Crypto Wallets for Beginners: What You Need to Know

 Once you’ve purchased cryptocurrency, you need to decide how you want to store it. Here, we break down crypto wallets.

Summary

Owning cryptocurrency requires using a crypto wallet to store your funds. There are many different types of crypto wallets. A crypto wallet can be hosted online, or it can be software downloaded on your phone or computer or a specialized piece of hardware, among other options. Regardless of the crypto wallet type, they all store public and private keys which control the associated crypto and allow you to send and receive cryptocurrency. Transactions are then completed on the blockchain using the keys held in your wallet.

Contents

• Understanding Crypto Wallets

• Hot Wallet, Cold Wallet, or Both?

• Custodial vs. Non-Custodial Wallets

• Different Types of Crypto Wallets

• Wallet Security Best Practices

• Choose the Best Crypto Wallet For Your Needs

Understanding Crypto Wallets

There is no perfect crypto wallet, each different type of crypto wallet has pros and cons. Some have better security, while others are easier to use, and some are more mobile. Certain crypto wallets require more personal responsibility, while others require you to trust a third party to keep your assets safe. Key choices you’ll make with regard to what crypto wallet you end up using include deciding on a:

• Custodial or non-custodial wallet

• Online, mobile, desktop, or hardware wallet

• Hot or cold wallet

Hot Wallet, Cold Wallet, or Both?

A hot wallet is always, or almost always, connected to the internet. Because you need to be connected to the internet to transact, this is the most convenient type of crypto wallet. A hot wallet can be web-based or it could be an application downloaded on your phone or computer. Your crypto exchange wallet, where the cryptocurrency you purchased on an exchange will end up, is one example of a hot wallet. The downside of hot wallets is that their constant internet connection makes them more vulnerable to hacking than cold wallets.

A cold wallet, on the other hand, is a wallet that is almost always disconnected from the internet, making it extraordinarily hard to hack. Typically, cold wallets come in the form of a crypto hardware wallet — a specialized device that is plugged into your USB port or accessible via bluetooth. This is considered the most secure type of crypto wallet, but lacks the convenience of a hot wallet that would allow you to trade and transfer your cryptocurrency funds quickly.

While a crypto hardware wallet must be connected via personal computer to the internet to make a transaction and interact with the blockchain, the “signing” of the transaction itself happens “in-device,” meaning when your private keys are used to sign a transaction they remain on your device away from potential bad actors. A crypto hardware wallet will therefore still be considered a cold wallet even while in use. Most of the time this device is offline and is generally used for long-term storage of large amounts of crypto. Paper wallets are also cold wallets, but they are no longer widely recommended as a way to store your keys.

Custodial vs. Non-Custodial Wallets

The private keys in a crypto wallet control the funds in that wallet by assigning ownership to the holder of the keys. A non-custodial crypto wallet enables you to control the keys yourself, rather than delegating the job of securing the keys to a third party, like an exchange. This is considered more secure but requires you to take more responsibility. If you were to lose your wallet or forget your password, you could lose your funds if you don’t have a recovery phrase.

If the keys in your crypto wallet are controlled by someone else, it’s considered a “custodial” wallet. These crypto wallets are typically exchange or web-based wallets that you can access through your phone or desktop. You must trust the custodian of your keys the same way you’d trust a vault to hold your valuables, and it is therefore important to choose a reputable crypto custodian.

Despite the lower level of security, some prefer custodial crypto wallets since they don’t require as much personal responsibility and are more convenient, allowing you to trade and transact more seamlessly. If you forget your exchange password, it’s usually a straightforward process to reset it, whereas if you forget a non-custodial crypto wallet password there may be no way to recover your funds.

Different Types of Crypto Wallets 

Web-based wallets are accessed via your browser, and as there’s nothing to download, you can access this crypto wallet from any phone or computer. These are considered the least secure types of crypto wallets given their continuous connectivity to the internet. Although most were initially custodial, several web wallets are now non-custodial giving you sole control of your keys, which is widely considered an improvement.

Mobile and desktop wallets are based on software that is downloaded to your phone or computer, and they are more secure than web-hosted wallets. Most mobile and desktop wallets are non-custodial, and some are available for both Android and iOS devices, or only work with a specific operating system. Likewise, some desktop wallets are available for Linux, Mac, and Windows, while others are only offered on one operating system. And lastly, some crypto wallets have both a mobile and desktop version.

Crypto hardware wallets are specialized devices that are offline when not transacting and usually look like a thumb-drive. When transacting, crypto hardware wallets are connected to the internet via the USB port or bluetooth connection to a personal computer, and the “signing” of the cryptocurrency transaction is done “in-device,” making it impossible to hack remotely. These types of crypto wallets are the most secure but also the least convenient. They are often known as cold wallets given that they usually remain disconnected from the internet. In addition, these crypto wallets typically cost between $50 and $200, whereas most other wallets are free. Crypto hardware wallets are recommended for those expecting to hold large amounts of cryptocurrency long term.

Wallet Security Best Practices

Whichever crypto wallets you choose, it’s recommended you ensure that you have passwords for the wallets themselves as well as for the devices they are stored on. For all non-custodial crypto wallets, you should keep a recovery phrase that will backup your wallet and allow you to regenerate the associated private keys on a new wallet should you misplace the original device. Be sure to store this phrase in a safe place; anyone with access to it may also access the associated funds.

Keeping up to date antivirus software and using a virtual private network (VPN) is also recommended. For an exchange wallet, it’s recommended you follow the exchange’s security recommendations, which usually includes two-factor authentication (2FA) such as Google Authenticator or an SMS password.

Choose the Best Crypto Wallet For Your Needs

Choosing which wallets to use, like choosing which cryptos to buy, doesn’t have a one-size-fits-all answer. Most crypto enthusiasts use a combination of wallets: an exchange wallet, a mobile wallet, and a hardware wallet. Your exchange wallet is used to buy, trade, and sell. Your mobile wallet contains a smaller amount for making purchases, and your hardware wallet is used to secure the majority of your funds. However, you may also prefer a custodial solution such as a trusted exchange to store the majority of your cryptocurrency.

What Are Central Bank Digital Currencies (CBDCs)?

 CBDCs are not cryptocurrencies, even if built on blockchain. They are centralized — controlled by central banks — while crypto is famously decentralized

Summary

Central banks are responding to the rise of cryptocurrencies and other digital payment technologies by exploring adoption of central bank digital currencies (CBDCs). A CBDC is a digital representation of central bank-issued money that can be built on a blockchain or distributed ledger. Despite potentially sharing some architecture with cryptocurrencies, CBDCs are not considered cryptocurrencies because of certain technical differences and because they are controlled by a central authority.

Contents

• Central Bank Digital Currency Isn’t Crypto

• Characteristics of CBDCs

A central bank digital currency (CBDC) is a digital representation of a country’s government-issued, central bank-controlled money. CBDCs are different from the digital reserves and settlement account balances that central banks, commercial banks, and other financial institutions hold. The design of CBDCs can vary significantly in terms of access, privacy, and underlying architecture, but some central banks have proposed building their CBDCs on a blockchain protocol or distributed ledger.

Central Bank Digital Currency Isn’t Crypto

Even in circumstances where CBDCs are blockchain-based, they are not cryptocurrencies because they are controlled by centralized authorities — central banks. A cryptocurrency, by definition, is not maintained by a centralized entity, but is instead managed by a decentralized network of nodes that reach agreements on the state of the ledger through a consensus mechanism.

Characteristics of CBDCs

At the time of this writing, CBDCs have only been proposed by central banks and have not yet been implemented for country- or region-specific use, beyond closely monitored private trials. To date, more than 20 varying CBDC prototypes have been created. In particular, the digital yuan in China and the Bahamanian Sand Dollar in the Caribbean appear the closest CBDCs to being officially released.

Central banks have proposed varying degrees of accessibility for CBDCs. For example, some have considered creating a CBDC that would be available to the general public, particularly in the event that the use of cash continues to decline substantially. The Bank of International Settlements (BIS) has argued that introducing a CBDC into this context could diversify retail payment systems and bolster those systems’ ability to bounce back if technological issues interfered with private payment infrastructures. Central banks have also proposed restricting CBDC access to financial institutions that hold reserves at those banks. In this case, the CBDC would be designed to improve wholesale payment, clearing, and settlement systems between banks.

Central banks have entertained a variety of underlying architectures for CBDCs, including Distributed Ledger Technology (DLT) and blockchain, a subset of DLT. Distributed ledgers are shared, decentralized databases that are maintained by multiple nodes without a central authority. A blockchain is a peer-to-peer network that maintains a record of transactions by timestamping them and recording them into blocks, which are linked in a chain and cannot be easily altered. Central banks have cautioned that the use of a blockchain or DLT could result in confidentiality issues (because of the public nature of the ledgers) and scalability challenges.

Central banks have also debated whether people should be allowed to transact anonymously with CBDCs. Physical central bank money (cash) is the most anonymous payment method, but some monetary authorities have rejected the idea that digital central bank money should retain this characteristic.

A 2020 survey conducted by the London-based journal Central Banking found that 46 countries were researching the potential adoption of CBDCs including China, the United Kingdom, and the European Central Bank, suggesting that money as we know it may soon look quite different.

Pros and Cons of Automated Trading Systems

 Are you ready to trust your trading strategy to bots? Read about the advantages and disadvantages of algorithmic (algo) trading.

Summary

Automated, or algorithmic (algo), systems across all asset classes execute pre-set orders that can exclude the influence of human emotion or market swings. This is one advantage of algo trading, as emotional trading can result in overtrading, which in turn can trigger losses. Another benefit of algo trading is that a computer-managed system lets you trade multiple accounts and strategies simultaneously. Algo trading can help to reduce the incidence of mistakes made by humans when placing trades and can identify profit and loss (P&L) opportunities much faster than a human trader. Algorithmic trading is not for novice traders. It relies on expensive, complex software and takes place primarily at large investment banks, hedge funds, proprietary trading firms, and regulated cryptocurrency exchanges.

Contents

• Advantages of Automated Trading Systems

• Disadvantages of Automated Trading Platforms

• Should You Automate at All?

Trading is about making money — not losing it —  but unfortunately, many do, in fact, lose. People often correlate losses with emotional trading or becoming too personally invested in the outcome of a trade. Over-involvement can lead to over-thinking and then to over-trading, which in turn may lead to loss. In the discipline of trading, it can help to stick with a consistent strategy. Automated, or algorithmic (algo), systems across all asset classes execute pre-set orders that can exclude the influence of human emotion or market swings. As a burgeoning asset class with a fast-growing infrastructure, cryptocurrency exchanges have also begun to give customers the ability to execute automated trading strategies through the use of trading bots.

Still, automated trading platforms are not without drawbacks. For starters, computers depend on a strong internet connection and a reliable source of electricity to function. Moreover, some trading strategies are so complex that computers cannot execute them efficiently, and may require constant monitoring and human intervention anyway. So whether you’re an individual investor or a professional trader, you should carefully assess whether or not automated trading systems would enhance or detract from your trading style.

Advantages of Automated Trading Systems

• Eliminates Trading Based on External Factors: Algorithmic software generally calls for each trade to be programmed, which means traders can avoid reactionary or ill-considered buying and selling based on negative economic or company news, or from fear of missing out (FOMO) on a lucrative asset. Algo trading can also prevent quick-finger transaction mistakes — like accidentally omitting a zero on a sell order price.

• Provides Opportunities for Backtesting: In trading, backtesting refers to when an investor looks to history for clues about how to invest in the future. With this strategy, you can use historical market data to test whether a certain trading plan will work based on past results. You can then automate that plan rather than guessing and potentially losing funds.

• Automation Keeps You On Plan: Many traders start out with a trading plan, only to forget about it over time. A common aphorism in the investment community is “plan the trade, then trade the plan.” The latter is much easier if you automate your trades to consistently execute your trading plan in pursuit of profitable results during a particular period.

• Helps You to Stay Diversified: Trading is all about maximizing profits while minimizing risks, and algo trading solutions can help traders achieve this goal at a much faster and error-free pace than trading manually or with analog tools. Computer-managed systems allow you to trade multiple accounts and strategies simultaneously, and identify profit and loss opportunities through ultra-fast market scans.

 Disadvantages of Automated Trading Platforms

• Watch Your WiFi and Power Source: Algo trading systems are electronic, meaning they depend on a reliable power source — and more crucially, a strong WiFi connection. If your automated trading software functions on your own computer instead of on a broker’s software, a failed internet connection can trigger a big loss if orders are not fulfilled on time.

• Over-Optimization: In addition to backtesting, some trading platforms contain an optimization tool. This feature allows you to enter a range for the specified input and tells the computer to figure out which input would have worked the best for your strategy. Some systems have multi-factor optimization capabilities that let you input many variables — combinations of scenarios — to see their effects on the end result. Unfortunately, though an enticing exercise, optimizing a backtest in this way often leads to a system that performs poorly in reality. When this happens, your strategy is said to be “over-optimized,” meaning it’s too complex for the system to apply it in the real world; it looks good on paper only. For this reason, it’s a good idea to start your automated trading practice with small, simple orders and build expertise over time.

• Algo Trading Software Is Complicated and Expensive: In general, algorithmic trading happens primarily at very large trading firms, such as investment banks, hedge funds, and proprietary trading firms. Because of their resources, these firms generally build their own proprietary trading software. In terms of individuals, some experienced proprietary and quantitative traders also use algo trading software. Quantitative traders usually are savvy enough to build their own software. But, proprietary traders who may not be so tech-savvy must buy the software, either from their brokers if they offer it, or from a third-party vendor. The algo-trading software that’s available to anyone off the shelf is generally inferior in one or more ways — it can contain loopholes, missing documentation, and so on. If you’re thinking of purchasing off-the-shelf algo-trading software, you likely should bring an expert consultant along with you. Further, for the average person, algo trading software is prohibitively expensive.

• Scammers: Scammers are everywhere, and automated trading systems are no exception. If a system promises something that’s “free” or “too good to be true,” you should be very skeptical. Research the provider of an automated trading system thoroughly before paying any money for its services, and be sure to look at the fine print. Compare and contrast the system with competitive offerings and read customer reviews across a range of reputable websites.

Should You Automate at All?

If you’re trying to trade from your home computer, then an exchange’s server-based automated trading system can help you to avoid catastrophe from a failed personal internet connection. But if you’re wondering whether you should go the route of algorithmic trading at all, then consider it carefully because setting up a viable algo strategy can take a lot of time, money, and technological sophistication. If you’re a professional trader, then algo trading is worth a try to see if it’s a good match for your trading style and temperament.

If you’re a disciplined individual trader with extra time and money to spare and a high tolerance for risk, then you might wish to try your hand at algo trading. But before you launch full scale into it, think about starting with a very basic custom or “wizard” strategy until you’re more familiar with algo trading. A wizard strategy is essentially a template that you can customize based on your own parameters and trading goals. Moreover, some traders believe that mixing automated and manual strategies produces better results. So that also could be a technique to try before you commit fully to algo trading.