Understanding Blockchain Wallet Types: Custodial vs. Non-Custodial, Hot vs. Cold, and Device Options

As the cryptocurrency ecosystem continues to grow, various types of wallets are being released. For cryptocurrency investors, it is important to understand how each wallet works, what they offer, and how secure they are. We will look into the different types of wallets based on three categories that are easy for users to understand: ownership (custodial vs. non-custodial), internet connectivity (hot vs. cold wallets), and user devices (PC vs. mobile). This will help you choose the wallet that best suits your needs in terms of security, convenience, or flexibility.

 

 

Classification Based on Ownership: Custodial vs. Non-Custodial Wallets (Centralized vs. Decentralized Wallets)

Ownership is one of the fundamental ways to differentiate blockchain wallets. As explained earlier, ownership refers to who controls the private keys associated with a user's digital assets. The commonly used categories are custodial wallets and non-custodial wallets, also known as centralized and decentralized wallets, respectively.

 

Custodial (Centralized) Wallets

 

Many users first encounter cryptocurrency through centralized exchange platforms like #Binance, #Coinbase, and #Upbit etc. These exchanges make it easy to buy, sell, and transfer cryptocurrencies, requiring users to register their identity information to create an account. Once this information is registered, the exchange acts as an intermediary, facilitating transactions on behalf of the user. This setup is convenient for users unfamiliar with managing cryptocurrencies directly, as the exchange handles the technical aspects of private key storage and transaction execution.

 

However, in custodial wallets, the exchange holds control over the private keys required to manage the user's assets. This means that users do not have full ownership of their funds; instead, they must rely on the exchange to manage and protect their assets. This setup is similar to traditional banking, where customers deposit money in a bank, which then handles withdrawals, transfers, and other financial activities on their behalf. While centralized exchange users can conveniently manage their funds, this centralization makes exchanges attractive targets for hackers, who continuously attempt to exploit vulnerabilities in the exchange's security systems. Therefore, users should ensure that the exchange managing their private keys has robust security measures in place.

 

In addition to hacking issues, users must also consider potential service interruptions or bankruptcy of the exchange. For example, some exchanges have suffered large-scale cryptocurrency thefts due to hacking, and there have been instances where exchanges abruptly ceased operations, resulting in financial losses. Recently, there was the bankruptcy of FTX.

 

Non-Custodial (Decentralized) Wallets

 

On the other hand, non-custodial wallets, also known as decentralized wallets, allow users to have complete control over their private keys. With a decentralized wallet, users are responsible for managing their own keys, which can be a more complex process for those unfamiliar with blockchain technology. However, this approach offers significant advantages over centralized wallets in terms of security and autonomy.

Decentralized wallets (such as #D’CENT, #MetaMask, #TrustWallet etc.) communicate directly with the blockchain network, and users do not rely on a third party to execute transactions or safeguard their assets. This eliminates the risk of losing funds due to an exchange being hacked, service interruptions, or bankruptcy. However, users also have full responsibility for securely storing and managing the private key, often provided as a recovery phrase (12 or 24 words) during wallet setup. While this may be less convenient than relying on an exchange, it offers a higher level of security against hackers and other external threats.

 

Decentralized wallets are preferred by experienced cryptocurrency users who value privacy and control. Users have full access to their private keys and can independently manage their assets without relying on centralized institutions. This autonomy aligns with the original philosophy of decentralization in blockchain and can be particularly appealing in environments where trust in centralized institutions is questionable.

 

It's important to note that some blockchain networks like #Ripple (XRP) and #Stellar (XLM) have specific mechanisms for managing addresses within wallets. For example, Ripple requires users to activate an address (or account) with a minimum deposit of 10 XRP. In a large exchange with 100,000 users, this would require a deposit of 1 million XRP. To avoid this issue, exchanges often use a #Destination Tag or #Memo system to distinguish individual users under the same address, similar to how a hotel assigns room numbers to guests for deliveries. In contrast, decentralized wallets assign a unique address to each user, eliminating the need for such a system.

 

💡 How to use XRP account : https://userguide.dcentwallet.com/coin-send-receive/coins/ripple-xrp

 

 

Classification Based on Internet Connectivity: Hot Wallets vs. Cold Wallets (Software Wallets vs. Hardware Wallets)

 

Another way to categorize blockchain wallets is based on whether the wallet storing the private keys is connected to the internet. This criterion gives rise to two main types of wallets: hot wallets (software wallets) and cold wallets (hardware wallets).

 

Hot Wallets (Software Wallets)

 

Hot wallets (like #TrustWallet, #OKXWallet etc.) store private keys on a device connected to the internet, allowing users to manage their digital assets. Hot wallets offer convenience as they do not require connecting to another device, enabling users to send and receive cryptocurrency in real-time via smartphones or computers. However, the fact that hot wallets are always online makes them vulnerable to hacking attempts. If a hacker gains access to the device holding the private key, they can use it to transfer the user’s assets to another address. As explained before, the ownership of digital assets on the blockchain network is determined by the electronic signature generated by the private key, so a hacker with access to the private key can effectively control the assets.

 

 

 

 

One of the major risks associated with hot wallets is the potential for malware or phishing attacks. Hackers can use malicious software to steal private keys from internet-connected devices, often without the user's knowledge. In many cases, detecting such breaches can be difficult unless the user has strong cybersecurity knowledge. Therefore, while hot wallets offer convenience, they are not considered the safest option for storing large amounts of cryptocurrency.

 

Cold Wallets (Hardware Wallets)

 

On the other hand, cold wallets (e.g., #D’CENT, #Ledger, #Trezor etc.) store private keys on devices that are not connected to the internet, providing a much higher level of security. Because cold wallets are offline, they are not exposed to the types of online attacks that threaten hot wallets. For this reason, cold wallets are a preferred choice for storing large amounts of cryptocurrency.

Currently, cold wallets are available in various forms, including hardware wallets and paper wallets. Hardware wallets are physical devices that securely store private keys and only connect to the internet when signing transactions. These wallets provide additional security by keeping the private keys offline except during the transaction process. Paper wallets are another form of cold wallet, consisting of printed documents containing the user’s private and public keys. While paper wallets are very secure if stored safely, they are more vulnerable to physical damage or loss.

 

 

 

However, a downside of cold wallets is that they are less convenient to use than hot wallets from the user's perspective. To manage assets stored in a cold wallet, users must first transfer the private key stored in another wallet to the cold wallet. During the initial wallet setup, users must go through the process of generating and confirming a #seed phrase, usually represented as 24 words, which is a human-readable form of the complex hash value of the private key. When approving transactions, users must enter a registered PIN code to complete the process. To enhance and optimize the user experience, the D’CENT biometric wallet is designed to allow users to manage and approve transactions using fingerprint recognition and provides a UX for accessing various blockchain-based services.

 

Main purpose of using a cold wallet is to securely store private keys offline. However, if a hacker obtains the hardware wallet and manages to hack the device, it's important to ensure that the hardware wallet being used employs a certified secure chip to provide protection against physical security threats. 

 

 

User Devices: PC vs. Mobile

 

The final classification to explore is based on the type of device used to access a blockchain wallet. Depending on whether the wallet is used on a PC or mobile device, different options and functionalities are available.

 

PC Wallets

 

PC wallets are browser-based wallets that allow users to interact directly with decentralized applications (DApps) and perform transactions. Many blockchain wallets are designed for use on desktop or laptop computers, and PC-based wallets typically require users to download and install software to manage their private keys and conduct transactions.

 

PC-based wallets are favored by heavy users who want access to advanced features or use various DApps. The larger screen of a PC allows for a more comprehensive interface for managing services, and many early blockchain wallets were designed for PC use, making this environment familiar to long-time users.

 

However, like all internet-connected devices, PC wallets are still vulnerable to cyber-attacks and should be used with caution. One of the most well-known desktop (or PC) wallets is #MetaMask, initially released as a wallet for storing Ethereum and ERC-20 tokens, now supporting various Ethereum Virtual Machine (EVM)-based networks. MetaMask currently has over 30 million users and holds an 85% market share on the Ethereum-based network. Though it started as a PC-based wallet, it has recently released a mobile version as well.

 

 

Mobile Wallets

 

While exact market data on PC adoption rates isn't available, smartphone adoption rates (76%) are generally higher than those of PCs. This is largely due to the convenience and portability of smartphones. Mobile wallets provide flexibility, allowing users to conduct transactions from anywhere using a smartphone or tablet. They are typically designed to be compatible with mobile operating systems like Android and iOS, enabling users to manage their assets through mobile apps. Mobile wallets are especially useful for users who need to perform frequent transactions or quickly access their assets.

 

Additionally, mobile wallets often integrate with biometric authentication features such as fingerprint or facial recognition, offering an added layer of protection. However, a disadvantage of mobile wallets compared to PC wallets is the risk of the phone being lost or stolen. Similar to PC wallets, hot mobile wallets store the user's private key on an internet-connected device, making them vulnerable to hacking.

 

 

 

Conclusion

 

Blockchain wallets can be categorized based on ownership (custodial vs. non-custodial), internet connectivity (hot vs. cold wallets), and the type of device used (PC vs. mobile). Each type of wallet offers its own advantages and disadvantages in terms of security, convenience, and control, depending on the user's priorities. By understanding these distinctions, users can choose the wallet that best fits their needs and securely manage their digital assets in the rapidly evolving world of blockchain technology.

 

Lastly, D'CENT provides a cold wallet solution that encrypts private keys and stores them offline in a secure chip. It offers an easy-to-use and secure mobile solution through the D'CENT mobile app, while also integrating with PC-based wallets. This design allows users to maintain their familiar user experience, with final transaction approval handled by the hardware wallet. We hope this overview of the different types of cryptocurrency wallets has been helpful, and that you choose the right wallet based on your usage needs, ensuring a safe and smart cryptocurrency investment experience.