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“Novi is ready to come to market,” Facebook exec David Marcus wrote in a memo posted Wednesday. He leads F2, Facebook Financial, the fintech unit overseeing FB’s much-ballyhooed cryptocurrency project.
Diem (née Libra) has proceeded in fits and starts for the last 2+ years. Following cold shoulders from the financial powers-that-be, FB has gradually pared back its crypto ambitions. But now, FB says it’s ready to release Novi, a digital wallet for stablecoins.
From where it started—seeking to build its own currency—wallets could seem like a meek starting point.
Au contraire. Crypto wallets underpin every part of the cryptocurrency ecosystem, from storing your digital gold in a metaphorical vault to minting JPEG images as non-fungible tokens (NFTs).
Like digital assets or decentralized ledgers, wallets need not have a physical substrate. That inevitably makes them harder to grasp. Today’s explainer walks you through the ABCs of wallets, the logic that underpins them, and the pros and cons of various products. This should be especially helpful for those who are just diving into crypto.
What’s a crypto wallet?
An accessible analogy is a digital equivalent of the accessory in your pocket or purse. For anyone from 2035 reading this: People used to carry around these leather, folding holders for their paper bills (“cash”), credit/debit cards, and government IDs.
While that’s a good starting point, crypto wallets represent much more than their analog predecessors.
The basics: Wallets don’t “hold” your crypto like physical ones carry credit cards. Crypto wallets store the digital credentials you need to access bitcoin or other tokens. Essentially, this is your machine-readable proof that you own your coins.
At the highest level of abstraction, a wallet simply constitutes a public key and a private key. Long alphanumeric strings of characters, these are the cryptographic basis that Bitcoin, Ethereum, and other blockchains run on. Your public key corresponds with a wallet address. Your private key is the only way you can move funds. Don’t give it to anybody!
Hot vs. cold
Hardware wallets are considered the most secure way to hodl. These physical devices—commonly taking the shape of a thumb drive—let you keep a private key in “cold” storage. You’re air-gapping your key (disconnecting it from the internet/metaverse). By not leaving any traces on a server, phone, or anything else hackable, you’re dramatically improving your security posture.
- Some common names in this space: Ledger, Trezor, Mycelium, and Electrum.
To access your coins, you have to plug the wallet into a computer (or connect it via Bluetooth). There’s recourse for losing the actual physical drive if you’ve taken the necessary precautions. Upon set-up, you get a seed/recovery phrase to recover a wallet that is lost/broken/Thanos-snapped. Users must make sure to carefully record this seed phrase, store it somewhere safe, and guard it like a state secret.
Seed phrases are a list of words that enable recovery of on-chain assets.
- A Ledger Nano X, for example, comes with a 12-, 18-, or 24-word phrase. This is the final resort for recovering your keys in the event that your hardware wallet is stolen or lost...or you forget your PIN to access it.
- On MetaMask, a software wallet, a 12-word seed phrase lets users recover funds if they’ve forgotten their password.
Paper, technically, is a form of cold storage. With this method, you print or write down the key info. There are worldly risks associated with a paper-based security protocol: You could lose it or someone could steal it. Fire, water, or the last airbender could destroy it.
- As Gemini notes, paper wallets have “gone out of style.” Since many online private key generators services are open-source, scammers have created faulty, unsafe rip-offs.
- The Winklevoss twins have a quite sophisticated paper system. They snipped up their private keys and scattered the cut-outs in secure vaults across the U.S.
Software-based wallets come in all shapes and sizes, with an animal kingdom’s worth of different characteristics. They’re available via desktop programs, browser-based plug-ins, and mobile apps. Sit tight for a longer walkthrough of these types of wallets. Common browser-based examples include: MetaMask, Coinbase Wallet, and Exodus.
The TL;DR—Security is paramount. If you can’t protect your funds, then other considerations—like interfaces or QR codes—don’t really matter.
Trust no one?
In a trustless world, security is naturally the most important criteria for choosing a wallet. If you’re a whale with 100+ BTC and 1,000+ ETH, you’re not storing it in a “hot,” internet-connected wallet. Same story if you’re a died-in-the-wool libertarian or blockchain purist in a crypto-regulated country.
Security is the sine qua non of digital asset handling, but it’s not your only consideration. Cold wallets have trade-offs. Stored assets are somewhat illiquid. You and you alone are responsible for your private keys and seed phrases. Nobody can save you.
- The NYT offers the cautionary tale of this poor soul: He can't access ~$320 million of BTC, because he forgot the password to the encrypted USB with his private key.
Not everyone self-custodies their keys. If you use a custodial wallet, you’re entrusting your keys to a third party, like a crypto exchange. This is a more convenient way to use crypto, especially if you’re just dabbling. Custodial systems work until they don’t:
- Mt. Gox, once the world’s dominant crypto exchange, was infamously hacked. Users lost their funds; The Japanese exchange began liquidation proceedings in 2014.
- Quadriga, a Canadian crypto exchange, absconded with customers’ assets in 2019.
“Any crypto wallet that won't give you your private keys should be avoided at all costs,” Elon Musk has said. See two common lines in the crypto community:
- “Not your keys, not your coins.”
- “Be your own bank.”
Two case studies
BRD is a digital wallet-maker that operates in 170 companies. The company expects to cross the 10 million user mark in the next couple of months, CMO Spencer Chen told us. Along with security, BRD has two must-haves for crypto wallets:
- “Self-custody or decentralized,” per Chen.
- Recovery methods. “Accidents happen and consumers need at least one recovery method.”
BRD’s products don’t “change at the whim of a corporation. The infrastructure is global,” Chen said. “The core covenants of blockchain have enabled us to protect over $20 billion of crypto...with a team of less than 20."
Amadeo Pellicce, a senior product manager at Blockchain.com, said: “Unfortunately, many people first entering crypto are not educated on the benefits and mechanics of private keys and are either unaware of the option entirely or don’t feel empowered to utilize it.”
His company differentiates itself through private key wallets, “enabling users to control their own money,” Pellicce told us, and additional trading services. The crypto bull market has been kind to the company, with the total number of (self-custody) wallets jumping 45% in the last year, per Pellicce.
"What’s...special about our wallet is the sheer volume it represents. To put it in perspective, Wells Fargo has 70 million customers,” Pellicce said.
Exchanges know scale, too
There are counterparty risks to doing business in cryptoland with a hot wallet, ranging from exit scams to security breaches. But there are risks and inconveniences associated with being your own bank. Ultimately, to self-custody or not-self-custody comes down to your personal preferences and risk appetite.
And to dial back the FUD-ometer a bit: Billions and billions’ worth of crypto flows through exchanges without incident. In Q2, Coinbase trading volumes totaled $462 billion and the crypto company had $180 billion of assets on its platform. Centralized as it may be, Coinbase has become the poster child of the US crypto industry.
Even if they may have certain drawbacks—and are less secure than hardware cold storage—software wallets and custodial services are increasingly popular.
Software wallets: a quick and dirty primer
Based on our basic definition of a wallet, online offerings are a dime a dozen. How’s a wallet provider to set itself apart? Beyond playing up industrial-grade security bona fides, there are plenty of ways:
- Basic functionality: You should be able to send funds from your wallet to another address or receive money. You should be able to see your balance, too. QR codes have also become standard fare in crypto wallets, to send or receive funds.
- Ease of use. If your wallet is designed to be an on-ramp for crypto newbs, you’ll want accessibility and an easy-to-navigate layout. If not, providers risk losing business.
- UI/UX: Similar to the above and relatively self-explanatory. User interface and experience could be make-or-break for end users.
- Exchange integration: Coinbase’s crypto wallets integrate seamlessly across the exchange and its portfolio of services. On the other hand, third-party wallets can roll up incorporated mini-exchanges into their service.
- Interoperability*: This is important for Ethereum* and other chains with smart contract, decentralized app (dApp) ambitions. This is how you can acquire an NFT on OpenSea, provide liquidity in De-Fi, and “sign in” with many decentralized services.
- Supported assets: Coinbase Wallet—a browser extension—rolled out to much fanfare in October 2020. The company bills it as a one-stop-solution to store “all your crypto and NFTs in one place,” with support for 500+ assets.
- KYC and AML: For developers, this depends on who they’re trying to serve, how decentralized their organization is, their jurisdictions, and what level of compliance they’re looking to achieve. KYC and AML refer to Know Your Customer and anti-money laundering verification. Regulated crypto on/off-ramps (exchanges) are required to use these identification measures.
- Decentralization: Many providers will typically let you be your own bank by managing your own private keys. Wallets like MetaMask and Coinbase Wallet are a portal to the distributed, serving as an identifier, helping users exchange, and more. They’re non-custodial and user-controlled, and as such, interact directly with the blockchain.
- Fiat/crypto exchange: Typically using third-party services, providers can offer a feature to let you directly buy crypto with fiat currency directly within the wallet.
The above should be viewed as a menu of options rather than a checklist, because some of these considerations are contradictory. Wallet providers optimize for different sets of users.
In terms of crypto adoption, we’re still early. Expect heavyweights across multiple industries to jump into the fray, like PayPal did at the end of 2020. This week, for example, the top shareholder question for Robinhood’s earnings call was: “Is Robinhood getting a crypto wallet?” (Right now, if you buy crypto on the trading app, you’re really just buying an IOU. You can’t actually move the funds to another wallet.)
With more wallets flooding the zone, we'll be wondering: Will ownership of private keys be a dealbreaker? How many new investors will intentionally seek out self-custody solutions? Will terms like “blockchain” even resonate with new, crypto-curious end users?
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