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 Core Wallet, for Litecoin we would suggest Litecoin-QT, and for Ethereum we would suggest either Ethereum Wallet or MyEtherWallet.

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

There are also useful offline wallets like TREZOR (these are good for long-term storage).

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. Or, 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.

IMPORTANT: Never share your wallet password or private key and never enter your password or private key anywhere (unless you are accessing your wallet via private key and password). To send coins and receive coins you only need to share your public wallet address (your “public key”).

What Is A Bitcoin Wallet? The basics of cryptocurrency wallets using a Bitcoin wallet as an example.

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!

TIP: 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.

TIP: Watch out for browser extension malware if you are using online wallets, you may want to use a different browser for your online wallet than you do for your day-to-day internet browsing.

TIP: The term “hot wallet” describes a wallet connected to the internet. The term “cold wallet” describes a wallet not connected to the internet (for example a hardware wallet unplugged and in a safe.) When cryptocurrency is in “cold storage” that mean it is being held offline in a “cold wallet.” Funds you want to use like cash should be in hot wallets, funds you want to store long term are best held in “cold storage” in an offline wallet.

TOP 6 CRYPTOCURRENCY WALLETS. A video on the different types of cryptocurrency wallets.

IMPORTANT: 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.
Get $10 in free Bitcoin when you sign up at Coinbase and buy or sell $100 in Cryptocurrency

What do you think?

Hugh on

I have not bought any crypto cuurency as of this date and have been searching on line for basic information. Your information is the best that I have located online. The one fact I can’t find is if I buy any currency do I need to obtain a wallet to keep it in

Thomas DeMichele
Thomas DeMichele on

In general, you need some sort of cryptocurrency wallet to store cryptocurrency in.

A simple solution for a new user is Coinbase. Coinbase is a wallet/broker hybrid (where you can store and buy crypto). From there it is easy to move your coins into official wallets and top wallets like Bitcoin Core wallet, MyEtherWallet, or TREZOR (or to simply keep your coins on coinbase). Although, with that said, you can simply start with a wallet and obtain your cryptocurrency by other means as well (on an exchange, from a peer-to-peer transaction, etc).

Each wallet type has pros and cons, but the top wallets and Coinbase are all sensible choices.

See: http://cryptocurrencyfacts.com/how-to-send-and-receive-cryptocurrency/ (that explains how to get coins in and out of wallets).

Ray Reyes on

Great explanation. Thanks!

Ambadas godbole on

I like decentralise currency.

Thomas DeMichele
Thomas DeMichele on

#bumpersticker idea

sophia on

Someone told me you need a blockchain wallet , but aren’t they all blockchain wallets ?? What did they mean by this??

Thomas DeMichele
Thomas DeMichele on

Essentially all cryptocurrency wallets are “blockchain wallets.” Blockchain is a technology that that creates a digital ledger of transactions encrypted by cryptogorahy.

It is the core mechanic behind Bitcoin for example (read more here: http://cryptocurrencyfacts.com/what-is-a-blockchain/ ).

What you need for a given cryptocurrency is a wallet that can handle the specific kind of coin.

For most ICO tokens (token being a name for a cryptocurrency essentially) you need an ERC-20 friendly wallet like MyEtherWallet. For other coins you need the specific wallet for that coin or a third party wallet set up to hold that coin.

ERC-20 friendly tokens aside (for those, again, use a wallet like MyEtherWallet), always download the official wallet of a coin when you can, and always do your research before downloading. There is a lot of room to go wrong here if you don’t know what you are doing 😉

IMPORTANT: There are fake wallets out there and putting your coins in them will result in you losing your coins. This is super lame, and we want to avoid this. Thus, don’t go following random online instructions without triple checking what you are doing. When in doubt look to entities like Coinbase, official wallets like Bitcoin Core’s wallet, trusted third party wallets like MyEtherWallet, trusted hardware wallets like Trezor, etc. Those are hardly the only choices, they are just examples of upstanding wallets.

ScaredyNewb on

How are wallet/broker services, particularly Coinbase, fundamentally different from MtGox? Are there security issues, and how are these addressed?

Thomas DeMichele
Thomas DeMichele on

So, I don’t want to act like I have done a deep study of this, but in general, Coinbase is a way more professional entity. They are licensed to operate in the U.S., insured, and keep a really tight ship from what I understand.

The business was built from the ground up to be a trusted wallet-broker-exchange for U.S.-based users.

MtGox was a Magic the Gathering exchange built and then sold to a guy who seemed at best half interested in running a tight ship (it was in his hands that the events occurred; let’s not try to pass judgement on those events here).

No exchange is 100% safe, and we still see exchanges go down these days (and with that we see funds disappear, or oddly low limit buys fill, etc). However, the major exchanges have thus far mostly avoided MtGox’s fate (GDAX, Bittrex, Binanace all have a good track record for example). Meanwhile Coinbase one-ups”sites that are exchanges only by also providing a wallet service (Coinbase is a little different than GDAX, the exchange; MtGox was an exchange).

Coinbase also offers an extra layer of security with their “vault” product.

So it is different in not just being some exchange run by a half interested guy on the internet, in having a more secure-on-paper wallet element, and in being a more established and better maintained business.

For extra security, use the vault and/or look into a long term storage option for the Bitcoin you are going long with (like TREZOR or a paper wallet, etc).

I personally wouldn’t consider Coinbase/GDAX on the same level as the exchanges from back in the day, but they are hardly fundamentally different in every respect (especially when comparing GDAX to another exchange).

All that said, my answer is I’m sure lackluster compared to an answer someone from Coinbase could give 🙂

Jose on

Awesome presentation, still consider myself a beginner, although I spent probably 4 to 5 hours reading about different cryptocurrencies, wallets, and exchange services. BTW I purchased Litecoin two months ago.

Thomas DeMichele
Thomas DeMichele on

Congratulations! I think Litecoin is a solid long term investment. It hasn’t preformed like BTC has in the past few months (since the first of the year, that is another story). However, at the end of the day it has faster and cheaper transactions than other top coins AND it has longevity. I think holders will be nicely rewarded at some point.

Anyway, that is my two bits on litecoin. Thanks for the kind words! Keep learning about crypto and enjoying it!

Anandakumar on

I have LITE COIN classic, ( lcc Coin )
We hold the Coin in NOVA EXANCHANGE, now it’s move to close, unfortunately lcc Coin don’t have wallet, so we want to safe our Coin in wallet, so pls give any valubale advice to save our Coin.
A. Ananda kumar
India

Thomas DeMichele
Thomas DeMichele on

I believe Litecoin Classic is an ethereum-based token that is not directly related to litecoin. That means you would use a ERC-20 friendly wallet like MyEther wallet and then set it up for the Litecoin Classic token. Here is an example of how this is done (you need the specific contract address, symbol, and decimal for that wallet): http://cryptocurrencyfacts.com/how-to-create-a-custom-token-in-myetherwallet-how-to-add-a-token/

I would use another source to confirm this. Assuming I am correct, start by sending a small amount and verify that it works. You wouldn’t want to test out a wallet address with a large amount of coins.

For the future, although everyone has to make their own choices, it is often wise to focus on coins that are traded on popular exchanges and have their own official wallets. Anything in the top 50 or so coins by market cap is generally a safe bet. It avoids some of the problems one can have with less traded coins such as finding buyers, finding wallets, and finding exchanges to trade them on.

Jp on

Great information!
I have a question:
I purchased a certain company’s cryptocurrency using the Changelly exchange. The transaction went through but it didn’t show up in my wallet. I have a wallet on an exchange’s web site. I don’t remember if my personal wallet was active at the time or not. Anyway, the message they sent me was to do this:
“Your transaction was completed successfully on our end. If you still haven’t received your money, you can sync your wallet with the blockchain, update it or contact the support team of your wallet. That should work.” The support team has been useless. How do you sync a wallet to a blockchain? Thanks in advance for your help.

Thomas DeMichele
Thomas DeMichele on

So, first off, the transaction process is a multi-part thing when sending from a third party like an exchange to another one. In overly simple terms: Part 1 is the first entity completing their end, part 2 is waiting for the transaction to process, part 3 is waiting for the entity to credit the account.

If you had to change Bitcoin into Ethereum, for example, it could take hours. So that is one thing to note.

On an exchange you wouldn’t have to sync your wallet. Syncing a wallet is more something you would do if you had a wallet where you were in control of your private keys, or had a hardware wallet that was offline.

You almost certainly “just have to wait” in your case. I end up waiting all the time when sending between exchanges personally, sometimes for uncomfortably long periods of time. It is just part of the deal with some of the coins with slower speeds.

You can also check the public ledger to see if your transaction has been added, often you’ll have a transaction number. For example, you can check ether transactions here: https://etherscan.io/

Further, if you check your wallet in the exchange it may show you the status of the transaction.

It can be stressful when you send a transaction out into the void via third parties and then play the waiting game, but in general it is just a matter of waiting.

http://cryptocurrencyfacts.com/cryptocurrency-transactions-take-time-waiting-is-normal/