The cryptocurrency industry is inseparably linked to a “be your own bank” ethos, and a cryptocurrency wallet is perhaps the most important component.
A cryptocurrency wallet can be used as a transfer agent for payment distribution, an escrow for a contract, a redistribution of an estate, a place to hold stock, and even as a place to actively and passively accumulate dividends.
To recap, the multitude of benefits of cryptocurrency include:
- It can be accepted anywhere without government interference or friction.
- It can serve as a store of value that does not require the holder to maintain custody of expensive metals, art, or stacks of fiat currency.
- It can move automatically via smart contract, without the need or interpretation of accountants and lawyers.
As such, different users tend to have different cryptocurrency wallet needs.
To understand the mechanics of how a cryptocurrency wallet works, we recommend reading through our cryptocurrency wallet guide. The following guide will focus on which type of cryptocurrency wallet may be a good fit for your specific cryptocurrency needs.
Use Case #1–The Cryptocurrency HODLer
“HODLing,” a playful acronym that stands for Hold On for Dear Life, is one of the most popular ways people interact with (or lack of it) with their cryptocurrency.
If you plan on buying cryptocurrency and holding onto it for a long period of time, you likely fall into this category.
Considering the astronomical rise in prices of cryptocurrency assets like Bitcoin and Ethereum, HODLing is considered one of the best cryptocurrency investment strategies.
- $10,000 worth of Bitcoin bought in April 2016 and held until April 2021 would be worth about $1.3 million.
- $10,000 worth of Ethereum bought in May 2016 and held until May 2021 would be worth about $3.9 million.
As you can imagine, security practices, precautions, and threats may drastically differ when it comes to protecting $10,000 versus millions of dollars.
Many early cryptocurrency investors suddenly saw their laptops, cold wallets, exchange wallets, or other means of securing their cryptocurrency skyrocket in value. In just under a decade, their holdings became less of a hobby but more of a lucrative holding that any malicious third party would love to grab.
The Cryptocurrency HODLer takes the security of their cryptocurrency very seriously, and their needs are best suited for cold wallets.
A cold wallet isn’t connected to the Internet, and as such, cannot be targeted by online hacks. You also maintain full custody of your cryptocurrency at all times, unlike keeping it on a cryptocurrency exchange, which takes custody of your assets.
There are dozens of popular cold wallet products on the market, such as Ledger Nano S, Keep Key, or Trezor. These devices are basically USBs programmed and optimized for the security of your private keys.
How does a cold wallet work?
Your cold wallet has a set of private and public keys for each digital asset. Your private keys are never revealed, but your public keys are visible. If you wanted to move funds to a cold wallet, you would simply send it to the public key (also known as an address.)
Once the blockchain network confirms the transaction, your funds would now exist on that specific wallet on your cold wallet.
In order to take funds out of a cold wallet, you would connect it to your computer with a connection cable. From there, the interface will allow you to push a transaction live to the blockchain once you have confirmed your cold wallet passcode and whatever other authentication process a specific wallet requires.
If entrusting potentially millions of dollars to a plastic USB locked in a bank safe or filing cabinet makes you nervous, you may be interested in using an institutional-grade custodial service like Genesis or Anchorage. These companies take custody of and place your funds in cold storage and even offer insurance on the assets, at a price.
Use Case #2–The Cryptocurrency Trader
Maybe putting your cryptocurrency on ice isn’t something you want to do just yet. With thousands of different cryptocurrency coins and tokens available, you may be more inclined to explore the market.
The Cryptocurrency Trader is inclined to keep their funds mixed between cryptocurrency exchange wallets, software wallets, and maybe a cold wallet for longer-term holdings.
The vast majority of exchanges offer a built-in cryptocurrency wallet, making it easy to buy and sell cryptocurrency instantly. These exchanges are also portals to dozens of different digital asset trading pairs.
Now, it’s worth glossing over the difference between centralized and decentralized exchanges.
A single entity runs a centralized exchange. If it’s U.S. based, it must be appropriately incorporated and follow regulatory guidance, such as requiring customers to fill out KYC (Know Your Customer) and AML (Anti Money Laundering) identifications.
Centralized exchanges like Coinbase, Gemini, and Kraken, are considered to be incredibly safe, and they’ve each played a significant role in shaping how the U.S. government treats cryptocurrency.
However, centralized exchanges come with the risk that you don’t have custody of your funds. If one of these exchanges were hacked and funds were accessed, you could lose your money. Mt. Gox, one of the largest exchanges in the world at the time, was hacked in 2013, with losses of upwards of billions of dollars today.
A decentralized exchange, by comparison, doesn’t take custody of your funds. It’s simply a platform that allows for the direct peer-to-peer trading of digital assets through smart contracts and other programmed functionality.
Some DEXes offer cryptocurrency wallet functionality, but it’s more of a software wallet. If you lose access to that app or device, you could lose your funds as well.
There are nearly 6,000 cryptocurrencies listed on the popular coin price tracker CoinGecko, and they trade on a wide variety of exchanges. The majority of these assets are tokens and are only available on decentralized exchanges, like ShapeShift.
Final Thoughts: Use Case #3– Something In Between
There’s no cosmic rule that says you can’t keep your cryptocurrency in cold storage, on hot wallets like an exchange, and in other accounts.
If you’re in the legal industry, a great way to start thinking about cryptocurrency wallets is for their opportunity to be a decentralized escrow and transfer of value.
New tools and applications for cryptocurrency wallets will continue to evolve as the cryptocurrency industry evolves and matures.
Getting started is as simple as making an account on an exchange like Coinbase or Gemini.