Types of wallets
In the previous article, we looked at the functions and roles of wallets. In this part, we will look at the different types of wallets. There are many categories to classify the types of wallets, but I will explain them by dividing them into three representative categories: classification by the ownership status, classification by the internet connection, and classification by the user device.
Let's recall from the previous article that the ownership of assets in the blockchain environment is in the private key, and it was the role of the wallet to manage it. Who or where ownership exists is an important point for understanding the types of wallets.
Classification by the ownership (Centralized vs. Decentralized, Custodial vs. Non-custodial)
You may have experience using an exchange to buy cryptocurrency for the first time. You can buy or sell cryptocurrency through an exchange, and you can also send cryptocurrency to another exchange or wallet. Most exchanges use the user's email, mobile phone, or identity verification to sign up and serve as a substitute for the user's transaction.
This has the advantage of providing users with an environment that is very convenient and easy to own assets. Just as users trust banks to deposit and withdraw money when needed, exchanges also retain ownership of your assets. In other words, the exchange has the user's private key that guarantees ownership of the asset, and the user is only given the right to make a request to the exchange. Because the exchange stores and manages the private key in one place, it is called a centralized wallet. Similarly, it is also referred to as a custodial wallet in the sense of depositing assets.
Since exchanges are places where large amounts of money are stored and hold ownership of users' assets, they are also a prime target for attackers. Therefore, users should choose carefully, considering whether the exchange is safe from situations such as hacking, service suspension, or bankruptcy. In fact, there are still cases of damage caused by storing assets on exchanges.
Conversely, a wallet that directly manages private keys is called a decentralized wallet (also referred to as a non-custodial wallet). Decentralized wallets have to be managed by the users themselves, and could be somewhat inconvenient for users who aren't familiar with transactions. However, if managed well by the user, a decentralized wallet can be the safest place for storing your assets that completely removes the security threats faced by the exchanges. Since the decentralized wallet directly manages the private key, it directly interworks with the blockchain network and sends transactions. This gives you full control over your assets without having to trust anyone. The figure below shows the difference between a centralized wallet and a decentralized wallet.
Classification by the internet connection: (Cold wallet vs. Hot wallet)
A person with a private key can transfer assets by sending transactions directly to the blockchain network. This means that if you have the private key, you can move the asset even if you are not the actual owner of the asset. This is because blockchain networks verify ownership by digital signatures written with the private key, and does not verify who holds the private key. Therefore, there is no way to prevent attackers from moving your assets if they succeed in stealing your private key.
If you are storing your private key on a device in an environment connected to the Internet, such as a PC or smartphone, you should consider the situation in which an attacker can intrude through the Internet. For example, theft can occur through malicious code hidden in files downloaded through means such as e-mail. In many cases, you will not be able to easily determine if the theft has occurred, unless you are an expert. Therefore, in order to safely manage the private key from hacker attacks, it is safe to store it in a separate place disconnected from the Internet.
A wallet that stores the private key in an environment connected to the Internet and conducts transactions is called a hot wallet. Conversely, a wallet that stores the private key in a separate device that is disconnected from the Internet is called a cold wallet. While hot wallets are a bit more convenient because they allow you to transact within a single device, they are open to attacks. Conversely, cold wallets have to be managed in different devices, but compared to hot wallets, they are very secure from theft of private keys. If you are in an environment where you need to transfer assets frequently, you can use a strategy to store a small amount in hot wallets and store the rest in cold wallets.
Classification by the user device
As long as a wallet is connected to the internet, anyone can transact through the blockchain network. The wallets you can use depend on which device you use to connect to the internet. In a PC environment, you can manage after installing a program, but most people use the wallet extension installed in the browser. For example, the Metamask wallet is one of the most popular wallets that is built into the browser environment.
Free from the mobility restriction of the PC environment, there are numerous mobile blockchain wallets that allow you to transact on the go. These mobile wallet applications are serviced accordingly to the operating system (Android or iOS) of the user's smartphone.
In this part, we learned about the types of wallets. In the next article, we will go a little further and take a closer look at the security advantages of using a hardware wallet (cold wallet).