What is a bitcoin wallet?

Key points

• There are many types of bitcoin wallets. 
• Bitcoin wallets can be connected to the internet or kept offline.
• If done correctly, you can store bitcoin safely without trusting another party. 

You wouldn’t take money out of an ATM without a place to store it. The same goes for buying bitcoin. Before purchasing your first coins, you must have a safe place to keep them. That’s where bitcoin wallets come in.

What is a bitcoin wallet?

The funny thing about bitcoin is that it’s digital. It doesn’t exist in the real world. This brings up questions about how to store it. Doing so isn’t as intuitive or straightforward as storing something like gold. 

Bitcoin wallets store your private key and allow you to send and receive bitcoin. Your private key is the long alphanumeric code that functions as the password to access your funds.

There are many types of bitcoin wallets. Hot or cold, paper or hardware, custodial or noncustodial — they’re far from a leather wallet with some dollar bills.  

How does a bitcoin wallet work?

Bitcoin wallets are more like keychains than wallets, said Michael Jones, an economics professor at the University of Cincinnati who oversees the university’s cryptoeconomics lab. Your coins are stored on the blockchain. A bitcoin wallet stores the keys that allow you to access your coins.

Private keys are long strings of letters and numbers that are virtually impossible to guess. They’re also virtually impossible to remember. So bitcoin wallets do it for you.

“The wallet also creates a public key, similar to your bank’s checking account number, that is associated with that private key,” Jones said.

Your public key allows others to send you bitcoin. You can share it with anyone. They can’t access your bitcoin without your private key.

Types of bitcoin wallets

The two main types of bitcoin wallets are hot and cold. Hot wallets are connected to the internet. Cold wallets aren’t. Their levels of convenience and security vary as a result.

Hot wallets

Hot wallets tend to be convenient because they’re connected to the internet. But this convenience comes at a price, as they’re easier to hack. A few examples of hot bitcoin wallets are Electrum, Exodus and Mycelium.

Hot wallets come in a variety of forms. These include mobile, web and desktop. 

Mobile wallets

Mobile wallets run as applications on phones. They’re straightforward to use. 

The user experience is similar to that of many non-crypto payment apps, such as Revolut and Cash App. Deposits can be made via QR codes. Your crypto is accessible and can be transacted within seconds.

Mobile wallets are perhaps the most convenient. But they can be risky. Your smartphone could go missing. And depending on the device’s security, your crypto could go with it. 

Being connected to the internet also brings threats of malware, fraud and other cyber risks.

Web wallets

Web wallets are similar to mobile wallets in terms of convenience and risk. Your private keys are stored on a server connected to the internet. This means there are hacking risks.

Desktop wallets

The final type of hot wallet is a desktop wallet. 

Desktop wallets require an internet connection. So hacks are still a risk. But there is an extra layer of security compared to mobile and web wallets. You commonly don’t rely on a third party to store your coins. Instead, you download software onto your computer. Your hard drive normally stores your keys.

Cold wallets

Cold wallets differ from hot wallets because they’re not connected to the internet. Ledger, Trezor and Ellipal are a few examples of cold bitcoin wallets.

Cold wallets are considered the most secure type of bitcoin wallet. They aren’t connected to the internet, making them safe from malware and hackers. But they aren’t the easiest approach.

You must take the extra step of setting up your cold wallet after buying crypto on a centralized platform, such as Coinbase. You also need to keep this wallet safe. If you lose it, you’ll lose your private keys and the coins that accompany them.

Types of cold wallets include hardware and paper.

Hardware wallets

Hardware wallets store your crypto on an external device, often similar to a USB, that isn’t connected to the internet. 

You have total control over your bitcoin and crypto assets. Hardware wallets are considered among the most secure storage options. If you set up your hardware wallet correctly, you are required to trust nobody — apart from yourself. You must be vigilant about storing your wallet or the seed phrase that unlocks it. A seed phrase is a simplified version of a private key. 

Paper wallets

Paper wallets offer the same security strengths as hardware wallets. Like an offline USB, it’s difficult to hack a piece of paper. 

A paper wallet consists of private and public keys to the wallet printed on paper, sometimes in QR code form. You can receive cryptocurrency transactions by sharing your address with others, inputting the key or scanning the QR code with a smartphone.

Before the growth of hardware wallets, paper wallets were viewed as among the best storage options. But hardware wallets are more ubiquitous today. They provide similar security benefits but are easier to use. 

Hot wallet vs. cold wallet by USA TODAY Blueprint

Custodial vs. noncustodial wallets

A custodial wallet is managed by a third party on behalf of the end user. A few examples of custodial wallets are the ones found on Binance, Freewallet and BitMex. A noncustodial wallet is managed directly by the end user. Trezor Model One and Trust Wallet are a couple of examples.

“The difference between a custodial and noncustodial wallet represents a trade-off between autonomy and convenience,” said Ethan Jiang, assistant professor of finance at Western New England University. Custodial wallets are the most convenient. They’re set up and managed by a third party, much like a traditional bank account. So you don’t have to worry about the technical details of storing your keys.

“A custodial wallet will reflect a higher fee structure but also provide plenty of support, especially for beginners,” Jiang said. But some investors don’t like the idea of a third party having custody over their funds. As the saying goes, “Not your keys, not your crypto.” This is where noncustodial wallets enter the picture.

Noncustodial wallets allow you to retain complete control over your bitcoin. But self-managing your crypto means it’s only as secure as you are. If you lose your private key, that’s it. Your crypto is gone forever.

What to consider when picking a bitcoin wallet

Which wallet you should use depends on your preferences. Here are some considerations for picking a bitcoin wallet.

Convenience vs. control

If convenience is paramount, a custodial wallet is likely the best choice. Many custodial wallets are no harder to use than PayPal. A support team can help you resolve issues that arise. And if you lose your password or access to your email or phone, you can still recover your funds.

Using a custodial wallet forces you to give up some control of your coins. A noncustodial wallet may be a better fit if you’re wary of trusting another party with your assets.

Reputation

Reputation is another important factor to consider for both hot and cold wallets. “While innovation and new ideas are good, I would be very cautious about using a wallet that was just released to the public and hasn’t been proven over time,” Jones said. 

Usability

You don’t want to spend the remainder of your investing life fighting with your bitcoin wallet. Look for a user-friendly and intuitive option so you don’t make mistakes and lose your funds.

What constitutes user-friendly may vary from person to person. The best way to determine how intuitive a wallet is to test-drive it.

Security

Every investor has preferences. But the simplest question to answer is which type of wallet is the most secure. Noncustodial wallets excel in this regard. And hardware wallets are the gold standard. 

Hardware wallets may be more intimidating to set up. But they offer peace of mind. There are no risks of hacks or losses if you’re disciplined enough to keep your wallet secure. The security of a noncustodial cold wallet is advisable if you hold any reasonable amount of crypto.

You can rest easy knowing your bitcoin is there. The only remaining question is how much that bitcoin will be worth.

Frequently asked questions (FAQs)

What is a bitcoin wallet address?

A bitcoin wallet address, also known as a public key, allows others to send you bitcoin. It’s a randomly generated string of letters and numbers unique to each wallet. Each cryptocurrency has its own wallet address format, which can be up to 40 characters.

You can share your wallet address with others because they can’t access your bitcoin without your private key. Never share your private key.

Why do you need a bitcoin wallet?

You need a bitcoin wallet to store your bitcoin securely. Most places where you can buy bitcoin, such as exchanges, offer wallets by default. But they require you to trust those parties.

You can withdraw and store your bitcoin yourself by setting up another wallet. If done correctly, there is no counterparty risk. You are not required to trust a third party to safeguard your bitcoin.

How do I open a bitcoin wallet?

Opening a bitcoin wallet isn’t difficult. But it can be confusing for a non-crypto native. It also varies depending on the wallet type. The most secure avenue is a hardware cold wallet. You must purchase a wallet, follow basic setup instructions and remember your all-important seed phrase. 

The seed phrase is a passphrase usually consisting of 12 or 24 words. It’s the most important piece of information to any bitcoin investor. If anybody has your seed phrase, they can access — and take — your bitcoin. There are many stories of investors forgetting or losing their seed phrases and therefore losing access to their bitcoin.