11/13/2017

Simple Guide To Digital Wallets

Digital Wallets
Top to bottom, left to right: Exodus, Ledger, Blockchain, and MyEtherWallet

 

Introduction

A digital wallet is a storage device for cryptocurrencies, similar to a folder on your computer but it holds digital assets instead of files. There are several different kinds of wallets ranging from the typically less secure but more payment-friendly mobile and web or browser wallets to software or paper wallets that may be less easy to transact with but far safer for long-term storage. Using a digital wallet for the first time can be intimidating for new users but after a few test transactions it can quickly become second-nature.

Before creating a wallet
The first rule when dealing with digital currencies is that you are solely responsible for the security of any money you store online. Always store your password in a safe location and make sure to use a strong password containing letters, numbers, and symbols. Many exchange, online wallets, and cryptocurrency users have suffered from security breaches resulting in the loss of significant assets so skepticism toward exchanges and wallet providers is highly recommended. 

Types of wallets

  • Paper Wallet: A storage device for digital assets consisting of a physical, printed version of a cryptographically-generated public and private address. These are often used for cold storage. The first 'paper wallets' were made of paper, but the word has come to be used as an explanation for anything that physically (as opposed to on-screen) displays the public & private key. 'Physical bitcoins' like Caucascius coins also fall under this 'technical' definition.
  • Software Wallet: An application for electronic devices used to store and transfer digital currencies. These are usually associated with cold storage.
  • Web or Browser Wallet: A web-based application used to store and transfer digital currency or currencies. Such wallets are generally hot wallets by definition.
  • Mobile Wallet: An application intended for storing and transferring digital currency or currencies on devices running on Android or iOS.

Types of storage

  • Cold Storage: Distinguished from 'hot storage'. Refers to the offline storage of cryptocurrency. Funds stored offline are not in any way directly connected to the internet. This is primarily done for security reasons or to facilitate easy physical exchange or long-term storage. USB sticks, special hardware, or even paper wallets can be used to facilitate cold storage.
  • Hot Storage: Distinguished from 'cold storage'. Refers to the online storage of cryptocurrency. This includes online wallets, mobile app wallets, and storage on websites. Though exchanges generally keep most of their digital assets in cold storage, an individual's exchange balance can be thought to be 'hot storage' since they can transfer it very quickly using the online interface.

Questions to ask when choosing a wallet
Does the wallet provider have access to the private keys to your wallet or has the service been decentralized by allowing the user to retain sole custody of their private keys? Is the wallet provided a paper, mobile, web browser, or software-based wallet, and what steps have been taken to ensure the security of the wallet? Can the wallet hold the token or tokens I want to obtain? Does the wallet provide my desired functionality? Is the wallet provider reputable?

Diversification of assets
Diversification in cryptocurrency doesn’t only mean holding different types of tokens; it also means keeping your digital assets in different wallets. Many users of digital currencies keep some of their assets in offline or “cold storage” for safekeeping and some of their currency online in “hot storage” for ease of use in making purchases and trading tokens. Mobile wallets and exchanges are generally considered the least secure, followed by software wallets, with Paper and hardware wallets being the safest because they allow you to generate your private keys offline. Some software wallets allow users to generate private keys offline but users must make sure their wallet client provides such functionality.

Safety features to consider
Most wallets include basic encryption allowing users to set a password for wallet access but passwords can be vulnerable to keylogging attacks. Some wallets include two-factor authentication, which allows users to require a second password automatically generated by a third-party application to access the wallet. Wallets enable with multi-signature functionality allow users to require multiple passwords to access a wallet.

Other considerations
Unless specified otherwise, transactions made with digital currencies are irreversible and not anonymous. Practice sending small amounts of currency between digital wallets before making large transactions and always double-check to be sure you’re sending tokens to the intended address. The price of digital currencies can be extremely volatile so you should always do your own research and be aware of the taxes and regulations of your local jurisdiction before making an investment.
 

Authored by

Seth Goldfarb

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