Introduction to Crypto Wallets

This guide explains the basics of cryptocurrency wallets, including how they work, the pros and cons of different types of crypto wallets, and how fintechs can embed crypto wallets into their products to offer new financial options to their customers.
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Key Takeaways:
  • Cryptocurrency wallets are a method of storing public and private keys
  • There are different types of wallets – hot & cold, and custodial & non-custodial
  • Different types of wallets offer different levels of security and convenience
  • Requirements for offering your users crypto products using a wallet

What are crypto wallets?

Cryptocurrency wallets primarily safeguard users' public and private keys while offering a user-friendly platform for managing digital assets. These wallets facilitate cryptocurrency transfers via the blockchain, and some even enable users to execute specific actions with their crypto assets, such as trading or interacting with decentralized applications (dapps).

Digital assets associated with crypto wallets include tokens like Bitcoin and Ethereum, stablecoins like USDC and DAI, and NFTs.

If you're ready to integrate crypto wallets into your product, read our docs to get started.

How do crypto wallets work?

It's crucial to understand that cryptocurrency transactions don't equate to sending crypto tokens directly from one person's mobile device to another. When transferring tokens, a user's private key authorizes the transaction and transmits it to the blockchain network. This network then processes the transaction, updating the sender's and recipient's balances accordingly.

Therefore, referring to these digital storage solutions as 'wallets' can be somewhat misleading, as they don't hold cryptocurrencies like physical wallets store cash. Instead, crypto wallets access the public ledger to display a user's balance across various addresses and store the private keys needed to authorize transactions.

What are public keys and private keys? ‍

A key is a long string of random, unpredictable characters. While a public key is like a bank account number and can be shared widely, the private key is like a bank account password or PIN and should be kept secret. In public-key cryptography, every public key is paired with one corresponding private key. Together, they are used to encrypt and decrypt data.

Different types of crypto wallets

Crypto wallets are available in a variety of formats, with each offering different levels of accessibility and security features. These options cater to different user preferences, usage requirements, and familiarity.

The main distinctions between different types of crypto wallets are whether they are hot (online) or cold (offline), as well as whether they are custodial or non-custodial. 

Hot Wallets vs. Cold Wallets

A primary distinction among crypto wallets is whether they are categorized as hot (online) or cold (offline) wallets. 

Hot wallets are connected to the internet, providing users with a convenient way to access and manage their cryptocurrencies. However, this increased accessibility can also make hot wallets more susceptible to potential cyber threats. 

On the other hand, cold wallets store digital assets offline, enhancing security by reducing the risk of cyber attacks. These offline storage solutions are ideal for long-term investors who prioritize safeguarding their assets over frequent transactions.

Types of Hot Wallets

Desktop Wallets: Desktop wallets operate from your desktop or laptop, offering a user-friendly interface for managing your cryptocurrency assets. In contrast to web or exchange wallets that maintain constant online connectivity, desktop wallets are only "hot" as needed for transaction purposes. Typically non-custodial, these wallets place the onus of protecting private keys solely on their owners.

Web Wallets: Web wallets are wallets provided by a third party which offer seamless access to a user’s holdings using a web browser.

Exchange Wallets: Exchange wallets are a type of web wallet associated with an account on a crypto exchange. These are typically custodial wallets that allow for fast access to the exchange services – including buying, selling and swapping crypto tokens.

Mobile Wallets: Mobile crypto wallets are apps that allow users to interact with their crypto holdings – often including spending – using their phone or any other internet-connected mobile device.

Types of Cold Wallets

Hardware Wallets: Hardware wallets ensure secure storage of private keys through various formats. These physical devices, which bear a resemblance to USB thumb drives, remain offline until connected to a computer or mobile device.

Paper Wallets: Paper wallets – as the name suggests – are the ultimate “cold” solution: a piece of paper where private keys are written down and safely stored.

Custodial Wallets vs. Non-Custodial Wallets

Another key factor that differentiates crypto wallets is whether they are custodial or non-custodial. The main difference between these two types is in who is responsible for securing the wallet's private keys.

Custodial Wallets

Custodial wallets entrust a third party, such as an exchange or financial institution, with the management of users' private keys. Most hot wallets, such as web wallets or exchange wallets, are custodial.

By using a custodial wallet, users are entrusting control over their tokens and the private keys required for transactions to the platform. This enables the wallet to offer much greater convenience and usability features. However, it also means that users are reliant on the third party's security measures and may not have full control over their assets. 

Many custodial wallets provide robust measures to ensure that users' private keys are secure, including two-factor authentication (2FA), email verification, and even biometric authentication. Many exchanges prohibit users from conducting transactions until these security precautions are in place.

Additionally, exchanges and custodial wallet providers often undertake extra measures to guarantee the protection of users' tokens. One common practice involves transferring a portion of funds to the company's cold wallet, shielding them from online aggressors.

Non-Custodial Wallets

In contrast, non-custodial wallets put users in complete control of their private keys and, by extension, their digital assets.

Upon creating a new non-custodial wallet, users are prompted to write down and safely store a sequence of 12 randomly generated words. This is known as the user's "seed" or "recovery" phrase. This series of words are used to generate the user's public and private keys, and serves as a backup mechanism in the instance that the user loses access to their wallet.

This means that anyone with the seed phrase has full control over the wallet's funds. As well, in the event that the seed phrase is lost, the user permanently loses access to their funds. Due to this, it is crucial for non-custodial wallet users to safeguard their seed phrase. This includes taking safety measures such as avoiding storing a digital copy, photographing the phrase, or making a copy on a public printer.

It is worth noting that hardware wallets are inherently non-custodial, as private keys reside within the device itself. Some software-based wallets offering users complete control over their private keys also exist.

With all non-custodial wallets, the user must assume responsibility for their own security concerning passwords and seed phrase storage. If any of these elements are lost, recovery may prove challenging or unattainable since they are generally not stored on third-party servers.

Building crypto wallets into your product

As blockchain technology continues to grow and mature, people around the world are eager to use products and services that integrate the exciting potential of cryptocurrencies in an easy-to-use, intuitive way. 

By building crypto wallets into your app or platform, you can provide access to popular crypto features, or bypass existing rails to enable your usual financial services in a faster, cheaper way.

Why offer crypto wallets to your users ?

By building crypto wallets into your app, you can enable powerful products for your users, including:

Cross-border Payments

Crypto wallets enable faster, cheaper remittances and other types of cross-border transactions. 

By converting local fiat currencies into cryptocurrencies such as stablecoins, users can make transactions that avoid the high fees and friction points of traditional finance.

With crypto-wallets, your users cross-border transactions benefit from:

Higher Speed: Crypto transactions settle in seconds. Plus, unlike traditional financial systems that operate during specific hours, blockchain technology works 24/7, allowing transfers at any time.

Lower Fees: By eliminating many of the steps required to send remittances traditionally, crypto-based transactions can be made much more cheaply.

Borderless Transactions: Transactions from an embedded crypto wallet are sent via tokens such as USDC, enabling them to be sent to any wallet worldwide, and then exchanged into a local fiat-currency if desired.

USD-based Accounts

Holding value in US Dollars can be a great benefit for users in regions with highly inflationary local fiat currencies, such as Latin America and Africa.

Allowing users to seamlessly convert their funds into a stablecoin such as USDC – which is pegged 1:1 to USD – can help them retain value for longer, and make saving easier.

Crypto-backed Yield

By holding funds in USDC or other cryptocurrencies, you can give your users access to powerful financial instruments made possible by blockchain technology – such as DeFI yield, or tokenized real world assets.

DeFi Yield: DeFi protocols such as Aave and Uniswap enable yield rewards through activities such as market making, lending and staking. 

Tokenized Real World Assets: Platforms such as Ondo issue tokens backed by real world assets, such as US Treasury bills. This allows investors outside of North America to benefit from T-bill yield – one of the safest investment tools in the world.

What is required to build crypto wallets into your app?

Although the financial tools made possible by Web3 technology are exciting, building them is complex. This complexity occurs at every stage – touching fiat, navigating compliance, and understanding DeFi. In order to integrate crypto wallets into your app, you'll need to solve for:

Custody: A system for managing the public and private keys that allow for crypto transactions. Keeping those keys safe and secure is of supreme importance for your users.

Ledgering: A system for logging and displaying transaction histories for each of your users, so they can follow their activity in your app. Many crypto custody platforms do not include this functionality natively.

Compliance: Crypto transactions involve many regulatory concerns, differing from region to region. It is important to ensure you're following the regulations imposed on you and your users.

Yield Strategies (Optional): If you intend on offering crypto rewards to your users, determining safe, liquid yield sources is extremely important.

Conduit can help

Conduit's end-to-end platform allows you to invisibly build crypto wallets – including ledgering, yield strategies – in an easy, safe and regulation-friendly way. With a single API, you can offer your users exciting financial products, backed by our stringent safety measurements and stringing yield curation strategies.

For a demo of our platform, contact us today.