Even though Bitcoin only exists digitally, you’ve still got to keep it somewhere, whether you’re hoping to use it to buy goods or services today or to invest it for the long term.
That’s why when you start buying Bitcoin, you’ll also need to begin using a Bitcoin wallet. Luckily, crypto wallets generally work just like physical billfolds—they keep up with your cryptocurrencies and store the information proving ownership of any tokens you hold in it.
What Is a Bitcoin Wallet?
“A Bitcoin wallet (and any crypto wallet, for that matter) is a digital wallet storing the encryption material giving access to a Bitcoin public address and enabling transactions,” says Alexandre Kech, CEO of Onchain Custodian, a custody service for digital assets. Bitcoin wallets not only hold your digital coins, but they also secure them with a unique private key that ensures that only you, and anyone you give the code to, can open your Bitcoin wallet. Think of it like a password on an online bank account.
With a crypto wallet, you can store, send and receive different coins and tokens. Some just support basic transactions while others include additional features, like built-in access to blockchain-based decentralized applications commonly known as dapps. Among other things, these may allow you to loan out your cryptocurrency to earn interest on your holdings.
How Does a Bitcoin Wallet Work?
Because Bitcoin operates on a secure digital ledger called blockchain, using a Bitcoin wallet isn’t as simple as opening a leather flap. For that reason, it may be helpful to think of a Bitcoin wallet like email, says Sarah Shtylman, fintech and blockchain counsel with Perkins Coie.
To send an email, you must use your password to log into your account, input a recipient’s address and then hit send. To send Bitcoin, you similarly need your coded key, essentially your password, to access your cryptocurrency. You then need your intended recipient’s Bitcoin wallet address, similar to an email address, to send the cryptocurrency to them.
“On the Bitcoin network, the public address is an identifier that points to a particular ledger entry (i.e., a Bitcoin balance) on the blockchain, and the private key is what enables its holder to make changes to the associated ledger entry (i.e., to transfer the Bitcoin to a different address),” says Shtylman.
It’s important that you keep track of your Bitcoin wallet’s key. If someone else has it, they can hack into your wallet and send it to their own wallet. And, if you lose your key, you could lose access to your cryptocurrency. That’s because many cryptocurrency wallets are decentralized and cryptographically secured, meaning there’s no central customer support number for you to call to prove your ownership and identity and reset your password. An estimated 20% of all Bitcoin currently in circulation, worth billions of dollars, is lost in digital wallets that users can’t access.
Types of Bitcoin Wallets
As with physical wallets, Bitcoin wallets come in a range of styles, each offering a tradeoff between convenient access and security against theft.
Mobile wallets, like Mycelium and Edge, are those that run as apps on phones, tablets and other mobile devices. “Transacting is easy as funds can be sent to other wallet addresses represented by QR codes,” notes Adrian Przelozny, CEO of Independent Reserve, a crypto exchange in Asia and the Pacific. “While they are great for portability and convenience, they are also the least secure.” Not only can the crypto wallet itself get hacked, but if someone steals your device they could also take your coins.
Web-based wallets, like Coinbase and Blockchain.com, store your coins through an online third party. You can gain access to your coins and make transactions through any device that lets you connect to the internet. These web-based wallets are frequently associated with crypto exchanges that allow you to trade and store crypto all in one place.
While convenient, web-based wallets still hold many of the same risks as mobile wallets, namely that because they’re connected to the internet, they can be hacked. Though this is a rare occurrence and stolen funds have generally been replenished through insurance, you may not want to take this risk with your money. In addition, there have been times when exchanges have shut down, and people lost the coins in their web wallets.
Desktop wallets, like Atomic Wallet, Electrum and Exodus, are programs you can download onto a computer to store coins on your hard drive. This adds an extra layer of security versus web and mobile apps because you aren’t relying on third-party services to hold your coins. Still, hacks are possible because your computer is connected to the internet.
Hardware wallets are physical devices, like a USB drive, that are not connected to the web. To make transactions, you first need to connect the hardware wallet to the internet, either through the wallet itself or through another device with internet connectivity. There is typically another password involved to make the connection, which increases security but also raises the risk you may lock yourself out of your crypto if you lose the password.
Hardware-based crypto wallets are also known as cold storage or cold wallets. (Wallets connected to the internet, in contrast, are called “hot wallets.”)
“By design, hardware wallets make transacting more cumbersome as users must connect their device to the internet to sign an outgoing transaction,” says Przelozny. “As such, they are useful for those who are investing long-term and wary about leaving their coins on an exchange.”
In a paper wallet, you print off your key, typically a QR code, on a paper document. This makes it impossible for a hacker to access and steal the password online, but then you need to protect the physical document. “Paper wallets are rarely used anymore as they probably pose the highest risk in terms of destruction, loss or theft of private key,” notes Kech.
What to Consider When Picking a Bitcoin Wallet
Picking the best crypto wallet for you can be an arduous process, so here’s what you should keep in mind as you evaluate your options.
You aren’t tied to any particular type forever; you can have multiple Bitcoin wallets. You combine the best features of each, such as keeping a small amount in a mobile wallet for transactions but maintaining the bulk of your holdings in a more secure, hardware wallet.
1. Think About How You Plan on Using Crypto
“Usually, the tradeoff will come down to safety versus speed. In other words, security versus convenience,” says Przelozny. For someone who frequently trades and spends tokens, the best crypto wallet might be a more convenient mobile or web option connected directly to an exchange, whereas someone who holds a lot of crypto as a long-term investment may be better off using a cold storage wallet.
However, keep in mind that any time you move crypto off of the exchange and wallet you purchased it on, you may have to pay a withdrawal fee to move it into your wallet of choice.
2. Research a Wallet’s Reputation
When you buy cryptocurrency, you generally aren’t tethered to any one wallet brand or type. Take time to read reviews about user experience, extra features and, of course, security. Pay attention if a wallet has ever been hacked and avoid those that have faced serious breaches in the past.
3. Research Wallet Backup Options
Some wallets allow you to back up your data using another method, either online or on a physical device. That way if your computer or mobile device crashes, you can regain access to your coins. If you plan on owning a lot of crypto, you may prioritize wallets that allow you to thoroughly back up your data.
4. Pay Attention to Key Management
Different wallets have different setups for who is in charge of maintaining private keys, which has big implications for you, notes Shtylman. With some wallets, the wallet’s service provider manages the wallet keys. This means you may be able to regain access if you lose your key by contacting them.
Other wallets, however, are fully reliant on the user. Even the manufacturer may not know the private key securing the wallet. In these cases, it may be impossible for you to regain access to a wallet whose key you lose.
If you’re concerned about getting locked out of your Bitcoin wallet, you may focus on those providers who retain custody of your key. However, if the lack of centrality of crypto is what appeals to you, you may opt for a crypto wallet where you retain complete control of your key—and, by extension, your coins.