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- A Bitcoin wallet is a digital app or program that allows you to securely send and receive bitcoins.
- Bitcoin wallets do not actually store funds, but instead store the private keys that give you access to your cryptocurrency.
- Bitcoin wallets come as either hardware or software, with hardware wallets offering the most security.
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"Not your keys, not your coin" is a popular saying within some parts of the cryptocurrency community, and for good reason.
It's a reminder that if you choose to store your bitcoin on a cryptocurrency exchange account, the exchange actually owns the key to your digital assets. And if you don't own the private keys needed to transfer and access your bitcoin, you don't control it.
So how exactly do you control your keys and, by extension, your bitcoin? A dedicated Bitcoin wallet.
Bitcoin wallets are designed to store the private keys to your cryptocurrency, enabling you to move your funds without having to rely on a third-party. Here's what you need to know about what a Bitcoin wallet is and how it works.
What is a Bitcoin wallet?
A Bitcoin wallet is a software program that allows you to transfer and store bitcoin. Bitcoin isn't technically "stored" anywhere so the wallet actually stores a private security key that corresponds to the Bitcoin address of your wallet. The key is actually what gives you ownership and control of bitcoin stored in it, making it an invaluable tool as an investor.
A Bitcoin wallet is "a way for you to store your digital keys, or access, to certain locations on the blockchain," says Lex Sokolin, global fintech co-head at blockchain firm ConsenSys.
Similar to other cryptocurrencies, bitcoin is stored in addresses on its blockchain, which is essentially a ledger or database that can't be modified or erased. Each address has two keys (i.e., alphanumeric codes) associated with it, a public key and a private key. The public key is what other people can use to send bitcoin to it, and the private key is what you'd use to send bitcoin from it.
This is precisely why some investors prefer storing their bitcoin on a wallet instead of a third-party platform. A wallet holds the private key, which is necessary to validate that the true owner of a Bitcoin address is really requesting that bitcoin be sent from that address.
Types of bitcoin wallets
All bitcoin and cryptocurrency wallets revolve around the storage of a private key. When it comes to wallets, you basically have two options: hardware or software.
Hardware wallets
Hardware wallets are generally small, handheld devices that store your bitcoin offline and can be plugged into your computer in order to verify transactions. "A hardware wallet stores private keys through a device that is not your computer, while a software wallet runs on your computer or phone," says Sokolin.
Hardware wallets remain offline at all times (and are often referred to as "cold" wallets for this reason), theoretically making them safer when compared to their digital counterparts.
While the cost of hardware wallets vary from one manufacturer and model to another, wallets can generally range from $60 to $180. Wallets at the lower end of this spectrum will be just as secure as those at the more expensive end, although they may lack certain extra features, such as Bluetooth connectability and support for a wider range of cryptocurrencies.
Software wallets
Software wallets, also known as "hot" wallets, can be accessed either via a desktop browser or smartphone app. Whereas hardware wallets are used for long-term storage of large amounts, software wallets are better for storing smaller amounts and making daily spending and receiving payments convenient and fast.
"A software wallet is an app on your phone or computer containing your private keys. Because it's usually connected to the internet, it's theoretically hackable, though the most reputable software wallets are considered extremely difficult to hack," says Glen Goodman, a cryptocurrency analyst and author of The Crypto Trader.
Software wallets can come in three varieties:
- Desktop wallets: These wallets are installed directly onto a computer, where the private keys are stored on its hard drive. Funds can be accessed only from that computer, allowing you to have full control over your wallet.
- Mobile wallets: These wallets function the same way as desktop wallets, but designed for the mobile experience. Mobile wallets are convenient and can be used on the go, but can carry a greater risk of malware.
- Web wallets: These are wallets that can be accessed through a web browser, oftentimes hosted by a provider who manages the security of your private keys.
In theory, software wallets are more user-friendly than hardware alternatives, if only because they don't require you to keep track of the whereabouts of a physical device. Some software wallets also offer built-in trading features, so you can quickly sell your crypto through their app or desktop site.
Another advantage of the software wallet is that it can be cheaper than a hardware equivalent. Many of the most popular software wallets charge only transaction fees, which are set by the network of the cryptocurrency you're using. That said, with average bitcoin fees hitting as high as $30 during peak periods, multiple transactions can certainly take a bite out of your wallet.
Why are Bitcoin wallets so important?
The main advantage of a Bitcoin wallet is that it protects investors from potential cryptocurrency exchange hacks. While the major exchanges are improving their cybersecurity constantly, breaches still occur from time to time, with Binance - the world's biggest exchange - being hacked as recently as May 2019.
"If someone has a very large amount of cryptocurrency, an offline hardware wallet is a must. For people who only have small amounts of crypto, a decent software wallet can provide a reasonable level of security for most purposes" says Goodman.
Having your own wallet means you're protected from potential hacks, and yet it also protects users from situations where an exchange freezes a customer's funds or account. For example, popular cryptocurrency exchange Coinbase acknowledges that in "extremely rare circumstances," it will prevent access to customer funds when required to comply with an order from a court or other authority.
The financial takeaway
Bitcoin wallets are a great way to take full control of your cryptocurrency funds. The most secure wallets are hardware-based, since they involve the use of devices that never go online. That said, software wallets may afford a greater level of convenience and ease.
However, while cryptocurrency wallets help you gain control of your funds, they require you to step up your security game. You generally need to store hardware wallets - and their seed phrases - in secure places, otherwise you may have to kiss goodbye your bitcoin in the event of loss or theft.