The Complete Guide to Different Types of Crypto Wallets

Similar to how a bank account is designed to store fiat currencies, crypto wallets store digital currencies like bitcoin (BTC), ether (ETH), and USDC (as well as other types of digital assets, like NFTs). But unlike traditional bank accounts, some crypto wallets put you in direct control of your assets rather than trusting a third party like a bank to hold them for you. Aside from just storing digital assets, crypto wallets also serve as an essential tool to connect to decentralized apps (dApps) that make up the blockchain ecosystem.

In short, crypto wallets are the cornerstone for securing and managing your blockchain-based digital assets. Crypto wallets provide an essential interface to send, spend, save, and trade your crypto.

In this article, we’ll cover how crypto wallets work, key concepts like private keys and recovery phrases, and the differences between custodial, non-custodial, software, and hardware wallets.

What is a crypto wallet?

A crypto wallet is a digital tool that allows users to store and interact with cryptocurrencies and other blockchain-based assets. Crypto wallets enable users to buy, transfer, and manage crypto assets like bitcoin (BTC) and ether (ETH), and USDC. Increasingly, crypto wallets also support the ability to store and manage non-fungible tokens, or NFTs. Crypto wallets are an essential tool for interacting with blockchain networks and virtually every on-chain action (e.g., buying/selling crypto, trading assets, connecting to dApps, etc.) requires a crypto wallet.

Crypto wallets come in various forms, each offering unique features tailored to different user needs. Determining which kind of crypto wallet is right for you will likely come down to important personal considerations regarding security, accessibility, and functionality. But before diving into all the different types of crypto wallets, it's essential to understand the fundamentals of how crypto wallets function and their role in the broader cryptocurrency ecosystem. This foundational knowledge will make it easier to grasp the distinctions between wallet types and their respective benefits.

Crypto wallet fundamentals

Understanding the basics of how crypto wallets work is crucial for anyone venturing into the world of digital assets. Below, we explore the inner workings and key components of crypto wallets.

How does a crypto wallet work?

At its core, a crypto wallet interacts with blockchain networks to facilitate transactions by serving as the bridge between a user and the blockchain. Unlike a traditional wallet that holds physical money, a crypto wallet doesn’t store your cryptocurrency directly. Instead, it holds the “private keys” (something we’ll explain in more detail shortly) that grant access to your crypto assets on various blockchains. By interfacing directly with blockchain networks, crypto wallets also enable you to create new blockchain addresses, which are directly correlated to the digital assets you own on a particular blockchain.

When you send or spend cryptocurrency, for example, your wallet uses your unique private key to “sign” (or approve) the transaction, ensuring it’s secure and authorized. This digital signature acts as a tamper-proof validation of the transaction’s authenticity. Once signed, the blockchain network processes the transaction, verifying its details and updating the shared ledger to reflect the transfer of assets.

In addition to their central role in signing transactions, crypto wallets also provide real-time access to your balance and transaction history, making it easier to manage your digital assets.

What are public and private keys, and what’s a crypto wallet address?

A full understanding of crypto wallets entails a quick foray into cryptography. The cryptographic systems used in most blockchain networks are part of a field called public-key cryptography (or asymmetric cryptography). This cryptographic system uses pairs of related keys — one only for the owner (i.e., private), and one that may be shared with those they interact with (i.e., public). Here’s a basic look at how this cryptographic system works:

• The private key is known as the owner’s key, and it must be kept private because anyone who has it can act as the owner. When you create a new “address” on a blockchain (more on addresses shortly), it will have an associated private key and public key. The private key is what enables you to control (i.e., send, trade, etc.) your crypto.
• The related public key is derived from the private key, and it may be shared with other parties. The public key can be used to verify that a message (or, in this case, a transaction) was signed by the owner (with their private key), and therefore that the message or transaction is authentic.

Note: The public key is derived from the private key, but the same process in reverse (i.e., deriving a private key from an associated public key) is practically infeasible. Crucially, a public key can validate that a transaction was signed with its related private key without revealing the private key itself.

In simpler terms, a private key can be described as the digital equivalent of a password or PIN for accessing your funds on the blockchain. It’s a long, unique string of characters that acts as a proof of ownership and authorization for all transactions made from your crypto wallet. Without the private key, no one — not even you — can access or control the funds tied to it. This makes it both incredibly powerful and critical to keep secure.

A public key, on the other hand, requires relatively little safeguarding. Individual blockchain “addresses” (often called crypto addresses or wallet addresses) are derived from your public key, which serve as public-facing destinations to receive funds. Blockchain addresses are closely related to, but technically different from, your public key. Addresses are represented by a string of alphanumeric characters that look something like this: 0x6645Aa8F6e14594ac2BFA3C915DAB0705c617BFE. You can think of addresses like an account number or mailbox: while anyone can send assets to a crypto address, only the owner with control of the associated private key can send funds from the address.

Note: Unlike traditional bank account numbers, wallet addresses are pseudonymous; they don’t reveal the identity of the owner. However, since all transactions on the blockchain are publicly visible, wallet addresses also serve as a traceable record of all incoming and outgoing crypto transactions.

What is a recovery phrase?

A crypto wallet recovery phrase is a series of 12–24 words generated by your crypto wallet. It represents your wallet’s master private key, which is then used to create individual, blockchain-specific private keys that then give rise to an associated public key and public blockchain address. To understand what that means, remember that:

• A crypto wallet technically stores your private keys; your assets themselves exist on various blockchain networks.
• Private keys are used to create public keys which, in turn, are used to create public blockchain addresses.

So when you create a new blockchain address using your crypto wallet, its associated private key has been derived from your wallet’s master private key (the recovery phrase is also called a “seed phrase” because of this functionality). As a human-readable sequence of words, your recovery phrase is much easier to record compared to the long hexadecimal string of a private key.

Your recovery phrase acts as a backup for the private keys contained within your wallet (and the funds controlled by those private keys). It’s also distinct from the login password you’ll create when setting up a crypto wallet. A recovery phrase is meant to be used if you lose access to your login password, your crypto wallet, or the device your wallet is installed on. Even on a brand-new device that you’ve never used, you can use your recovery phrase to restore your crypto wallet and all the private keys it contains. (Which also means that anybody with access to your recovery phrase could do the same, gaining unauthorized access to your wallet.)

It’s important to note that you should never share your recovery phrase with anyone; doing so could allow unauthorized access to your assets. Additionally, you’ll need this phrase to restore your wallet or manage an existing crypto address on a new device.

Note: When you initially set up a crypto wallet, you’ll be instructed to securely record your recovery phrase (i.e., write it down offline). Typically, the setup process will require you to re-input your recovery phrase to ensure that you’ve recorded it accurately. Outside of this instance, you should never supply your recovery phrase to anybody for any reason.

Understanding the different types of crypto wallets

Now that you know the basics of how crypto wallets work, it’s time to explore the different types available. With a wide array of use cases and user preferences, different types of crypto wallets have emerged to cater to varying needs. Whether you prioritize security, accessibility, or seamless interaction with blockchain applications, there’s a wallet designed for you. Let’s delve into the categories of wallets and their unique advantages.

Custodial vs non-custodial crypto wallets

Both custodial and non-custodial crypto wallets enable you to do basic tasks like viewing balances and transaction history for your crypto addresses, and carry out simple functions like sending and receiving digital assets like USDC. The key distinction between custodial and non-custodial crypto wallets is about who controls the wallet’s private keys. Non-custodial wallets give you full control over your private keys (and full responsibility for securing them). Custodial wallets give that power and responsibility to a third party (like a centralized crypto exchange, or CEX) that controls your private keys on your behalf. 

An analogy can be helpful to understand this key difference: If keeping crypto in your wallet is like keeping valuables in a storage unit, the custodial approach is like having the storage complex manager hold the key to your unit, while the non-custodial approach is like holding the key yourself.

This distinction has important implications.

What is a custodial crypto wallet?

Custodial crypto wallets are managed by third parties, such as centralized crypto exchanges, who hold your private keys on your behalf. This means that the third party has full custody over your cryptocurrency, and you must trust them to keep it secure. While custodial wallets are convenient and user-friendly, they come with risks. For example, if the custodian’s security is compromised or they become insolvent, you could lose access to your funds.

When you create an account on a CEX, you’ll also be creating a custodial crypto wallet. This entails establishing traditional login credentials (i.e., a username/password combo), but you won’t be asked to record a recovery phrase tied to your private keys. In fact, you won’t have access to your private keys at all. For the most part, the exchange handles the technicalities behind the scenes, and you interact with a simplified interface that enables you to do things like buy, sell, send, receive, and trade crypto assets — but these wallets typically do not support advanced blockchain features like connecting to dApps.

The primary appeal of custodial wallets lies in their accessibility and ease of use, especially for newcomers to crypto. These wallets, typically provided by CEXs, offer a user-friendly interface that allows individuals to buy crypto with fiat currency through familiar processes, like linking a bank account or using a credit card. The onboarding experience often feels similar to setting up an account with an e-commerce platform, making it an intuitive option for those new to digital assets.

However, custodial wallets come with notable risks. Since a third party controls your private keys, you must trust their ability to secure your assets. While some reputable exchanges may offer insurance or comply with stringent regulations to protect users, others may operate in less secure or regulated environments. Additionally, using a custodial wallet typically requires sharing personal information, such as your legal name and address, which might deter privacy-conscious users. For these reasons, custodial wallets may be ideal for beginners or those prioritizing simplicity, but they may not be the best choice for users seeking maximum control or privacy.

What is a non-custodial crypto wallet?

Non-custodial wallets (also known as self-custodial wallets) store your private keys within the wallet itself, giving you direct control over them. While you could record each private key individually, most non-custodial wallet users simply record their wallet’s recovery phrase (which represents the wallet’s master private key) securely offline.

The main reason to use a non-custodial crypto wallet is to avoid trusting a custodian (like a CEX) to protect your private keys. Custodians, much like traditional banks, can face risks such as security breaches, insolvency, or even mismanagement of funds. By using a non-custodial wallet, you remove the dependency on third parties. This level of autonomy is desirable for some, but it also demands a greater level of responsibility, as losing your private keys or recovery phrase can result in permanent loss of access to your assets. In this sense, a non-custodial wallet isn’t necessarily “more” secure, but rather has a different security profile altogether; risk of loss falls on the individual rather than a third-party institution.

Determining if a non-custodial crypto wallet is right for you largely depends on your appetite for autonomy and responsibility. If you prioritize autonomy and are comfortable with assuming total responsibility for safeguarding your assets, then a non-custodial crypto wallet is likely for you. You’ll also need a bit more technical knowledge to use a non-custodial wallet, as their interfaces tend to be more complex and dynamic than custodial wallets. Lastly, a non-custodial wallet is essential for connecting to dApps (because interacting with dApps requires you to sign transactions with your private key). If you’re interested in exploring on-chain ecosystems of dApps (including decentralized finance and more), then you’ll need a non-custodial wallet.

It’s also important to note that not all non-custodial wallets support fiat-to-crypto onramps or crypto-to-fiat offramps. That means that, depending on your non-custodial wallet, you’ll likely need to make your initial fiat-to-crypto purchases using a custodial wallet with a CEX, and then send your funds to an external, non-custodial wallet. Similarly, you may have to reverse this process when you wish to sell crypto assets for fiat currency and return those funds to, say, a bank account.

Software vs hardware (hot vs cold) crypto wallets

Crypto wallets can also be classified based on if they are digital devices (i.e., software wallets) or physical devices (i.e., hardware wallets). The software/hardware distinction is also sometimes talked about in terms of hot vs cold crypto wallets. Most software wallets are considered “hot wallets” because they’re usually installed on internet-connected devices and require an internet connection to function; while most hardware wallets are considered “cold wallets” because they’re designed to store private keys offline. Ultimately, the hot vs cold classification is more about how the wallet is used than its type.

Once again, understanding these categories is essential to choosing the right wallet for your needs.

What is a software wallet?

Software wallets are entirely digital tools that allow users to manage their cryptocurrency through applications on various devices, such as phones, tablets, or computers. They can also be accessed as web-based platforms (e.g., centralized crypto exchange websites) or browser extensions. Software wallets are typically free and readily available from CEXs or other third-party wallet providers.

Software wallets come in both custodial and non-custodial varieties. Custodial software wallets are often hosted by centralized exchanges (CEXs), where private keys are stored on servers managed by the exchange. Non-custodial software wallets, on the other hand, store private keys directly on the user’s device, offering greater control but requiring more responsibility.

Most software wallets are installed and used on internet-connected devices like computers or mobile phones. (For this reason, they’re often called “hot wallets” due to their around-the-clock internet connectivity.) This high degree of availability is convenient for everyday use, such as trading, sending, or interacting with dApps. But this availability also makes software wallets less secure than their offline-by-default hardware wallet counterparts because phones and computers can be hacked, and being connected to the internet increases that risk potential.

What is a hardware wallet?

Hardware wallets are exclusively a type of non-custodial wallet, meaning you retain full control over your keys and assets. Hardware wallets are physical devices, often resembling USB drives, designed to store private keys offline. By default, these devices are not connected to the internet. This "cold storage" approach reduces the potential for your private keys to be exposed to online threats, offering a high level of security against hacking and unauthorized access.

When using a hardware wallet, transactions are signed securely with your private key on the device itself. Then, once the transaction is signed, you connect the hardware wallet to an internet-connected device like your phone or computer to broadcast the signed transaction. This approach avoids exposing your private keys while connected to the internet, reducing the risk that a hacker could potentially gain access to them.

While hardware wallets provide unmatched security, they do come with some trade-offs. They typically cost between $50 and $200 USD and may require additional software installation to interact with the device. This extra step can be intimidating for beginners who likely find exchange-hosted custodial wallets far more intuitive. However, for those holding significant amounts of cryptocurrency or prioritizing security, the investment in a hardware wallet is often well worth the added complexity.

How to choose the crypto wallet that’s right for you

Crypto wallets are not one-size-fits-all. Each type fulfills different needs based on user priorities, whether it’s security, convenience, or interaction with blockchain applications. By understanding the tradeoffs between software and hardware wallets, as well as their relationship to custodial and non-custodial options, you can better navigate the crypto landscape and secure your assets effectively. Remember that this variety of crypto wallets exists because users have diverse goals, from casual investing to long-term investing to engaging with complex DeFi protocols. Choosing the right wallet involves understanding these options and aligning them with your specific requirements.

Many cryptocurrency users find it beneficial to use multiple wallets to address their varied needs. For example, a user might rely on a software wallet for everyday transactions, trading, or connecting to dApps due to its convenience and accessibility. At the same time, they might use a hardware wallet for long-term storage of significant funds, where security is the highest priority. This combination allows users to balance the flexibility of software wallets with the robust protection offered by hardware wallets, promoting both usability and peace of mind.

The future of crypto wallets

Crypto wallets have come a long way, evolving from basic storage solutions to sophisticated tools enabling complex blockchain interactions. The future likely holds more user-friendly designs, enhanced security measures, and seamless cross-chain compatibility. Whether you’re investing in cryptocurrencies or exploring on-chain ecosystems, understanding crypto wallets is fundamental to navigating this digital frontier confidently and securely.