When you dive into the world of cryptocurrencies, there is one term that will quickly and repeatedly come up: the term "wallet". But what exactly is a wallet, how does it work, and why is it so crucial for your crypto experience? We’ll explore this and more in this article.
A wallet is more than just a digital wallet. It acts as your access point to the blockchain – the heartbeat of the crypto world. With a wallet, you can securely store, manage and carry out transactions with crypto assets like Bitcoin. Although your cryptocurrencies are anchored in the blockchain, the wallet interacts directly with this ledger to give you control over your holdings.
From online wallets that combine user-friendliness with quick access, to hardware wallets that offer the highest level of security, there is a variety of wallet types. Each type has its own functions and security features tailored to different user needs. Both public and private keys are required for transactions – and these are securely stored in your wallet.
In this article, we explain what a wallet is, how to create a wallet address, and what steps are necessary to securely manage your cryptocurrency funds.
What does wallet mean?
A wallet manages cryptocurrencies like Bitcoin, Ethereum, Litecoin, and other altcoins, but does not directly store them. What is actually in the wallet are the private and public keys that allow access to the addresses and thus the users' holdings. A wallet is not a physical wallet and bears no resemblance to a traditional wallet.
Instead, your wallet is a storage location for your addresses, public and private keys. You need these to access your public address on the blockchain and thus your cryptocurrencies like Bitcoin.
To be precise, a single wallet can contain multiple private keys. You can create as many wallets as you like. In fact, most cryptocurrency owners use multiple wallets to ensure maximum security for storing their various cryptocurrencies.
Note: Crypto wallets specialised in securely storing digital currencies should not be confused with the multifunctional services of Google Pay or Apple Pay. The latter act as a digital wallet that not only holds credit cards and boarding passes, but also car keys and tickets – all conveniently accessible through an app. In contrast, crypto wallets focus on a single purpose: storing cryptocurrencies. Everyday conveniences like quick payments with Apple Pay or organising car keys and boarding passes in a single digital wallet are not the goal here.
How does a wallet work?
A wallet interacts with the blockchain to manage your cryptocurrencies by storing public and private keys, which are essential for sending and receiving digital currencies like Bitcoin. Through these keys, the wallet can verify transactions and allow users to access and secure their crypto assets.
A crypto wallet does not look like your traditional wallet. Think of it more like a safe or a treasure chest. To access your assets, you need a key in the form of a password. Losing your wallet keys is a major issue as you can no longer access your wallet. Caution: If your keys are stolen, someone else has access to your cryptocurrencies.
Anyone can access your wallet if they know its storage location (public address) and the associated password (private key). If someone only knows the storage location, it is not a problem as the assets are securely stored in the blockchain. However, if you lose your keys or they are stolen, you can no longer access them, or another person will be granted access to your balance. Therefore, you should protect your keys accordingly and keep them in a safe place.
How can you create a wallet?
Here's how you can set up your wallet:
Choose the wallet type: Decide whether you want to create a hardware wallet, a software wallet, or a paper wallet based on your security needs and frequency of use.
Download wallet software: For a software wallet, download the appropriate app from a trusted provider. Alternatively, for online wallets, visit the provider’s website.
Installation and security measures: Follow the instructions for installation and set up strong security measures such as a strong password and two-factor authentication (2FA).
Generate wallet address: After setting up, a wallet address is automatically generated. For added security, you can also print out a paper wallet.
Create a backup: Secure your recovery phrase or private key in a safe place to restore access to your wallet in an emergency.
After setting up your wallet, you should familiarise yourself with its functions, especially how to manage addresses and perform transactions. Security is of utmost priority: Secure your recovery phrase, encrypt your wallet files, and keep the software up to date. Practise transactions with small amounts and always keep your private keys secret to protect your crypto assets and your privacy.
Types of wallets
There are many different ways to store cryptocurrencies. Cryptocurrency owners can choose the wallet that best meets their needs.
We have summarised the different types of wallets and their advantages and disadvantages for you.
Custodial wallet
Custodial wallets are wallets where a third-party provider retains control over your private keys. This type of wallet is often used by crypto exchanges, where the security and custody of the cryptocurrencies are in the hands of the provider. This offers convenience but also means you do not have full control over your crypto assets.
Note: Note that with custodial wallets, your crypto assets are legally owned by the wallet provider. Therefore, you should choose a provider like Bitpanda that ensures secure asset protection through regular external security checks and compliance with industry standards.
Non-custodial wallet
Non-custodial wallets are wallets where you, as the user, have exclusive control over your private keys and thus your cryptocurrencies. They offer more security and control as no third party has access to your assets. However, they also require a higher level of responsibility for securing and managing your keys.
Note: Careful handling is important when using a non-custodial wallet. Ensure your software is always up-to-date and consider using multi-signature wallets for added security.
Cold wallets
Cold wallets offer one of the most secure methods of storing cryptocurrencies as they are completely offline. This includes hardware wallets, paper wallets, and any other form of storage medium that is not connected to the internet. Due to this offline nature, cold wallets are largely immune to online hacking attacks, phishing attempts, and other cybersecurity risks that threaten online wallets.
Note: It is important that cold wallets are carefully managed to ensure access to cryptocurrencies in the event of loss or damage to the device. For maximum security, it is recommended to store the cold wallet in a secure location and possibly deposit backup copies of private keys or recovery information in several secure locations.
Hardware wallet
Hardware wallets offer a very high level of user-friendliness and security, making them probably the best option for storing cryptocurrencies. The private keys are stored on a cryptographically secure hardware device and cannot be read in plain text. Therefore, hacking attacks are almost impossible, even if a computer is infected with a virus.
Note: To ensure that hardware wallets have not been compromised before purchase, you should never buy used hardware wallets and always obtain them directly from trusted manufacturers!
Paper wallet / physical wallet
A paper wallet is a form of cold storage and refers to a physical document containing your public and private keys, usually in the form of QR codes. Physical wallets can also take other forms, such as metal plates with engraved keys. These types of wallets are, of course, always offline and therefore offer high security due to their completely offline nature.
Note: It only takes a few minutes to create a paper wallet. Open-source services are available online to create the keys on the user's device, meaning the keys will not be sent via the internet.
Hot wallets
Hot wallets are crypto wallets that are constantly connected to the internet, enabling quick and convenient access to your cryptocurrencies. These include, for example, web wallets, mobile wallet apps, but also web-based desktop wallets. Due to their constant online connection, they are less secure against unauthorised access but offer higher user-friendliness for frequent trading and transactions.
Note: Bitpanda stores all user holdings in secure offline wallets that are state-of-the-art. In addition, users can secure their accounts with two-factor authentication (2FA). Users also have an overview of their active devices and sessions, can log out, and close active sessions with another device. Bitpanda also offers SSL encryption and protection against DDoS attacks. However, please note that it is generally recommended to store only a small portion of your holdings on an exchange and the majority of your coins in "cold storage" (offline).
Software wallet (desktop / mobile / online)
A software wallet offers high user-friendliness and high security. Your balance is stored on a computer desktop or a mobile device. You can immediately access your cryptocurrency holdings and have full control over your private keys, which are stored in a "single wallet file". For security reasons, this file is also encrypted, meaning you can use a custom passphrase to access it.
Note: You can either use a separate wallet for each cryptocurrency you own or a software wallet that can store multiple cryptocurrencies.
Online wallet / web wallet
An online wallet is a type of software wallet that is accessible through a web browser. It is hosted on a server and allows the user to access their cryptocurrencies over the internet. Although it can be conveniently used from any device with internet access, it is considered less secure than other types of wallets, such as desktop or hardware wallets, which enable offline storage.
Note: Maximise the security of your online wallet by conducting regular security audits and using features such as automatic logout timeframes and notifications of unknown login attempts.
Bitcoin wallet & more: Cryptocurrencies and their own wallets
In the world of cryptocurrencies, choosing the right wallet is crucial. A Bitcoin wallet, specifically designed for the first and best-known cryptocurrency – Bitcoin (BTC) – offers tailored features that cater to the management and security of BTC. Just as Bitcoin wallets are optimised for BTC, there are also dedicated wallets for other cryptocurrencies like Ethereum (ETH).
Using specific wallets for different cryptocurrencies offers several advantages. Firstly, they ensure higher compatibility with the respective blockchain protocols, leading to smooth transactions. Furthermore, dedicated wallets are often better able to support specific features of the respective cryptocurrency, such as smart contracts with Ethereum.
Another important aspect is security: Wallets developed for specific cryptocurrencies can include specific security features that address the unique risks and attack vectors of the respective blockchain. For example, many Bitcoin wallets offer advanced security measures such as multi-signature verification and hierarchical deterministic (HD) address generation to help keep holdings safe.
Finally, the user experience can be improved by using a dedicated wallet for your crypto assets. The interfaces of such wallets are often more user-friendly and provide a better overview of transactions and holdings. Whether you create a Bitcoin (BTC) wallet or another crypto wallet, the specialised software helps optimise your crypto experience.
How wallet security is maintained
Security is the top priority when managing cryptocurrencies. To optimally protect your digital assets, you should proceed with care when creating a Bitcoin wallet or another crypto wallet. Here are some best practices to secure your wallets:
Careful selection during creation: When setting up your wallet, choose established and proven software or hardware. The provider should always have high-security standards and positive user reviews.
Prefer offline storage: Use cold storage options like hardware wallets for the majority of your coins. These wallets are not permanently connected to the internet, minimising the risk of online theft.
Activate security features: Enable all available security features such as two-factor authentication and multi-signature protection mechanisms. These additional security measures make unauthorised access more difficult.
Backup the recovery phrase: The recovery phrase allows you to restore access to your wallet if you lose access. Keep it in a safe place – preferably offline, e.g. in a safe or another secure location.
Regular updates and reviews: Keep your wallet software always up to date to benefit from the latest security updates. Regularly review your wallet settings and adjust them if necessary.
Education and vigilance: Stay informed about the latest security trends and be vigilant against phishing attempts and other fraud methods.
Wallets and their significance for the crypto world
Wallets play an important role in the crypto world as they represent the interface between users and the blockchain. They are not only storage places for digital currencies but also enable transactions on the blockchain. Every transaction, whether sending Bitcoin or interacting with a smart contract on Ethereum, begins and ends with a wallet.
Exchange wallets offered on crypto exchanges are particularly useful for active traders and those who frequently carry out transactions. These wallets are usually custodial wallets, meaning the exchange holds the private keys and thus the responsibility for the security of the holdings. They offer the convenience of conducting transactions directly on the platform without having to transfer funds from an external wallet first. This saves time and allows for quick reactions to market changes.
The choice of the right wallet depends on individual needs and the desired balance between convenience and control. For daily transactions and trades, exchange wallets can be ideal, while for long-term investments and larger sums, a personal wallet offering more control and security is recommended.
A look into the future of wallets
Modern wallets are not just storage places for cryptocurrencies but are evolving into multifunctional platforms. In the future, they could revolutionise how we think about and manage finance through integration with DeFi ecosystems and support for multi-signature transactions. These technologies increase security while offering new opportunities for generating returns or participating in governance systems. Further innovations could include seamless interfaces between different blockchain networks and even greater automation through smart contracts. In the dynamic world of cryptocurrencies, continuous learning is key to staying up to date and fully leveraging the advantages of evolving wallet functions. You can find more information on multi-signature wallets and DeFi in our Bitpanda Academy.
Conclusion: How to choose and set up the right wallet
Choosing the right wallet is an individual decision that depends on your needs in dealing with cryptocurrencies. Consider security, convenience, desired features, and the frequency with which you want to access your cryptocurrencies. For daily transactions, exchange wallets are practical, while hardware wallets provide long-term security. After selecting your wallet, many providers offer guides to help you set up and use your wallet securely. Keep in mind that the cryptocurrency ecosystem is constantly growing and changing. Therefore, it is important to continuously learn and handle your wallet and assets responsibly.
Frequently asked questions about wallets
We clarify the most frequently asked questions about wallets to give you a comprehensive overview.
What is a wallet?
A wallet is a digital tool that allows you to store, send, and receive cryptocurrencies. It interacts with the blockchain to enable transactions and is secured by two different encryptions (keys): the public key (the wallet address) and the private key, which is known only to the user.
Where do I get a wallet?
You can get wallets from various sources, including crypto exchanges, official project websites, or app stores. Hardware wallets are usually sold by the manufacturers or authorised dealers. You can set up your Bitpanda wallet, for example, through our Bitpanda Smart Investment App.
Do you need new wallets for new cryptocurrencies?
Not necessarily. Many wallets support multiple cryptocurrencies. However, the wallet must be compatible with the respective cryptocurrency. Some new or less common cryptocurrencies may require a specific wallet.
What is a wallet address?
A wallet address is a string of characters assigned to your wallet and serves as a receiving address for cryptocurrency transactions. It works similarly to an account number at traditional banks.
How can you create a wallet address?
A wallet address is usually generated automatically when you set up a wallet. In the case of software or online wallets, this is done by the wallet program or service. With hardware wallets, the address is created by the device once it is set up.
How many coins can you store in a wallet?
The storage capacity of a wallet and the number of coins it can hold depends on the type of wallet, its technical specifications, and the type of coins. Hardware wallets generally support a large number of different cryptocurrencies, while the capacity of software wallets can vary.
Custodial wallets, like those on crypto exchanges, usually offer unlimited storage, but you do not retain control over the private keys.
Further topics on cryptocurrency
Are you interested in a more comprehensive discussion of cryptocurrencies? Then we recommend taking a look at our additional articles to delve deeper into the world of digital currencies.
Difference between crypto broker and exchange
How can I keep my cryptocurrencies safe?
How does a blockchain work?
