What is a crypto wallet and how does it work?

A crypto wallet is an app or a device that stores the secret keys used to control cryptocurrency. Despite the name, it does not hold coins the way a leather wallet holds cash. The coins stay on the blockchain, and the wallet holds the keys that prove they are yours to spend.

What does a wallet actually hold?

Every cryptocurrency balance is an entry on a blockchain's ledger, the shared record of who owns what. Each entry is tied to an address, a string of letters and numbers that works like an account number.

A wallet stores the private key for each of your addresses. A private key is a long secret number that authorizes spending from that address. When you send a payment, the wallet uses the key to produce a digital signature, a piece of math that proves the instruction came from the key's holder without revealing the key. The network checks the signature and updates the ledger.

Most wallets create all of their keys from a single backup called a seed phrase, a list of 12 or 24 ordinary words. Anyone who has those words can rebuild the wallet on another device.

What is a crypto wallet used for?

A wallet does four everyday jobs:

• Receive. It shows an address or QR code that others can pay.
• Send. It builds a transaction, signs it and broadcasts it to the network.
• Show balances. It reads the blockchain and adds up what your addresses hold.
• Connect to apps. On networks such as Ethereum, a wallet also acts as a login for dapps, which are applications that run on a blockchain.

What types of wallet are there?

Wallets are usually sorted in two ways. The first is whether the keys sit on a device connected to the internet. Phone apps and browser extensions, such as MetaMask and Phantom, are hot wallets. Hardware wallets, which are small devices that keep keys offline, are cold wallets.

The second is who holds the keys. With a self-custody wallet, also called non-custodial, you hold them. With a custodial wallet, such as an account at an exchange, a company holds them for you and you log in with a password.

Where do people go wrong?

Self-custody removes the middleman, and with it the safety net. There is no help desk that can reset a seed phrase, and a transaction sent to the wrong address cannot be recalled. Most losses come from ordinary mistakes and tricks: a backup thrown away, a seed phrase typed into a fake website, or a signature given to a malicious app.

Critics argue that this makes self-custody a poor fit for most people, who are used to banks that can reverse errors. Supporters answer that leaving coins with a company carries its own risk, as the customers of failed exchanges found.