Crypto Wallets
A cryptocurrency wallet stores private keys and allows you to send and receive cryptocurrency. In this lesson, you will about different types of wallets with their pros and cons.
Learning Objectives
You will learn about:
- Custodial Wallets
- Software Wallets
- Hardware Wallets
Video Walkthrough
Use this video to follow along with the steps in this lab.
Custodial Wallets
Custodial wallets are similar to traditional online banking. Coinbase.com is an example of an online custodial wallet. You log in to the Coinbase.com website with a username, password, and (recommended) second factor. In this example, Coinbase.com stewards your private keys. Because Coinbase.com controls your private keys, they control your funds. If Coinbase.com got a letter from the FBI asking them to freeze your funds, Coinbase.com would be obligated to comply. Online wallets offer convenience. The security is debatable. If you are the type of person who doesn't trust banks and keep cash under your mattress, you probably wouldn't trust an online wallet. But if you're the type of person who trusts a bank to keep your money, an online wallet might be a good choice. Custodial wallets never give you access to your private keys.
Coinbase.com is based in the United States and attempts to comply with the confusing, often contradictory, regulations of the United States financial system. The fact that Coinbase.com operates in the United States and works with regulators gives some customers confidence. Others seek cryptocurrency exchanges outside of the United States because of a distrust of United States financial regulation.
Software Wallets
Private wallets like Coinbase Wallet and tastycrypto come as smartphone apps and browser extensions. You store the private keys on your device, and therefore you are responsible for your security. You can use these apps to create a new wallet. When you create a new wallet, you are given a (typically) 12-word seed phrase. The words are chosen from an official list. These words represent your private key. Anybody with the seed phrase can "restore" your wallet if they know your seed phrase. If you lose your seed phrase, you lose all your assets. You must keep this seed phrase in a secure location. I save my seed phrases in my password manager. If my password manager were to be hacked, I'd lose literally dozens of dollars. Private wallets might add an additional layer of protection by asking for a username and password for unlocking your wallet app or browser extension, but a hacker does not need this username and password to drain your wallet. All a hacker needs is your seed phrase. Once your wallet has been created, you can transfer funds to your wallet. Private wallets do not typically integrate with your bank, so transferring initial funds can be tricky if you do not already have any digital assets. Private wallets are decentralized. Every person maintains their own wallets instead of storing them centrally with a custodian.
Watch the Coinbase Wallet setup instructions.
Hardware Wallets
Hardware wallets are typically USB devices built specifically for cryptocurrency. They are basically small computers that emphasize security. For example, Ledger sells hardware wallets. Hardware wallets confirm transactions offline. Makers of hardware wallets recommend that you do not store your seed phrase in a password manager or anywhere else online. Instead, the private keys should only reside on the hardware device. Ledger recommends writing the seed phrase on a physical piece of paper that is kept secure.
Watch Ledger guide you through the setup of a hardware wallet.
Wallet Comparison
The table below compares key wallet differences.
| Comparison | Custodial Wallet | Software Wallet | Hardware Wallet |
|---|---|---|---|
| Key resides at | 3rd party | Your app/browser | Your physical device |
| Primary Authentication | Username/password/MFA | PIN; biometrics | PIN; biometrics |
| Top risks | 3rd party hacked; assets frozen |
Lose seed phrase; Divulge seed phrase; Device malware steals seed phrase |
Losing your device |
| Funding | Bank integration | Transfers from other wallets; Limited financial service integration |
Transfers from other wallets |
| Recovery | Password reset | Re-enter seed phrase | Re-enter seed phrase from paper backup |
Create a Software Wallet
In this section, you will go through the process of creating a software wallet. It's fairly quick and easy. You never need to use this wallet. This is just a learning exercise.
- Open your web browser.
- Go to the Coinbase Wallet download page.
- Install the extension for your browser.
- Click on the extension to open it.
- Click Create new wallet.
- Make note of the seed phrase. Below is a screenshot of an actual seed phrase. I'm not going to use this new wallet, so I don't mind giving the seed phrase here. If I added funds to this wallet and published this online (which...if you're reading this...I did), then you or a scammer could recover this wallet and have access to all of my digital assets.
Here is the text in case you want to try restoring mine later.
supply wage bacon away ill black fault current moment shadow round bullet
- You will be asked to confirm that you saved the phrase. There really is no possible recovery if you lose the phrase.
- You will be asked to create a password. This password will only be used to unlock the app. This protects against somebody taking your computer, clicking on the browser extension, and accessing your wallet. They would need this password to view the seed phrase in the app.
- You may be asked to claim a username. Skip this.
- Congratulations! You now have your very own crypto wallet!
- At this point, somebody could send you cryptocurrency. Click the receive button to view your crypto addresses. These are public and you could send them to anybody.
- Explore the interface.
- When finished, feel free to delete the browser extension. As long as you did not fund your wallet, you can forget the seed phrase and password.
Reflection
- Would you rather hold your private keys or let a custodian maintain them?
- How would you securely store your seed phrase?
- Suppose you had malware on your computer that took screenshots every 15 seconds and sent those screenshots to a hacker. What would happen if you saw your seed phrase on your screen during the wallet creation process?
Key Terms
- Custodial Wallet: A type of cryptocurrency wallet where a third party, such as an exchange, holds and manages the private keys on behalf of the user. The user trusts the custodian to secure their assets, but this also means the user does not have full control over their funds.
- Software Wallet: A type of cryptocurrency wallet that is software-based and can be installed on a computer or mobile device. Software wallets store the private keys locally on the device and provide an interface for managing and transacting cryptocurrencies. Examples include desktop wallets, mobile wallets, and web wallets.
- Hardware Wallet: A type of cryptocurrency wallet that is a physical device designed to securely store private keys offline. Hardware wallets provide a high level of security by keeping the keys isolated from internet-connected devices, reducing the risk of hacking and malware attacks. Examples include Ledger and Trezor devices.