So, you’ve either bought or are thinking about purchasing cryptocurrency. The question that probably brought you here is – where do I put it? The first step to using cryptocurrency, no matter which one, is creating a wallet. There are many kinds of cryptocurrency wallets and it’s important to understand the benefits and risks associated with each of them.
Every cryptocurrency wallet has two keys: a public key and a private key. These keys consist of random sequences of letters and numbers. The public key is your wallet address, where anyone can send crypto for you to receive in your wallet. It’s like a bank account number. The private key is more like a bank password and allows you to send your crypto to other wallets or interact with decentralized applications. Another word you might hear, seed phrase, is a human-readable version of your private key – typically either 12 or 24 words.
There are two main types of wallets: custodial and non-custodial. Custodial wallets are hosted by an institution, while non-custodial wallets are managed entirely by you.
With non-custodial wallets, you are holding your crypto in a wallet only you have access to, like holding cash in your physical wallet. Non-custodial wallets allow you to hold both your public and private key, putting you in full control of your funds – it’s just you and the blockchain. But, with great power comes great responsibility. If you lose access to your wallet and your private key, or a bad actor comes across it, you may never see your hard-earned crypto ever again. If using a non-custodial wallet, be sure to have a safe place to store your private key. If you’re an experienced crypto user who cares deeply about decentralization and having complete control of your own funds, a non-custodial wallet may be the right choice for you.
Custodial wallets are wallets that are hosted by institutions – like a bank account. With custodial wallets, the institution with which you have an account holds the private key to the wallet. They are convenient in that you just need a username and password for the institution that is hosting it to log in. If you forget your password, you can simply verify your identity and create a new one. However, custodial wallets are only as secure as your account and the institution with which you have created your account. If the institution is trustworthy and you’ve followed the recommended security procedures, you shouldn’t have anything to worry about. If you are looking for convenience, trade frequently, are worried about losing access to your wallet, or want to mitigate the need for gas fees when trading, a custodial wallet may be the right choice for you.
Wallets can also be either ‘hot’ or ‘cold’. The distinction between ‘hot’ and ‘cold’ wallets refers to internet connectivity. Hot wallets are always connected to the internet, while cold wallets are primarily stored offline.
Because hot wallets are always online, you don’t need to connect them to the internet every time you are transacting with your crypto. However, because they are always online, they can be susceptible to cyber-attacks. Hot wallets can be custodial or non-custodial. An example of a custodial hot wallet is your AscendEX wallet, which is always online and which you log into with a username and password, while AscendEX holds the private key. Examples of non-custodial hot wallets include DeFi wallets that are mobile and web applications like Metamask for Ethereum and other EVM tokens, or Phantom for Solana. You still hold your private keys and need them to access these wallets, but they can’t be used unless they’re connected to the internet. The advantage of an exchange-based custodial hot wallet is that you can trade your funds instantly and for very low fees, without the need to store your private key (because the exchange is storing them for you). The advantage of a non-custodial hot wallet like a DeFi wallet is the ability to interact with smart contract applications and have control of your private key, but this comes with the need for greater responsibility, the danger of interacting with malicious applications, and the need to pay network fees, due to every transaction happening ‘on-chain’.
Cold wallets are most useful for storing crypto if you have little to no intention of moving it for a long period of time. Because they are always typically offline except when submitting transactions, they have little to no risk of being compromised, unless the private key is compromised. The most common cold wallets are non-custodial hardware wallets, made by brands like Trezor or Ledger. You hold the private key to these, and you’ll only connect them to the internet when you want to send crypto. There are custodial cold wallets, but these exist primarily for institutions in the form of custodial cold storage. If you plan to buy bitcoin and hold for a long time, cold wallets may be the right choice for you. But, if you want the ability to transact and trade quickly or interact with DeFi applications, you’re better off looking into hot wallets.
The last distinction between different wallet types is DeFi vs hodl vs exchange wallets. This distinction is how you will be using the wallet. DeFi wallets are always hot and generally non-custodial, hodl wallets can be either hot or cold and either non-custodial or custodial, and exchange wallets are always hot and always custodial.
DeFi wallets, like Metamask or Phantom, are used for interacting with dApps or decentralized applications. Because of this, they are always online. If you want to buy NFTs or interact with decentralized exchanges, DAOs, Web3 games, or other protocols, you will need a DeFi wallet. However, the ability to do more comes with greater risk. Because DeFi wallets interact directly with dApps, they are also the most vulnerable to attacks. If you click the wrong link, or a project gets hacked, and you approve a transaction from a malicious smart contract, your wallet could be wiped. For this reason, only interact with trusted applications and make sure to only keep as much on your DeFi wallet as you are planning on using with decentralized applications.
Hodl wallets can be any type of wallet that you are planning on “hodl-ing” your crypto in. However, the best hodl wallets are non-custodial cold wallets. This is because you hold your own keys, meaning that you are in full control of your crypto, and because they are primarily offline and thus less vulnerable to attacks. If you use a non-custodial cold wallet correctly, the only vulnerability is your private key.
Exchange wallets are always online and controlled by the exchange. Advantages of exchange wallets are the ability to recover your password if you lose your private key, to trade and transfer assets with speed and for lower fees than on-chain, and to hold a multitude of different assets from different chains in the wallet. Because exchange wallets are custodial, the only vulnerabilities are your account being compromised and the exchange being compromised. If you follow security procedures and are trading/holding/earning on a platform you trust, you should have nothing to worry about.