As we enter 2023, the ‘hardware wallets vs software wallets’ debate is as pertinent as ever!
Cryptocurrency exchanges are going bankrupt left and right, and we are all reminded of how important it is to self-custody your cryptocurrency.
Table of Contents
- What are ‘crypto wallets’?
- How do crypto wallets work?
- What are ‘software’ crypto wallets?
- What are ‘hardware’ crypto wallets?
- Should I choose a hardware wallet over a software wallet?
What are crypto wallets?
Crypto wallets are software, apps or devices that securely store private and public keys of your cryptocurrencies. The wallets communicate with the blockchain network to perform transactions: sending and receiving digital assets with the authorization of your private keys stored within.
Thus, crypto wallets are incredibly important for the cryptocurrency community. Digital asset managers must ensure, for their own good or for the good of their institutional clients, that funds are safe!
However, with all of the hacks and bankruptcies that have plagued the cryptocurrency community in the past couple of years, we no longer get to enjoy the safety that comes with holding our cryptocurrencies on exchanges.
How do crypto wallets work?
Cryptocurrencies are created and developed with blockchain technology. Unlike paper money and copper coins, they have no physical representation and cannot be handled physically!
Records of all cryptocurrency transactions are kept on the blockchain network, and crypto wallets are designed to generate and hold specific private and public keys which prove your ownership of the assets on the blockchain network.
Your private key is the only and most important data input that authorizes any outgoing transaction, therefore it should be kept secret and not share with anyone. If it falls into the hands of malicious minds, the funds and assets associated could be lost forever!
Public keys are cryptographically calculated and are generated by the private key. It allows for inquiries and retrieval of transaction data and other information on the blockchain network, but does not hold any power to move funds or authorize transactions.
A common misconception about crypto wallets is that they physically hold the cryptocurrency, like a regular wallet holds fiat currencies. This is not the case.
Cryptocurrencies exist on the blockchain only, and the cryptocurrency wallets hold the keys that authorize movements of the cryptocurrencies themselves.
There are two different types of crypto wallets, which are detailed in the following sections.
What are ‘software’ crypto wallets?
Software crypto wallets, also known as ‘hot’ crypto wallets are generally installed on computers, smartphones, tablets or even on cloud services.
Personal accounts on crypto exchanges such as Binance, Bittrex, and Coinbase also includes software wallets. These wallets are mostly connected to the internet for fast and up-to-date access, preferable to short-term investors and traders who is constantly moving funds for profit. Although it is extremely convenient, its internet access also makes it vulnerable to hacking and cyber-attacks!
As such, it is best practice to only hold cryptocurrencies in software wallets that are actively being used for trading. Additional risk is unnecessary, and mitigating risk is a top priority in the cryptocurrency ecosystem.
According to Inside Bitcoins, a London-based online news source for cryptocurrency, there had been more than $11 billion worth of cryptocurrencies stolen in different hacking incidents over the past nine years, with the biggest heist reported in 2014 with $6.68 bn worth of cryptos vanishing in four different incidents.
What are ‘hardware’ crypto wallets?
Hardware crypto wallets, also known as ‘cold’ crypto wallets or ‘cold storage’, are veritably safer for storing your cryptocurrency away from potential exploits.
These cryptocurrency wallets allow you to prove that you are the owner of the digital assets, and store your private key offline in a secure chip that is embedded within a physical hardware device.
Comparatively, hardware wallets are an exciting innovation because of their added security relative to other types of software wallets.
Hardware crypto wallets ensure that your private keys never go online! Hence, they are virtually immune to hacking risks associated with software crypto wallets.
When initiating a new hardware wallet, you will be given a set of 24 recovery words, known as your crypto wallet’s ‘recovery phrase’, which can be used to load access to your private key from another crypto wallet (software or hardware).
It is recommended that you write the 24 recovery words down on a piece of paper for safekeeping! You will want to keep it away from water and fire, or even use a stainless steel seed back up like the X-Seed or X-Seed Pro.
Whichever methods you use to record your 24 recovery words, be sure to keep it in a safe place and never share it online or with anyone you don’t trust!
Hardware crypto wallets allow the storage of private keys in a completely offline environment. Cryptocurrencies and other digital assets in a wallet online increase the risk of being stolen.
As the cryptocurrency ecosystem continues to grow, millions of institutional-grade wallets will come to exist as a common normality in the space. Those asset managers looking over these large funds have an imperative to practice good wallet hygiene to protect their investors’ funds.
They will be large, visible targets for hacking, and will practice safe crypto asset management. Will you?
Beware keeping your assets on exchanges online, where the private and public keys are actually in the hands of the centralized exchanges (and not you).
Transferring funds to a hardware wallet allows you to own your private key therefore have full control of your crypto and your financial freedom.
Should I choose a hardware wallet over a software wallet?
Software wallets and hardware wallets each have their own advantages and disadvantages. It is important to choose the right wallet that meets your specific needs.
Software wallets offer convenience and mobility, but they are vulnerable to hacking attacks. On the other hand, hardware wallets are offline and independent, which provides a higher level of security, but they can be bulky and require more effort to access.
Making the decision between a software wallet and a hardware wallet can be challenging. However, similar to the way you would manage risk with your fiat savings and investments, it is recommended to have multiple accounts and a crypto wallet to manage your digital assets.
A hardware wallet, also known as a cold wallet, is the safest option for long-term holders and investors. It is important to have at least one hardware wallet to manage your cryptocurrency portfolio. By storing your digital assets offline in a hardware wallet, you greatly reduce the risk of hacking and theft.
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