Understanding How a Cryptocurrency Wallet Works

A cryptocurrency wallet is a secure digital wallet used to store, send, and receive digital currency like Bitcoin. Most coins have an official wallet or a few officially recommended third party wallets. In order to use any cryptocurrency you will need to use a cryptocurrency wallet.

Below we discuss how digital wallets work and give some advice on which wallets to use.

TIP: If you want a simple wallet-exchange solution (so you can jump right into trading cryptocurrency) see our page on “How to Trade Cryptocurrency – For Beginners.”

How Does a Cryptocurrency Wallet Work?

Cryptocurrency itself is not actually “stored” in a wallet. Instead, a private key (secure digital code known only to you and your wallet) is stored that shows ownership of a public key (a public digital code connected to a certain amount of currency). So your wallet stores your private and public keys, allows you to send and receive coins, and also acts as a personal ledger of transactions.

Which Cryptocurrency Wallet Should I Use?

We typically suggest using an official (or officially endorsed) wallet for any given coin. So, for Bitcoin we would suggest using the Bitcoin Wallet, and for Litecoin we would suggest Litecoin-QT.

There are also universal wallets that can be used like HolyTransaction (one of if not the most popular).

If you are new to cryptocurrency, then either:

  1. Download the official (or officially endorsed) wallet from the official website.
  2. Sign up for a service like coinbase (which handles a wallet and exchange with one account).
  3. Use a universal wallet like the one noted above.

If you know what you are doing there are actually a wide range of different wallets to choose from which offer varying pros and cons.

IMPORTANT: Some software offered as a wallet is actually malware trying to take advantage of those willing to download and install unofficial software off the internet. Never trust mining or wallet software that comes from a source that you don’t know and trust. Start with well worn solutions like the ones explained above, then move onto other wallets after you know what you are doing.

Are Cryptocurrency Wallets Secure?

Cryptocurrency wallets are all built to be secure, but the exact security differs from wallet to wallet. Generally, like your user names and passwords, the security of your wallet comes from you using best practices. We suggest not keeping more currency than you need at one time in a single wallet that you use frequently, using google authenticator for extra layers of protection, encrypting your wallet, and using an official (or officially endorsed wallet). You can also use multi-signature transactions.

It’s smart to backup your wallet and private keys and to encrypt them. At least one backup should be on a CD or thumb drive to ensure that you have a “hard copy” laying around. If you lose your wallet or your keys then you lose the currency connected to it! As a rule of thumb don’t keep more currency in your digital wallet then you would in your real one! You can learn more about securing digital wallets from bitcoin.org.

Are Bitcoin Wallets Anonymous?

The answer is about the same as the answer to whether cryptocurrency is anonymous or not. The answer is that cryptocurrency is “pseudonymous.” Due to the open source and public nature of transaction blockchain ledgers, there are little bits of public data that can be used to backwards engineer someone’s identity (in theory). For most of us, the answer then would be, “it’s pretty darn close to anonymous”.

Types of Wallets

There are a number of different types of wallets you can use including online, offline, mobile, hardware, desktop, and paper. Each “type” refers to what type of medium the wallet is stored on and whether or not the data is stored online. Some wallets offer more than one method of accessing the wallet – for instance, Bitcoin Wallet is a desktop application and a mobile app.

Here is a quick breakdown of the different types of cryptocurrency wallets:

Desktop Wallet: The most common type of wallet. Typically an app that connects directly to a coin’s client.

Mobile Wallet: A wallet that is run from a smartphone app.

Online Wallet: An online wallet is literally a web-based wallet. You don’t download an app, but rather data is hosted on a real or virtual server.  Some online wallets are hybrid wallets allowing encryption of private data before being sent to the online server.

Hardware Wallet: Dedicated hardware that is specifically built to hold cryptocurrency and keep it secure. This includes USB devices. These devices can go online to make transactions and get data and then can be taken offline for transportation and security.

Paper Wallet: You can actually print out a QR code for both a public and private key. This allows you to both spend and receive digital currency using a paper wallet. With this option, you can completely avoid storing digital data about your currency by using a paper wallet.

Remember that with any wallet, if you lose your private key, then you lose your money. That is true for paper wallets, hardware wallets, or any other wallet type. The reason you lose your keys doesn’t matter; there is no way to reclaim your cryptocurrency without them.