So, you now know that a crypto wallet is needed to help you engage with Web3 brands and store digital currencies and assets safely.
if only it were all that simple.
There are actually a number of different kinds of wallets. All will have a different impact on how you engage within the space and so it's important for you to know what to look for.
Let's first look at the two primary wallet types.
Custodial and non-custodial wallets are the two primary types of crypto wallets.
In short, custodial wallets are those in which an exchange holds the user’s private key for them, such as Coinbase or Binance.
This means that you do not have direct access to your keys, so you cannot interact with other Web3 dApps or a blockchain with this wallet.
On the other hand, non-custodial wallets (also known as self-custody wallets) allow users to have direct access to their keys and complete control over their digital assets.
This control permits them to directly interact with a blockchain and use other Web3 applications.
Non-custodial wallets offer more security than custodial ones because users have full control over their funds and can take measures to protect them from malicious actors.
Additionally, since users have direct access to their keys, they can easily back up their wallet if needed.
However, it is important to note that non-custodial wallets require more technical knowledge than custodial ones since users must understand how to securely store and manage their private keys.
I like to think of the difference as a large apartment building where each apartment is a different dApp.
A custodial wallet is a single key to a single apartment. You can use it to get into that apartment and that apartment only. Binance's wallet allows you to interact with Binance, nothing else.
Non custodial wallets are like the master key. You can use them to engage and enter any of the apartments you want to.
For example, a MetaMask wallet could be used to transfer funds from Binance, sync to OpenSea, and even give you access to a Web3 analytics tool like Safary.
There are pros and cons to each, which I'll cover below.
Custodial wallets offer a number of advantages that make them attractive to many users.
The primary benefit is that they are much easier to use than non-custodial wallets, as users do not need to understand how to securely store and manage their private keys.
Custodial wallets are often integrated with exchanges, which makes it easy for users to buy and sell digital assets directly from the wallet.
Finally, custodial wallets are generally more secure than non-custodial ones since the exchange holds the user’s private key and can take measures to protect it from malicious actors.
Whilst easier to use, custodial wallets have a few issues you should be aware of.
Users of custodial wallets do not have direct access to their keys, which means they cannot interact with other Web3 dApps or a blockchain with this wallet.
Since the exchange holds the user’s private key, it can be vulnerable to hacks and other malicious activities.
If something like FTX's bankruptcy happens, all of the funds you have in the associated wallet could be lost to you.
Users may not be able to back up their wallet if needed since they do not have direct access to their keys. This is a big issue in case you forget your access credentials.
Non-custodial wallets offer a number of advantages that make them attractive to many users.
Users of noncustodial wallets have direct access to their keys, which allows them to interact with other Web3 dApps and a blockchain. You can use your wallet wherever you want.
And that direct access to your keys means you can easily back up your wallet if needed.
Finally, non-custodial wallets are generally more secure than custodial ones since users have full control over their funds and can take measures to protect them from malicious actors.
Non-custodial wallets also have some drawbacks you should be aware of.
Non-custodial wallets require more technical knowledge than custodial wallets, as users need to understand how to securely store and manage their private keys.
Non-custodial wallets are not integrated with exchanges, which means users must transfer funds from the exchange to the wallet before they can use them. The main issue here is that this often requires you to spend extra fees for transferring off the exchange.
Since users have direct access to their keys, they may be vulnerable to malicious actors if they do not take proper security measures.
A lot of the hacks and scams where individuals lose money are through social engineering to get access to private keys.
That's pretty much it for custodial wallets.
However, there are two forms of non-custodial wallets you should know about as well.
Hot and cold wallets are the two different types of non-custodial wallets.
Hot wallets are connected to the internet, making them more user-friendly but also less secure. MetaMask is a good example of this. It runs in your browser making it easy to interact with dApps.
Cold wallets, on the other hand, are stored offline and don’t require an internet connection, making them much more secure. Ledger is a good example here. You get a USB like stick to authorise online transactions through a 2FA code.
Hot wallets are typically much easier and faster to use. As a result, they tend to be used for daily transactions and engagements like logging into dApps.
Cold wallets require a manual approval for the majority of transactions which makes them far less convenient. As a result, they're better suited for long-term holdings of your digital assets.
Hot wallets offer a number of advantages that make them attractive to many users.
They're much easier and faster to use than cold wallets. The convenience makes them ideal for daily transactions and engagements like logging into dApps.
Hot wallets are also connected to the internet, making them more user-friendly and accessible. This means you can access your wallet from anywhere with an internet connection.
Most of the reputable hot wallets like MetaMask have a browser extension along with a mobile app so you can see and access your funds from anywhere.
Also, when comparing them to custodial wallets, hot wallets are generally more secure since users have full control over their funds and can take measures to protect them from malicious actors.
While more convenient, there are some glaring issues with cold wallets you'll want to be aware of.
Since they're connected to the internet, they may be vulnerable to malicious actors if users do not take proper security measures.
Hot wallets are also not integrated with exchanges, which means users must transfer funds from the exchange to the wallet before they can use them. The main issue here is that this often requires you to spend extra fees for transferring off the exchange.
Finally, non-custodial wallets require more technical knowledge than custodial wallets, as users need to understand how to securely store and manage their private keys.
This adds another element and potential for human error to cause problems.
Now let's look at cold wallets.
Cold wallets offer a number of advantages that make them attractive to many users.
The main advantage is that they're stored offline and don't require an internet connection, making them much more secure.
This means you can store your funds without worrying about malicious actors trying to steal them. Removing the internet connection removes many potential vectors of attack for hackers.
Also, some cold wallets are integrated with exchanges, which means you can transfer funds directly from the exchange to the wallet without having to pay extra fees for transferring off the exchange.
Cold wallets are much more secure than hot wallets since users have full control over their funds and can take measures to protect them from malicious actors.
The main disadvantage of cold wallets is that they're not as user-friendly or convenient as hot wallets.
Since they're stored offline, you'll need to manually approve each transaction before it can be completed. This makes them far less suitable for daily transactions and engagements like logging into dApps.
Also, some cold wallets require a certain level of technical knowledge in order to properly set up and use them.
This means users must understand how to securely store and manage their private keys in order to ensure the safety of their funds.
Also, that extra security can be an issue.
If you lose your recovery phrase for a cold wallet, it's gone - along with the assets you've stored with it.
Many cold wallets will offer a number of different ways to help you store the cold wallet seed phrase. Ledger sends out pieces of paper like the below to fill in.
It's an imperfect system. Especially as sharing this phrase with anyone else will give them full control over your assets.
There's no hard and fast answer for this.
We have a guide which will tell you how to act safely. But really, only you can choose what works for your needs.
Our recommendation is to think on security and to have a double approach.
A hot wallet for the daily interactions you make.
A cold wallet to store your assets.
To find which one is right for you, check out our reviews and rankings of the best crypto wallets here.
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