There are many aspects of cryptocurrency that are making it difficult for newcomers to adopt the technology. Since Bitcoin’s inception in 2009, blockchain technology and the supporting services have come a long way but we are still dealing with some basic concerns that are posing a barrier for entry to potential newcomers.
One of the main concerns when handling your money digitally is security. Here is our roundup of all the ways you can store your crypto. The main concern isn’t actually how coins are stored but who is in control of the keys that are used to transfer coins elsewhere.
Custodial wallets
Custodial wallets are the most widespread and widely used solution. For newcomers, custodial services (most often exchanges) are crucial for entering the markets. Custodial services usually offer a way for users to buy crypto using fiat money sent over from a user’s bank account.
A custodial service is the most convenient way to obtain cryptocurrencies. The trade-off is that holding cryptocurrencies on a custodial service means that you are trusting the service to release your crypto when you make that request.
The security and transparency of these kinds of services has improved and is continuing to improve so holding funds on a reputable exchange that also happens to be regulated and insured in some way should be relatively safe.
The exchange holds your crypto in its own wallets. You don’t hold your keys.
Identity verification is mandatory on most exchanges and crypto services.
Most crypto services offer support for multiple cryptocurrencies.
Most crypto services in general offer the option to exchange currencies for one another.
Pros
A reputable exchange will have strong checks in place to ensure the security of your money and that a so-called exit scam does not occur. It will very likely also have some form of insurance on the funds held in their customer’s name.
Cons
Will very likely require KYC, which could be a high barrier for entry to some prospective users. Can deny access to the service to any new or existing customer for various reasons.
There are many alternatives to custodial services. If you want to take on the responsibility of storing your own funds, this is called self-custody. Read on to see why self-custody holds appeal and also some drawbacks.
Software wallets
Custodial solutions and software wallets often behave in similar ways so it is sometimes hard to differentiate between them. In general, a custodial service will require an account with the provider while a software wallet will not.
Software wallets are applications that let you interact directly with one or more networks. These applications can live on your mobile device (mobile wallet), personal computer (desktop wallets) or in your browser (plugin) and will often look similar to a custodial service with an appealing and easy to use GUI.
In general, software wallets will give you full control over a wallet on the native network and will often generate keys from a seed phrase that you will need to store securely. These solutions give you all the control and all the responsibility over your keys. Software wallets require an advanced understanding of the workings of cryptocurrency (network or gas fees, staking options etc.)
You own your keys and the responsibility for their security and backup.
Most software wallets will not require KYC except for additional services.
Many software wallets support more than one currency except for dedicated wallets.
Some software wallets offer exchange through a third party or a DEX if it is available.
Pros
Anyone with access to the internet can utilize a software wallet. You are the sole owner of your keys and the means to recover the funds should you lose access. Your crypto is always completely under your control. Most software wallets are free to use.
Cons
You hold full responsibility for your funds and nobody can issue a refund for any reason or recover your funds if you lose the recovery phrase. In very unlikely scenarios, your software wallet could be breached via malicious software on your device or a change in the code of the application could make it inoperable (this can usually be solved with an update if it exists).
Software wallets are sometimes called hot wallets due to their online and always accessible nature. Check out this alternative guide to crypto wallets and security.
Hardware wallets
Hardware wallets are most often touted as the most secure method for holding cryptocurrencies. A hardware wallet is in principle similar to a software wallet. Keys are generated from a seed phrase and stored securely on the device. Signing a transaction requires a manual or offline action with the hardware wallet and dedicated software is required to communicate the transaction to the network.
Hardware wallets are a good solution for the issue of trust that occurs when holding crypto in custody with an exchange.
Hardware wallets offer a high level of security. The trade off is that the sole responsibility for your funds. If the device is stored securely offline it can be difficult or time consuming to access the funds.
A secure component on the wallet holds your keys. You hold the recovery phrase.
Identity verification is not needed except, possibly, when ordering a product.
Most modern hardware wallets support multiple currencies with different functions.
Trading and exchanging is technically possible over a DEX but not an intended use case.
Pros
Your keys are stored offline and your transactions will be signed securely by the device. Your money is always under your complete control and so are all the recovery mechanisms.
Cons
Hardware wallets are relatively expensive when compared to the other solutions. Outdated code could render a hardware wallet inoperable but that is unlikely. Depending on how the device is stored it can be difficult to get fast access to the funds.
Hardware wallets and paper wallets can be considered cold wallets as the keys are always kept offline.
Paper wallets
Paper wallets act in a way that is very similar to a hardware wallet. The key is stored offline and it is advisable to sign transactions offline too and only post them to the network after they have been signed.
In principle, a paper wallet is a piece of paper where the public and secret key are written together. This solution can be fine for small amounts of money or for tips. It is generally not advisable to print out secret keys in plain text as a secret key both reveals the public address and has the capability to empty said address.
For long term storage, alternative mediums to paper, like steel or wood work too, but suffer from the same vulnerability as paper wallets. On the other hand, they do not rely on software so they should always “work”. Backup copies can be created easily too by making copies but the drawback is that anyone who holds a copy can potentially empty your wallet.
You are the sole owner and holder of the keys. Nobody can recover a lost key.
No KYC is needed to create a paper wallet unless a network itself requires it.
One paper wallet should only hold one key pair from one network to reduce security risks.
Trading and exchanging is technically possible over a DEX but not an intended use case.
Pros
A paper wallet is a completely free offline storage solution. Again the keys and the means of recovery are under your complete control. They are not susceptible to online threats except if the secret key is mismanaged.
Cons
If you lose the last copy of the paper wallet, the funds are as good as lost. They are relatively difficult to operate as they will often require up to date software on an offline device to perform transactions securely.
Recap
As always, we should note that every solution has its pros and cons and should be weighed against your stake and how knowledgeable you are about operating each solution. It seems that we don’t have a full proof solution for storing crypto yet.
In our next blog we are going to talk about our new solution that aims to make it easy for anyone to securely hold crypto. No hassle, no setup complications and no worries. Wallet Protect secures your money with multisignature, fraud protection and Theft Cover by Coincover. You get to keep your own keys and keep your money online and always available. Stay tuned!
