In addition to these three basic types, Bitcoin wallets can use either single-key or multisig technology. They are also further distinguished as either “hot” or “cold” forms of storage: a hot wallet is connected to the internet, whereas a cold wallet is fully offline.
Software wallets encompass web, desktop and mobile wallets.
A web wallet allows users to interact with the Bitcoin blockchain via a web browser interface and hosts their private keys and other “credentials” on an online server. For this reason, a web wallet is also a hot wallet.
Many web wallets are hosted by a third-party, such as a cryptocurrency exchange, which enables users to store and seamlessly trade their cryptocurrency on a single interface.
Setting up a user account on a cryptocurrency exchange will typically automatically generate a user a Bitcoin wallet — and in some cases, a series of additional wallets for each of the cryptocurrencies that can be traded on the exchange.
The pros of an exchange-hosted wallet are their convenience, ease-of-use and integration with trading functionality on the exchange.
Setting up an account is similar to any account for an online service, although users will usually need to complete Know Your Customer (KYC) checks by uploading a form of official identification.
However, hosted web wallets usually imply that a users’ wallet keys are managed by a third-party, leaving them vulnerable to cyberattacks — such as exchange hacks — or scams.
For this reason, it’s important to make full use of all the security tools provided by the exchange or web wallet provider — including two- or multi-factor authentication for logins, withdrawal access management or anti-phishing tools.
In order to address concerns over users having to cede control over their keys to a third-party, some web wallets have also evolved into multisig wallets.
Multisig is short for multisignature and refers to a type of digital signature technology that makes it possible for two or more users to digitally sign a transaction.
A standard Bitcoin wallet — web or otherwise — uses single-key technology, meaning that one corresponding private key is required to access the funds.
A multisig wallet, by contrast, is configured so as to require more than one trusted party in order to authenticate transactions or to access the wallet’s holdings.
Multisig mitigates the single point of failure associated with a single key. Multisig can also help businesses to manage their enterprise wallets or be used for escrow transactions.
A desktop wallet is different to a web wallet as it relies on software that a user downloads and operates locally on their computer. Desktop wallets give users full control over their keys, which are stored as a wallet.dat file.
For security reasons, it’s advisable to password-protect access to this file and to ensure your computer is free from viruses or malware before installing and setting up a desktop wallet.
It is also important to backup the wallet.dat file or export the corresponding key or seed phrase, which will be required to retrieve your funds in case you have trouble with your computer in future.
Mobile wallets, as their name suggests, are operated using a smartphone app and can be handily configured to support everyday Bitcoin transactions using QR codes. Some mobile wallets are the app version of an online exchange account and are therefore tied to the same user login, wallet and account.
Similar to web and desktop wallets, mobile wallet users need to be vigilant about the risks of malicious apps or malware infections, as well as taking care to backup their private keys or seed phrase if they use a mobile wallet that allows them to manage their own keys.
As we have seen, convenient software wallets can be vulnerable to the security risks associated with online services and/or centralized third-party providers.
For this reason, users looking to securely store their cryptocurrency for a long time (HODLers) often use a hardware wallet — which is “cold” as it is not connected to the internet — as a safer alternative.
A hardware wallet is typically a small, physical electronic device that uses a random number generator (RNG) to generate the wallet’s corresponding public and private keys.
A hardware wallet often enables users to set up a security PIN code to protect access to the device, as well as a recovery phrase — sometimes called a mnemonic seed — for recovery.
This mnemonic seed is typically a 24-word recovery phrase that serves as a backup for the hardware wallet’s private keys.
While hardware wallets are a little harder to use than their software counterparts, they are regarded as the safest way to store cryptocurrency holdings, as they are immune to cyberattacks and computer malware. Many well-known hardware wallet models come with an accompanying desktop application that provides an easy-to-use interface.
Some hardware wallets can also be connected to decentralized exchanges or web wallets, helping users to overcome issues with accessibility and the lack of integration with trading functionalities.
A paper wallet is another form of cold storage and is literally a piece of paper on which a Bitcoin wallet address and its corresponding private key are printed, in the form of QR codes.
Although they are secure against the risks associated with hot wallets, paper wallets have significant drawbacks. As well as being physically flimsy — readers can use their imagination here — they also limit users to transferring the wallet’s entire balance at once.
To be able to spend only part of the paper wallet’s holdings, users need to transfer the entirety of their balance to a different type of wallet — web, desktop or hardware — and then spend a part of their balance from there.
Moreover, users run the risk that if they attempt to transfer just a part of their paper wallet balance to another wallet, the remaining funds will, by default, be sent to what is known as a “change address” on the Bitcoin protocol. They will not remain in the original paper wallet — a misunderstanding that puts users at risk of losing their funds if they do not ensure that they specify a new paper wallet for the change.