Anyone who wants to buy, sell or hold cryptocurrency tokens needs a crypto wallet. It’s like a physical wallet, but instead of holding paper money and credit cards, it stores the digital passkeys needed to send, receive and store crypto tokens you own. Users who don’t want to manage their own passkeys can use wallets hosted by a crypto trading platform or another third party. The collapse of the FTX exchange last year highlighted the risk of those hosted wallets as billions of dollars in tokens became inaccessible. Financial technology firms are racing to offer self-custody solutions, including some that keep assets in “deep cold storage,” off the network and out of reach of hackers.

1. Why the need for crypto wallets?
There’s no central authority for tokens as there usually is for traditional, government-issued money. Tokens reside on decentralized, distributed ledgers called blockchains. Users gain access to their tokens using the digital credentials stored in these crypto wallets. Wallets also keep track of token balances, and some of them allow users to exchange cryptocurrency for regular money and vice versa.

2. How do they work?
A crypto wallet manages two kinds of cryptographic keys, private and public. A private key is akin to a password: It demonstrates proof of ownership and is required to authorize transactions, so it should be kept confidential. A crypto investor uses a private key to generate a public key. A public key is like an email address for cryptocurrency; it’s the identifier that others can see and send assets to. 

3. What are the different kinds of crypto wallets?
There are two types of wallets—software-based “hot” wallets and hardware “cold” wallets. Hot wallets such as MetaMask and Trust Wallet are connected to the internet via computer or smartphone, ready for transactions but also potentially vulnerable to online hacks. Hosted wallets are a variation of the hot wallet that give users access to their tokens over a web interface. Cold wallets, by contrast, are usually kept offline. They lack convenience—a crypto owner has to take several steps to transfer an asset from USB-like hardware devices such as Trezor or Ledger in order to sell it, for example—but they are far more secure than hot wallets. Another cold-wallet approach is to write down the long alphanumeric key codes by hand and store them in a safe. 

4. How do crypto wallets assign custody?
Wallets can either be custodial, where a third party like a crypto trading platform holds a private key on behalf of a customer, or non-custodial, where the user is the only one with access to a private key. The latter kind, sometimes called a self-custody wallet, gives the owner complete control of a token and requires no fees for managing the assets. One downside: If you lose your key, you lose your token. 

5. Why was FTX’s collapse a cautionary tale?
FTX’s collapse in November 2022 revealed that the exchange misused customer deposits. Its bankruptcy left $8.7 billion worth of user assets stuck on the exchange. This led to a surge in demand for hardware wallets, with Ledger recording its highest weekly sales ever.

6. Who are the major providers of crypto wallets?
Trezor and Ledger have been making hardware wallets since 2013 and 2014, respectively, and are widely recognized brands in the crypto community. Among the most commonly installed software wallets on mobile and desktop platforms are MetaMask, created by Ethereum development firm Consensys; Trust Wallet, backed by Binance; and Coinbase Wallet, made by the eponymous cryptocurrency exchange. The growth prospects of self-custody continues to bring new players. In December, Jack Dorsey’s payments firm Block Inc. introduced a Bitcoin hardware wallet called Bitkey. That came months after Ledger’s €100 million funding round, which valued it at €1.3 billion ($1.4 billion).

This article was provided by Bloomberg News.