Table of Contents
What is a crypto wallet?
How to set up a crypto wallet
Key factors to consider when choosing a crypto wallet
The bottom line
Jun 21, 2022
9 min read
Investors can choose between many types of crypto wallets. Comparing the different types, how they work, and what they can do could help investors make a good choice.
Cryptocurrency wallets allow users to store, send, and receive cryptos. There are different types of crypto wallets, including USB stick-like devices or online wallet apps. It’s important to learn about the differences, pros, and cons of them before putting money into the crypto market.
Despite what their name suggests, crypto wallets don’t contain actual cryptos—those are kept on the cryptocurrency’s blockchain, a public database. Instead, crypto wallets hold private keys that are used to access cryptocurrency. The keys are used to generate public keys and wallet addresses, which can be shared with others to safely receive cryptos. Private keys should always be kept secret because they give someone full control of the crypto.
Most crypto wallets only work with a specific blockchain. A Bitcoin wallet is for Bitcoin, while an Ethereum wallet is for Ethereum-based coins and tokens. Investors may need separate wallets to invest in different digital assets, and should be careful to avoid sending crypto to an incompatible wallet because the crypto may disappear. There are, however, some wallet services that support multiple types of crypto with a single interface.
Choosing from different wallets can also be important because some crypto wallets may have additional features, like the ability to earn interest by staking the crypto, to store non-fungible tokens (NFTs), and detailed investment tracking tools.
Investors can create and manage their own crypto wallets, or they can open accounts on a cryptocurrency exchange and let the exchange manage the wallets on their behalf. Wallets can also be stored on hardware that’s primarily kept offline, or on software that stays connected to the internet. There are pros and cons to all the options.
In some cases, setting up a new crypto wallet is basically the same process as creating a banking or stock investment account. Here are four steps to set up and safely use a crypto wallet:
There are three general types of crypto wallets:
Many centralized cryptocurrency exchanges (CEXes) will create crypto wallets on behalf of their users. These are called hosted or custodial wallets because the exchange manages the wallet and is responsible for keeping it secure. CEXes may also offer customer service and account recovery options that aren’t available with non-custodial wallets. This may be the easiest way to invest in crypto.
Software wallets include desktop wallets, mobile wallets, and browser extensions. These are distinct from custodial wallets because they are not necessarily managed by a CEX. Software wallets are often free crypto wallets to set up, although the wallet creators may make money by charging fees on crypto swaps that happen within the wallet. These are also called “hot wallets” because they’re connected to the internet.
A hardware wallet is a physical device that stores the crypto wallet. A piece of paper with a QR code or the keys written on it (called a “paper wallet”) could serve this purpose. However, the most common ones today, such as Trezor and Ledger, are like USB thumb drives with added security and functionality. These are also called “cold wallets” because they’re not connected to the internet.
Hardware wallets can add another layer of security because their wallets’ private keys are securely stored on the device. The device can easily be disconnected from the internet, and the private keys could be protected from malware or cyberattacks that might compromise software wallets.
However, there’s an upfront cost to purchase a hardware wallet, and the wallet could be lost or stolen. It’s generally free to get started with a software wallet, and it may be easier to use for everyday crypto trading because it’s always connected to the internet. Some software wallets may be compatible with more crypto apps than hardware wallets.
The non-custodial software and hardware wallets that investors manage themselves also give investors full control over their private keys. Having the control can give investors more capabilities, including access to lesser-known cryptos, the ability to swap cryptos on a decentralized exchange, and to invest in decentralized finance (DeFi) projects.
Investors don’t need to limit themselves to one type of wallet. Avid crypto investors often have multiple wallets.
After choosing a type of crypto wallet(s), investors need to create an account at a crypto exchange, or create a password for a non-custodial wallet.
Creating an account on a CEX will likely involve a know your customer (KYC) process, in which the investor must share personal information and a picture of government-issued identification with the CEX. Users will also need to create a username and password.
Non-custodial crypto wallets (those that investors set up themselves) may not involve any identity verification process. Instead of having an account with a username, investors create a password. From there, the wallet generates a seed phrase, or a 12- to 24-word that’s used to create private keys. A seed phrase is usually easier to write down or remember than the actual private key.
Non-custodial crypto wallets are a little trickier to manage than custodial ones because investors are completely responsible for their wallets. Unlike with a CEX and custodial wallet, these generally don't have account recovery options and some don’t have any paid customer service staff.
It’s important to keep the seed phrase and private key safe. Anyone who gets either can recreate the wallet, choose a new password to log into a wallet service, and control the linked crypto.
The legitimate owner also needs the seed phrase to restore a wallet if their device crashes or they want to access their wallet on a new device. They could use the same phrase with other compatible wallets, which makes switching from one type of software wallet to another very easy.
Most crypto wallets come with a basic level of security, but adding additional security measures can be wise.
Many CEXes let users secure their account with multi-factor authentication (MFA), which requires the username, password, and an additional one-time password to log into the account. The additional one-time password can take the form of an SMS, which can be convenient, or an authenticator app or hardware token, which would be an even safer option.
Non-custodial wallets, including hardware, desktop, mobile, and browser extension wallets often require a password to log in. This can keep someone from accessing a wallet if they steal the device. However, the seed phrase is more important than the password. That’s because while the password may be specific to the device, the seed phrase can be used to recreate the wallet.
For example, if someone is using the MetaMask wallet on one computer, they can’t install it on a different computer and log in with the same password. They’d need to enter the seed phrase to access the wallet. They can then create a new password for the MetaMask installation on that specific device.
The biggest risks with software wallets are:
Onramps are the services that allow people to exchange fiat currency (e.g., U.S. dollars) to buy cryptos. Offramps enable people to change crypto back into fiat. When buying crypto, the fiat money may come from a linked bank account, wire transfer, debit card, or credit card. There’s often a fee to use an onramp, which varies depending on the funding source, amount, and platform.
CEXes often have an onramp built in, while non-custodial wallets usually do not. They generally only support crypto-to-crypto transfers. However, some non-custodial wallets can be linked to onramp services, such as Mercuryo, Moonpay, Transak, or Wyre. These services may require investors to go through a KYC process before purchasing crypto. Alternatively, an investor may need to purchase crypto from a CEX and then transfer it to their non-custodial wallet.
Because of the security risks, some avoid keeping too much crypto in a single exchange or software wallet in case it is compromised.
Setting up a crypto wallet can be easy, and there are often guides available for the most popular options. Before adding funds to a crypto wallet, investors should make sure it’s a trustworthy service that aligns with their investment style and goals. Consider:
Look for news about and reviews of cryptocurrency exchanges and self-custody wallet creators before signing up. Some CEXes are registered with a U.S. regulator, which could be a good sign that they aren’t scams. They may also have insurance that can help protect users’ funds if the exchange is hacked.
Crypto wallets have many different features, such as a simple interface or advanced trading charts. Consider what’s going to be easiest to use and which features could be helpful, such as a QR code generator or reader.
For custodial wallets, look for exchanges that support MFA, ideally with an authorization app or device. For hardware wallets, review the hardware’s security features and how it keeps the private keys secure when the device is connected to a computer.
Some wallets only support specific types of cryptos. For example, a Bitcoin wallet isn’t compatible with Ethereum-based cryptos. Also, some DeFi projects only support specific crypto wallets. Investors may want to review the options if they’re interested in specific DeFi projects.
While custodial and other software wallets are often free, they may charge transaction fees. If investors are interested in hardware wallets they would need to be purchased.
The important thing about choosing a crypto wallet is that it's not an all-or-nothing choice. Investors can set up and use multiple wallets. Moving crypto from one wallet to another can be simple. Setting up a new wallet may even be free for people switching between software wallets because they may be able to use the same seed phrase to set up a new wallet app.
Crypto investors can choose between many types of crypto wallets, including different options within the broad categories of custodial, hardware, and software wallets. Comparing the different types of wallets, understanding how they work, and what they can (and cannot) do could help first-time investors make a good choice. The understanding also becomes more important as investors dive deeper into the crypto ecosystem.
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