As Bitcoin is fully digital, you can only interact with it through a computer application. While there are many different applications that will allow you to transact on the Bitcoin network, it is very important that you understand the differences between them. While most differences in wallets are related to usability, the most important aspect you want to be aware of is how the private key of that wallet is treated. Mainly, who stores the private key and where they store it.
Public and Private Keys
All Bitcoin is stored at an address, known as a “public key” (think of a PO Box address). Just like how you must give others your PO Box address so they can send you mail, you must give your public key to others so they can send you Bitcoin. However, to gain access and use the Bitcoin at that address, you must have ownership of the “private key” (think of a key to the PO Box which gets you access to the mail inside). The private key allows you to send the Bitcoin. Therefore, it is very important it remains private and known only to the owner of the Bitcoin. If you are the only one who has the private key, you have true custody of your Bitcoin.
Wallet Types
With this basic explanation of Bitcoin keys, you can understand the major differences in wallets:
Self-custody or custodial
- If you are the only one who has access to the private key of that wallet, the wallet is considered self-custody, and you are the only one who can use the Bitcoin in it.
- If somebody else stores the private key for you and has access to it, the wallet is considered custodial. The custodian is one that controls the Bitcoin. This is the type of wallet used by all online exchanges.
Hot or Cold
- If the private key is stored on a device that is connected to the internet, it is considered a “Hot” wallet.
- If the private key is stored on a device with no ability to connect to the internet, it is considered a “Cold” wallet. The wallet application used in this instance will require a physical device that it can communicate with, called a hardware wallet, to store the private key.
Hardware Wallets
As mentioned above, a hardware wallet is an offline, physical device that stores the private key. If the private key to your Bitcoin has never been online, then somebody would have to have physical access to the hardware wallet to steal your Bitcoin. This makes hardware wallets more secure.
It’s important not to get confused by the terminology here, though. While it’s called a “wallet”, it is not the same thing as the wallet software application that sends and receives Bitcoin. You will need the wallet software to send or receive Bitcoin in all cases. However, the wallet software will send Bitcoin only when the transaction is signed by the private key. Therefore, if the software itself doesn’t store the private key, it will need to interact with the physical device (the hardware wallet) that does.
Therefore, while the hardware wallet is more secure, it does add an extra step when it comes to sending the Bitcoin.
