallets for storing cryptocurrencies. The company was founded in 2013.

Trezor has two main products:

• Trezor Model T is a hardware wallet, with support for 1800+ cryptocurrencies and tokens. Equipped with a touchscreen and supports USB-C.
• Trezor Model One is a simplified hardware wallet, with support for 1000+ cryptocurrencies and tokens. It works via USB port and does not support touchscreen.

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Like Ledger, Trezor wallets use a Secure Element chip that stores private keys offline. The wallet runs under Trezor Suite management, which allows sending and receiving crypto.

Trezor wallet is connected via USB cable. Transmissions over the cable are encrypted using a built-in random number generator.

Trezor supports the most popular tokens and blockchain networks. All wallet models have a small display where it is convenient to check the wallet status, enter the secret phrase and confirm transactions.

Trezor has 2 features: backup and remote wipe. If someone steals your wallet - you can zero it from your smartphone.

Seed-phrase

Seed-phrase is a sequence of words, usually consisting of 12, 18 or 24 words, which is used to create and restore cryptocurrency wallets. When creating a new cryptocurrency wallet, you will be prompted to write down and save a seed-phrase.

This phrase is the key to recovering your wallet in case you lose access or forget your password. If you lose your seed phrase, you will lose access to your funds. This is why it is so important to ensure that your seed phrase is stored securely, as anyone who knows your Seed Phrase can recover your wallet and access your assets. You should also write down your seed phrase on paper and store it in a safe place. Often when you buy a cold wallet, a special sheet for writing down your Seed-phrase comes with it.

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The standards for creating seed phrases may vary depending on the wallet or cryptocurrency platform. Therefore, it is important to carefully read the instructions and follow the recommendations of a particular wallet or platform to properly create and save a seed phrase.

Not long ago, there was an incident in which $60,000 was stolen from Brazilian blogger Ivan Bianco - he runs a YouTube channel about blockchain games called Fraternidade Crypto. During another stream, he accidentally flashed his seed phrases from his wallets. Within minutes, all the funds from his wallets were withdrawn to other addresses.

In 2020, there was an interesting case, not related to theft, but closely related to gaining access to someone else's wallet using an incomplete seed phrase. Crypto-enthusiast Alistair Milne offered his Twitter followers to participate in a contest: the person who manages to crack his own seed-phrase from the wallet can take the assets that lie there (the wallet held 1 BTC). He planned to publish the clues once every some time, starting with the first words. When he published the first 7 words the wallet was hacked and the Bitcoins were withdrawn.

A programmer named John Cantrell created a program and guessed Alistair Milne's seed phrase using the matching method. It took only 30 hours to search through all the combinations after the seventh word was published.

Cryptocurrency wallets: the conclusion of Cryptology traders

Choosing where to store cryptocurrency is an important aspect for any cryptan. There are two main types of cryptocurrency wallets: cold and hot, each with its own advantages and features suitable for different purposes.

Cold wallets are flash drive-like devices that are not connected to the internet, making them safer from hacker attacks and online threats. These wallets are ideal for medium to long-term cryptocurrency investments as they provide a high level of security for storing significant amounts.

Hot wallets, on the other hand, are permanently connected to the internet and provide more convenient access to assets for transactions. They are ideal for active trading and quick cryptocurrency transactions, as they allow you to react quickly to market changes. However, due to constant internet connectivity, they are more vulnerable to cyberattacks.

The best option for working with crypto assets is to use a combination of these two types of wallets. Cold wallets are for storing large amounts and long-term investments, while hot wallets are for frequent trading and quick access to funds. The choice between cold and hot wallets depends on individual goals and asset management strategies, but it is always important to remember that putting all your eggs in one basket is not comical.

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