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What are crypto wallets and how do they work

From Mt Gox to FTX, billions have been lost.

A lot could have been saved by remembering: “Not your keys, Not your crypto” 🔎.

To understand this, it is important to understand what are crypto wallets and how do they work.

A crypto wallet isn’t like a regular wallet in which you hold your credit cards and cash. They are only a tool to ‘access’ crypto tokens. A doorway with a key, if you will.

It is a misconception that wallets hold tokens. The crypto wallet does not hold any crypto. The crypto is stored on the blockchain. Wallets provide an access to those tokens on the blockchain.

So, it is logical that whoever has the key to the doorway, has access to the tokens! Simple!

Wallets operate with a pair of keys. A public key and a private key. The public key is the one that is used as the address to send the token to. The private key authorises transactions and therefore must always be kept confidential. Whoever owns the private key, owns what is held inside the wallet.

There are two types of wallets based on who has custody of the private keys

  • Custodial

  • Non-Custodial

Exchanges like Binance, KuCoin, and others provide custodial wallet services where they hold customers’ private keys. So it is these platforms that are responsible for safeguarding users’ funds parked on their platforms.

A non-custodial wallet, on the other hand, gives users full control of the private key. Thus, the user of a non-custodial wallet is responsible for its safekeeping.

So why do people not use non-custodial wallets all the time as common sense would suggest?

There are two reasons. Convenience and cost.

A custodial wallet is linked to the platform all the time and makes it super convenient to transact. Further, gas fees might be incurred every time funds are transferred to and from the custodial wallets. The best way to keep the funds secure is to use a non-custodial wallet. This is similar to locking away one's valuables in a safe deposit box of a bank. It does come at a cost and inconvenience but keeps the valuables relatively more secure.

There are two options for non-custodial wallets. They are referred to as

♨ Hot Wallet

❄ Cold wallet

A hot wallet is an s/w application, always connected to the internet. This may be operated via the web or mobile app. As it is always connected to the internet, it opens a route to hackers. Eg metamask, phantom etc.

The safest are cold wallets. These wallets are similar to pen drives that can be plugged in when needed. They are referred to as ‘cold’ as they are not connected to the internet when not in use. . Due to need-based access to the internet, these are the safest wallets for storing tokens.

With a hardware device, there is a risk of loss or damage. However, this poses no problem as the access is controlled by the private keys and these can be applied to a new hardware.

When it comes to crypto, remember, not your keys, not your crypto!

Act responsibly, for your own sake. Print the attached image and pin it on the board as a reminder!

Where is your not-in-use crypto parked?

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