By Susan Doktor
If you had a million dollars—or even a thousand Euros—chances are, you wouldn’t keep them under the proverbial mattress in your home. There are burglars out there, after all. There’s the risk of fire. And if you wanted to spend your money to pay your electric bill, you’d have to transfer your money to a bank account anyway, unless you wanted to pay your bill in person. And who wants to take the time to do that. You’re much more likely to stash your cash in a checking or savings account, where you can access it by writing a check.
Similarly, in the cryptocurrency market, it’s not just what or how much you own. It’s also where you keep it. Whether you own Bitcoin, Ethereum, or some lesser-known cryptocurrency, if you want to transact business with it, you need to keep your assets where you have convenient access to them. Enter the crypto wallet.
How Do Crypto Wallets Work?
To understand how crypto wallets function, you also need to understand how cryptocurrencies work. A cryptocurrency is a virtual form of currency that’s protected by cryptography. Some argue that it’s the safest currency to own. It’s stored redundantly in multiple places, collectively known as a distributed public ledger that’s also called a blockchain. Blockchain is less vulnerable to fraud and other financial risks than traditional bank accounts which are far more easily hacked. Dumpster divers can steal your bank statements. Depending on where you store them, passwords can be stolen. Cybercriminals can access your financial information by installing tiny, invisible skimmers that collect your financial data when you use your card at an ATM. Because some skimmers are used for legitimate purposes, such as transferring data from a remote retail location to a desktop or laptop computer, they’re available for purchase through blockbuster retailers like Amazon for a modest fee. It doesn’t cost much to get into the credit card fraud business.
But by design, funds held in blockchain are more difficult to access. When you purchase a cryptocurrency directly from its minter or through a crypto exchange, you’ll be given a private key to your assets. If you purchase through multiple channels, you’ll have multiple keys to manage.
Private keys are like passwords. You don’t want to share them with anyone. Private keys allow whoever holds them to spend, transfer, or withdraw funds from a crypto account. By contrast, crypto wallets give you the means to receive cryptocurrencies without sharing your private keys. They create public passwords for that purpose.
There are two basic categories of crypto wallets. Let’s take a look at how they differ.
Hard Wallets are Cool
If you plan on holding your cryptocurrencies for a long period of time as an investment, you may want to choose the hardware—also known as cold storage—option. With cold storage, your crypto keys are saved onto an external device. These devices usually resemble portable USB drives or slim cards that easily fit inside your regular wallet.
Some people consider cold storage the safest wallet option because your information is stored offline. You can purchase cold storage devices from many retailers and they typically run between $100 and $200. Some feature more sophisticated biometric data security such as fingerprint-only access. But cold storage devices don’t eliminate all risk. They can easily be lost—how many times have you misplaced a thumb drive? And like other electronic devices, they can be stolen from your home, purse, or glovebox. We’re certainly not recommending you keep your cold storage device there. But it’s been known to happen.
Some Like it Hot
Hot wallets (or software wallets) are a different animal. They keep your private and public keys online. That means you can access your crypto at any time from your computer, tablet, or smartphone. That makes transacting business with your crypto assets a more flexible, convenient affair. If you’re an active crypto trader, want to move your assets between external accounts, or use crypto to make purchases, a hot wallet may be right for you. But you pay for the convenience in a sense: hot wallets are generally considered more susceptible to hacking than hard wallets.
Hot wallets are usually provided free of charge from the cryptocurrency exchanges you use to buy crypto. Some exchanges provide hot wallets even to users who don’t purchase crypto assets from them. Some hot wallets can only accommodate one type of cryptocurrency, while you can store multiple types of currency in others. Wallets that give you access to multiple currencies save you some trouble. Who wants to carry two or three wallets when you can carry just one?
Wondering how crypto wallet companies make money? Mostly by driving business to affiliated businesses like cryptocurrency exchanges. But they also pay fees. On the surface, it appears that crypto wallets make money by charging you transaction fees. But they are more likely passing on the network fees they must pay themselves. Fees can vary by which currency you’re moving around, how much you’re moving, and even the time of day you complete a transaction. If you request a transaction during a busy part of the day, it’s likely to cost you more. Some crypto wallets allow users to influence the fees they pay. Choosing to pay a high fee will result in your transaction being processed more quickly. Choose a low fee and you can expect to wait in line for a little while.
Are Crypto Wallets a Must-Have?
Not necessarily. Cryptocurrency exchanges will create a crypto wallet and store the assets you purchase from them for free. Some people are content to choose that option. But if you have a great deal invested in crypto or have purchased from multiple exchanges you may want to centralize your funds in one separate crypto wallet. Or perhaps one cold and one hot wallet. The benefits are two-fold: greater security and, in the case of hot wallets, more convenience.
One More Way to Make Crypto Investing Less Risky
Crypto investing is similar to investing in more traditional assets like stocks and bonds. Financial advisors often stress the importance of diversifying your investments across companies, industries, and investment classes. Depending on what stage of life you’re at and how much risk you’re comfortable tolerating, they’ll advise you on how to allocate your funds. Traditional mutual funds, for example, which invest in multiple assets for you under one banner, help balance the risk of stock market investing.
The same principle holds in cryptocurrency investing. You can mitigate risk to a degree by holding a diversified portfolio of coins. Or you can take it one step further and purchase index tokens, such as TCAP. TCAP connects investors to a wider crypto market. The value of a TCAP token is tied to an index that takes into account the total performance of all cryptocurrencies. That makes TCAP tokens less volatile. You might liken them to ETFs or index funds in traditional financial markets.
Susan Doktor is a journalist, business strategist, and principal at Branddoktor. Her contribution comes to us courtesy of Money.com.
Source: Plato Data Intelligence: PlatoData.io