Cryptocurrency Wallets

When it comes to storing or saving your digital assets and cryptocurrencies there are many options available. Decisions must be made about the type of custody, the location, and the type of wallet. Here's a breakdown of the different types of custody and wallet options that are available.

The first thing when deciding how to store and save your crypto is whether you'll be using a centralized exchange for that or if you'll be holding your crypto yourself, which is known as self-custody. There are advantages to each option. In some cases you may want to keep some of your crypto on an exchange and self-custody the rest.

Keeping your crypto on a centralized exchange is a very convenient option for many crypto users and investors. By keeping your crypto on an exchange you make your crypto more available for selling, whether to lock in gains, selling to avoid further losses during a downturn, or converting to another asset. You may also avoid potential fees involved with moving your crypto to a self-custody wallet. Many exchanges do offer interest and rewards if you keep you crypto on the exchange or stake your crypto on the exchange. The process of earning these rewards tends to be easier than doing so through a self-custody wallet, though the yield of the interest and rewards could be lower.

From a risk standpoint, some crypto enthusiasts subscribe to the motto not your keys, not your crypto. This comes from the thought that since digital assets on centralized exchanges are not federally insured, that any loss of digital assets due to a hack or failure of the exchange would be the loss of the investor, not just the exchange. The exchanges, since they are not regulated like traditional broker-dealers, are not required to reimburse investors for losses and they are not required to have federal insurance either. Some do have their own insurance, but the amount of insurance is usually considerably lower than the amount of assets the exchange has in their custody. If there are was a significant enough loss due to a hack or some other situation, the insurance may not be enough to reimburse everyone.

Self-custody of digital assets is similar to holding your cash in your pocket. The cash is yours because you're in possession of it, and you can pretty much spend it how you want and with whomever you want. Because you're in possession of your crypto, the level of security and the safety of your digital assets is really up to you. If you lose the private keys to your wallet, or if they are stolen because you didn't protect them well enough, then there is no one else to blame. At the same time, you don't have to worry about your assets being stolen from or lost by an exchange or changes in regulations suddenly preventing you from trading, sending, or receiving certain digital assets,

Private keys are the seed phrase that give access to the digital assets on the blockchain.

Self-custody is accomplished by getting your own digital wallet and sending your digital assets to that wallet. Generally, a centralized exchange is going to act as an on-ramp for you to turn your fiat currency into some kind of digital asset. Once you've done that, you send your digital assets to your own digital wallet.

Now it's time to look at how to choose a self-custody wallet. It's important to know the differences between the types of wallets that are available.

A hot wallet is a wallet that is connected to the Internet. Most software wallets are hot wallets. A cold wallet is a wallet that is not connected to the Internet. These will typically be a hardware wallet.

A software wallet is a wallet that is simply a software application that accesses your digital assets on a blockchain and holds the private keys within the software application. Software wallets will run on your desktop computer as a dedicated software application. as an extension or plug-in in your web browser, or as an app on your mobile device.

A hardware wallet is a digital wallet that stores the private keys to access your digital assets within a secure chip. Although there is a software interface for the wallet on your desktop computer or mobile device, the important detail here is that the private keys are not stored in the software. The private keys are in a secure chip in the hardware device. The added protection comes from the inability for a hacker or malware to steal your digital assets because the signing on the device is accomplished by confirming the transaction details on the display and then pressing a combination of buttons on the device to approve the transaction. The hardware wallet itself is protected by the secure chip and a pin code or biometric lock. Essentially the only way someone could steal your digital assets with a hardware wallet is if they know the pin code or were able to get a copy of the private keys (seed phrase) for your wallet.

Never share the seed phrase for your wallet with anyone.

There are key factors that come into play when comparing different wallets. Here are some of the most prominent.

One of the distinguishing factors between the various wallet options are the cryptocurrencies that are supported. Some wallets may only support Bitcoin or a single other cryptocurrency. Others may support several different cryptocurrencies. And then there are some wallets that support dozens of cryptocurrencies. Depending on what cryptocurrencies you intend to use, purchase, or invest in, one wallet may offer the convenience of working for all of them. It may also become necessary to have more than one wallet.

This is where much of the decision regarding a software wallet or hardware wallet will come into play. Hardware wallets tend to provide the greatest amount of security. This is because extra steps, and knowing the seed phrase for the wallet, are needed to be able to send digital assets from the wallet and the private keys are not stored in the software that's being used for the wallet. Since the private keys are on a separate device, it is much less likely that someone could steal the digital assets from the wallet.

There are some software wallets that add additional levels of security, such as passwords, pin codes, and biometric authentication that's necessary to be able to withdraw digital assets from the wallet. However, there is still the possibility of exploitation of bugs and flaws in the software that would allow a bad actor to steal assets or gain access to the seed phrase.

Another thing to consider is whether the wallet is open-source of closed-source. Open-source means the code is available for the public to see. This allows anyone to inspect the code for flaws that could be exploited by hackers. However, it also allows hackers to more directly look for and potentially find flaws that could be exploited before they are patched. With closed-source the code is not available to the public. Hackers would need to find the flaws without looking at the code, using experimentation, but if a hacker finds the a flaw then the flaw could be exploited long before it's fixed.

Today it is fairly simple to send and receive money with the traditional financial system. We have a lot of tools available to us, from cash to checks to electronic transfer solutions like Venmo, PayPal, Apple Pay, Zelle, and more. They generally are very easy to use, and most people want any new system to be just as easy to use. This is where we see the trade off between security and ease of use.

Generally, software and hot wallets will be easier to use because you can do everything on your computer or mobile device by simply entering your password, pin code, or biometric authentication. With software wallets you can pick any software wallet you want that has the features you're looking for.

A hardware or cold wallet will make this process more complex because of the need to approve the sending of crypto from the wallet on a separate device. This is done by connecting that device to the computer or mobile device in some way or scanning a code on the hardware wallet with the mobile device to approve the transaction. With a hardware wallet you may need to primarily use the wallet software application the manufacturer provides, but some can work with other third party wallet apps, especially when you want to connect with and use certain blockchains and cryptocurrencies.

Most software wallets are available for free.

Hardware wallets need to be purchased. The price usually ranges between $80 $200, but could be more than $300 for some.

Every wallet is going to have advantages and disadvantages when compared to any other wallet. Each user will need to weigh the different factors and features of the wallets against what their needs are and what features they want. There isn't a perfect wallet out there. Some people may want, or even need, to have more than one type of wallet to meet their needs and wants.

Choosing a digital wallet can certainly be a complex decision. Fortunately, Escient Financial specializes in digital assets and cryptocurrencies and can help you choose the right wallet(s) for you. Feel free to...