Two to three decades ago, the term wallet was synonymous with a leather pouch or bag that fits in the palm of your hand and pocket. Such a wallet was used to store physical money and identification documents. But the internet and the launch of Bitcoin in 2009 and Ethereum in 2015 have resulted in the birth of cryptocurrency wallets.
What is a Crypto Wallet?
A cryptocurrency wallet is an app or physical device that allows users to store, retrieve, send and receive their digital assets. Crypto wallets can further be categorized into software and hardware wallets.
Software Wallet (Soft/Hot Wallet)
As the name suggests, software wallets exist as programmable applications that can be accessed on mobile phones, tablets, and desktop computers. They provide users with private keys that further safeguard access to their digital assets.
A private key is a randomly generated number or sequence of letters that allow only the owner of the software wallet to access and manage the funds stored within.
Software wallets are often known as hot wallets because they are always connected to the internet. Examples of software wallets include MetaMask, Trust Wallet, BlockWallet, MyEtherWallet, and imToken, to name a few.
Cryptocurrency wallets such as those available through crypto exchanges such as Binance and Coinbase also fall into this category of software wallets. But, these wallets do not provide their users with private keys, which remain with the respective exchange. Users can only secure their digital assets using passwords and two-factor authentication on the trading platform.
Advantages of software wallet solutions by crypto exchanges
The simple nature of software wallets, such as those provided by crypto exchanges, can have some benefits such as:
- Ease of use, especially when you are a frequent trader and use cryptocurrencies for day-to-day conversions into fiat and vis versa.
- They provide quick access in the scenario you need to liquidate your assets during a market crash such as the one caused by TerraUSD (UST) depegging from the $1 mark.
- The crypto exchanges can cover lost funds in the case of a hack. For example, Binance has a SAFU Insurance fund valued at $1 billion. The funds are meant to cover losses by its users during a security breach.
Advantages of self-custody software wallets
However, security breaches on crypto exchanges do happen, as was the case with KuCoin in 2020. In such a scenario, user funds and private keys were entrusted with the exchange. The breach exposed the weakness of soft wallets by crypto exchanges in that users did not have access to their private keys.
Therefore, self-custody wallets become attractive to users who want more control over their digital asset investments. Such control is why they are referred to as ‘non-custodial’ software wallets and offer the following benefits.
- Reliability – soft wallets such as MetaMask and BlockWallet have been time-tested. Potential weaknesses have been assessed and rectified.
- Soft wallets have additional web browser extensions that increase the efficiency of online transactions.
- They are free to use and easy to set up.
- Non-custodial software wallets support multiple chains and decentralized applications. Additionally, they have cross-asset bridges to other chains beyond Ethereum, such as the BNB Chain and Tron.
- Their code is open-source. Developers and community members can access their source code to test and inspect it for faults.
- Soft wallets, such as MetaMask, allow users to change the default connection to the blockchain with a more secure one, such as the ones provided by the OMNIA Protocol.
- Software wallets such as BlockWallet, are built with user privacy in mind. Consequently, users can interact anonymously without fear of their metadata leaking.
Disadvantages of software wallets
Software wallets also have the following disadvantages.
- Owners of software wallets can be vulnerable to phishing attacks that result in the theft of private keys and passwords.
- Users of custodial wallets such as those by crypto exchanges can become victims of SIM swaps, resulting in unauthorized access and draining of the accounts.
- If a crypto exchange goes bankrupt, such as QuadrigaCX, funds stored on the platform are no longer accessible and are considered lost forever.
- In the case of sanctions, crypto users from specific regions and countries are locked out of their accounts.
- Storing private keys to software wallets on computers and mobile devices is also risky. Such devices can abruptly stop working due to viruses or hardware failure. They can also be stolen.
- Recovery phrases can also get lost.
Hardware Wallet (Cold Wallet/Storage)
Conversely, hardware wallets are physical devices used to store digital assets. Hardware wallets are often called cold wallets because users have to physically connect the wallets to their computers to start transacting their crypto-assets. They can also unplug their devices from the internet immediately after completing their transactions, storing their funds offline.
Furthermore, owners of hardware wallets have complete control of their digital assets as they have the respective private keys and an additional PIN or password to access the device.
Examples of hardware wallets include Ledger, Trezor, SafePal, and D’CENT. Some crypto enthusiasts have even created hardware wallets at home, but purchasing from a known crypto wallet company is recommended for security reasons.
Advantages of Hardware wallets
Regarding benefits, hardware wallets might be preferable for the following reasons.
- The private key is kept within the hardware wallet, reducing the risks of storing it directly on the computer.
- The additional PIN encryption makes such devices more secure.
- Hardware wallets are designed to hold multiple digital assets that belong to different blockchain networks.
- Hardware wallets are immune to computer viruses (at least for now).
- All transactions are verified through the hardware wallet and not online on the computer.
- The code running the wallets is usually open-source, thus increasing transparency and accessibility to developers who can audit the code.
- The respective teams behind hardware wallets are constantly working to improve their code. For example, the team at Ledger has white-hack hackers who are consistently improving the security of their devices.
- Soft wallets also support some hardware wallets eg, Blockwallet is one example.
Disadvantages of hardware wallets
Despite the advantages highlighted above, hardware wallets do have the following drawbacks.
- Trezor and Ledger Nano X wallets are somewhat expensive, at around $85 and $149, respectively. They may be overlooked by crypto users who prefer to use their money to buy more of their favorite digital assets.
- Hardware wallets can be vulnerable to hacks through power glitching, side-chain attacks, and attacking the software at the core of the device.
- Owners of hardware wallets can be the victims of phishing attacks, as is the case with Ledger users after the July 2020 data breach of the company. The breach exposed over 1 million customer details (names, phone numbers, home addresses, and emails). As a result, potential hackers have on many occasions sent fake emails or hardware wallet devices to Ledger customers, hoping to steal recovery seed phrases and their digital assets.
- The high cost of genuine hardware wallets might encourage crypto users to attempt to find discounts online, leading to the purchase of replicas or even tampered devices aimed at stealing seed phrases.
- Digital assets in hardware wallets are not immediately accessible during a market crash. The time spent hooking up a wallet to a computer could translate to further losses when selling.
Which is Better? Software or Hardware Wallet
The pros and cons of software and hardware wallets highlighted above bring us to the all-important question of which is better. The answer to this question depends on several factors, such as the value of the cryptocurrency being stored, whether the crypto is a long-term investment, or if the owner of the funds is a regular crypto user.
Firstly, a hardware wallet is recommended if the stored crypto is valued in the thousands, hundreds of thousands, or even millions of dollars. The same applies to a long-term investor who believes in the vision of a particular crypto project and is willing to hold for multiple years.
Secondly, a day trader would benefit from having their funds in a custodial wallet on a crypto exchange. This will allow them to access their funds quickly to set buy and sell orders according to their technical analysis. Once significant profits are made, the trader can consider storing their profits in a hardware wallet.
Thirdly, a regular user of DeFi services such as staking, yield farming, token swapping, trading on DEXs such as Uniswap, and buying NFTs might prefer using a software wallet such as BlockWallet or MetaMask.
Fourthly, a mix of both hardware and software wallets might be ideal. A certain percentage of digital assets can be stored in cold storage. Another portion on self-custody software wallets to participate in DeFi, and another share on crypto exchanges to participate in regular day or swing trading.
By the way, did we mention that is important that wallets have a secure connection to the blockchain ? We’ve created a tutorial that explains how to leverage OMNIA’s secure endpoints to secure wallet’s connection. See tutorial here or go visit the app yourself.
Summing it up, the main difference between a software and hardware wallet is that one is purely a programmable application for the storage of crypto, and the other is a physical device to accomplish the same goal.
Both software and hardware wallets have advantages and disadvantages that should be considered before using one. A software wallet is ideal for crypto users who want quick access to their funds to participate in trading, DeFi, or cash-to-crypto conversions. On the other hand, a hardware wallet is ideal for storing large amounts of digital assets, particularly those kept as long-term investments.
Another option is the combined use of software and hardware wallets. This might be ideal to capitalize on all their benefits.