Introduction
Cryptocurrencies are a byproduct of a disruptive technology called Blockchain. Blockchain is a method of conducting financial transactions without the presence of a centralized authority. The blockchains have also introduced the concept of decentralized finance or DeFi. With DeFi, people can perform financial transactions outside of the regulatory requirements of the governments and regulated financial networks. As long as a person has internet, a digital wallet, and some computer knowledge they can sell and purchase cryptocurrencies using blockchains from any part of the world.
What is a Digital Wallet?
A digital wallet is a custodial or non-custodial account or space that allows digital currency investors or holders to store and manage their cryptocurrency reserves. Digital currencies are not tangible products; they are present in the form of a code within the DeFi ecosystem.
Therefore, the investors need a place to keep their cryptocurrencies safe and under their ownership. Digital wallets are like bank accounts that allow people to hold their money in them. However, digital wallets are not supervised by any centralized government authority usually.
Importance of Digital Wallets
Without a digital wallet account, cryptocurrency holders would not be able to keep their reserves under their custody. It is not possible to leave the digital currencies on a blockchain once they are claimed.
Digital currency investors can purchase crypto tokens using fiat currencies or any other altcoins. However, since all digital currencies are fungible, it means that the owners have to keep them stored in a secure location to claim their ownership. Therefore, digital wallets provide a secure location for digital currency holders to make sure that they can manage their cryptocurrency portfolios.
Types of Digital Wallets
Depending on their functions and use cases, there are several different types of digital currency wallets. Some of the most important classes of crypto wallets are mentioned below:
Hardware Wallets
Hardware wallets are the type of digital currency wallets that allow users to store their cryptocurrency reserves in a USB drive-like device. Hardware wallets are known for allowing cryptocurrency investors to store their digital currency reserves away from the internet connection. However, some hardware wallets allow digital currency investors to connect them with WiFi at their discretion. Since hardware wallets are stored away from an active internet connection, they are considered very secure and grant full control to cryptocurrency investors over their reserves. Some of the top hardware wallets are Ledger Nano S, Trezor, and Nano X among others.
Software Wallets
Software wallets are a type of digital currency storage that is present in the form of another computer program. Users can create a digital address using platforms like cryptocurrency exchanges, DEXs, swaps, liquidity pools, and other online options. Some financial services companies like VISA, PayPal, and MasterCard also allow cryptocurrency investors to store their crypto reserves using their platforms. In the same manner, there are also many dedicated software wallet service providers like Guarda, Exodus, Electrum, and Mycelium among others.
Hot Wallets
Hot wallets are digital wallets that are actively connected to internet. It is worth noting that both software and hardware wallets can be hot wallets while they are online. However, hot wallets are considered a security risk since they are constantly under the threat of hack attacks. Hot wallets provide users with public and private keys to unlock and keep their security.
Cold Wallets
Cold wallets are the type of cryptocurrency wallets that are not connected to internet. These wallets are mostly hardware wallets and are thought to have better security. It means that hackers are unable to access the reserves placed inside a cold wallet since they are not connected to internet or any online device. Cold wallets are also called offline wallets and they can be unlocked using fingerprint, password, pins, and face recognition in some cases.
Custodial Wallets
Custodial wallets are digital currency accounts where the private key of the wallet is under the control of a third-party service provider. Sometimes, cryptocurrency exchanges reserve the private keys of the digital wallet accounts they provide for their users. Such a measure is done to make sure that the investors do not end up losing their passwords.
Furthermore, it is also a way to increase the security of digital wallet accounts. With Custodial wallets, the responsibility of keeping the digital currency account secure and away from hacking threats falls on the third-party services.
Non-Custodial Wallets
Non-custodial wallets are digital currency accounts where the private and public key is under the possession of each crypto account holder. Non-custodial wallets grant greater autonomy to cryptocurrency investors individually. However, at the same time investors are charged with the responsibility of keeping both private and public keys of their digital currency accounts secure. In case the security of the non-custodial wallet is compromised, stolen, or hacked the user bears the sole responsibility.
How does a Software Wallet Work?
As clear from the information provided above, all digital currency investors need to have a digital wallet to store and manage their cryptocurrency portfolio. A software wallet is a type of digital wallet. A software wallet is a computer program or a mobile application that allows the users to collect their digital currencies. The users have to pick the ideal software wallet for them and download it first. The next step is to create an account and generate the passkeys.
Usually, Software wallets allow the users to generate a private and a public key. There are some cases where the software wallet owners also get a seed phrase. To keep the cryptocurrency account safe and away from the reach of hackers and threat actors, software wallet owners must store their private, public, and seed phrases in a remote location and not share them with anyone else under any circumstances.
Software wallets also allow the users to connect them with different blockchains, exchanges, and other cryptocurrency platforms to allow them to purchase, sell, borrow, lend, stake, and trade digital currencies.
Key Components of a Software Wallet
It is important to learn about the most basic and crucial building blocks or components of a software wallet. The users who have complete knowledge about every part of the working and functional software wallet can pick out the best option for their usage. Here are some of the key components listed as under:
Private Key
A private Key is a string of alphanumeric values that have been generated by a computer program at random. The purpose of the private key is to secure a cryptocurrency transfer between two parties. Private keys are typically symmetrical and are used to both encode and decode sensitive information. Private Key encryption is faster in comparison to a public key and the length of a private key determines its security strength. The longer a private key is, the more time the hackers had to spend breaching it.
Public Key
A public Key is also like a password. Typically, a software wallet is protected by both private and public keys. A public key is an asymmetrical code and it is used for sharing with others while making a cryptocurrency transaction.
It is worth noting that private key is kept a secret while users can share public keys freely to provide an address or location for making the required cryptocurrency transaction. Public keys are sent to the intended user for completing a DeFi transaction and only the authorized and intended user can decode it with their private key.
Seed Phrase
The seed phrase is an emergency password that allows cryptocurrency traders to recover their accounts in case they have lost their private key. When a user is setting up their digital wallet account they are asked to generate a unique seed phrase using personal information provided by the users.
A seed phrase is used only in the event when the user has lost their private key or it has been hacked. The seed phrase is like a master key just like the unique answers that allow users to recover their email or online accounts using preset answers.
It is worth noting that every transaction performed using a software wallet requires transaction fees. Usually, the software wallets do not charge users for depositing new currencies. However, users are charged for making new purchases or sending their cryptocurrency reserves to other locations. It is a good idea for a user to learn about the transaction fee structure on a software wallet before creating a new account.
Integrations
Software wallets should allow the account holders to integrate them with different platforms such as DEXs and CEXs. The more a platform a software wallet can integrate, it would be ideal for the users since they would not have to use multiple software wallets to move their reserves to make get their desired prices and cryptocurrency trading options. Exchanging more software wallets can also increase the transaction fees for users and make trading more expensive for them.
OS Compatibility
Operating System or OS compatibility is also an important aspect of a software wallet. If a software wallet can provide support for the users on multiple operating systems such as Android and iOS platforms, it means that users have better support. The user can keep using the same account on multiple devices without having to traverse through different types of software wallets and spend massive transaction fees.
Storage
Software wallets should offer support for more than one type of cryptocurrency. The more types of cryptocurrencies, a software wallet can support the better. At the same time, the storage capacity for the account should be such that it runs out with a few hundred tokens.
Types of Software Wallets
Just like a Software wallet is a type of a digital wallet, there are also many more kinds of software wallets. Some of the most important classifications are mentioned as under:
Mobile Wallets
Mobile wallets are the type of software wallets that are present in the form of a mobile or smartphone application. These days most people use smartphones and having a digital currency wallet stored in your handset is one of the easiest and most convenient ways of managing a cryptocurrency portfolio. The users can keep an eye on their cryptocurrency portfolio using widgets and smartwatch reminders with mobile software wallets.
Desktop Wallets
Desktop wallets are present in the form of software that allows users to download the program on their laptops or computers. Many people choose desktops to store their cryptocurrencies on account of important features like massive storage and instant connection to the internet. Many professional traders use software desktop wallets to make sure to perform digital currency analysis in real-time.
Users can also secure the wallet.dat file on their PCs with a strong password to keep it away from the reach of hackers.
Web Wallets
Web wallets are useful for cryptocurrency traders who do not have enough space on their smartphones or computers. The web wallets allow the users to store their cryptocurrency reserves using online storage. However, web wallets are always online and they are at a greater risk of getting hacked or stolen. On the other hand, users can access their web wallet contents from any location and any device using their private key or seed phrase.
Paper Wallets
Paper wallets are an obsolete and antiquated method of storing cryptocurrencies that have largely been discarded now with a few exceptions. Paper wallets are created using a piece of paper and a key generating program. The program issues two strings of encryption code and two QR codes. The paper wallet is cold storage and a non-custodial wallet and it is not connected to internet.
Full and Light Node
Full node software wallets enable the users to download the entire blockchain on their device before conducting any new transaction. On the other hand, a light node wallet is a software wallet that only offers support for performing custodial services and trading without downloading the entire copy of the blockchain.
Official and Alternative
Official wallets are dedicated wallets that are used for storing only one type of cryptocurrency or classification of a token that fits a particular standard such as ERC-20 etc. On the other hand, alternative software wallets are secondary accounts that are created to complement or upgrade the official wallets and can support several types of cryptocurrencies.
Multi and Single Coin
Multi coin wallet is a type of cryptocurrency wallet that can hold and store several variants of digital currencies at the same time. It is worth noting that software wallets need specific programming to enable storage or exchange support for a new type of digital currency. On the other hand, single coin software wallets are rudimentary accounts that can hold only one type of token.
Open and Closed Source
Open-sourced wallets grant other developers to read their core code and programming without any restrictions from the creator. On the other hand, the closed sourced software wallets are protected with patents and copyright and developers need to get official approval to read, use, or copy the code.
Deterministic and Non-Deterministic
Deterministic wallets generate the passkeys for the users using a single starting point such as the seed phrase. It means that an additional layer of randomization is added to the private and public keys generated based on the unique information for a seed phrase. Non-deterministic wallets do not depend on the seed phrase or a unique starting point for creating all the passkeys.
Advantages of a Software Wallet
People use Software wallets on account of the following key advantages:
Ease of Access
Software wallets are easy to access and they are always readily available for anyone with a simple online search. Anyone who is looking for a suitable software wallet in their area can take to the internet and read about the reviews from the consumers that are present in their location. It is also possible to access foreign software wallets using VPN or location-changing services.
Cost Effective
Software wallets are typically cheaper in comparison to hardware wallets. The users can download the software mobile, desktop, or web application for free and create a new account for free as well. In some cases, exchanges like Binance and Huobi also grant a starting bonus for the users as an incentive for creating a new digital wallet account.
User Interface
The user interface of a software wallet is very simple and user-friendly. The users do not need to have extensive knowledge about computers or programming languages to effectively use all its features. In some cases, users can also take help from customer support or online tutorials to guide them to unlock all the premium features of the software wallet
Limitations of a Software Wallet
Security
Software wallets are typically always connected to internet and therefore they are at a greater security risk. In some cases, users end up with hacked accounts or connect their wallets with spiked links that can steal their cryptocurrency reserves within seconds.
Password
Keeping track of seed phrases, private keys, and public keys can be a real challenge for software wallet users. Sometimes, these passkeys are stolen and they can also be hacked when the threat actors are determined enough. In some cases, users also lost or forget their passkeys which can result in them losing all their cryptocurrency reserves forever.
Conclusion
Software wallets are one of the best and most convenient ways for traders to manage and store their cryptocurrencies. They are easy to use, free to download, and offer premium upgrades at reasonable prices. The users need to learn to keep their passkeys secure and stored in a remote location to keep enjoying their software wallet accounts. Exodus, Atomic, BitGo, and Jaxx Liberty are some of the best software wallet services providers in 2022.
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