Level 2
Wallets Explained
What crypto wallets really are and how they work.
6 min read
A cryptocurrency wallet is software (or hardware) that stores your private keys—the secret codes that prove you own your crypto. Despite the name, wallets don't actually "hold" your coins. Your coins exist on the blockchain; the wallet holds the keys to access them.
Why This Matters
Understanding wallets is critical for security. Choosing the right wallet type and knowing how it works protects your funds. Many people lose crypto because they misunderstand what a wallet actually does.
Simple Analogy
Think of your crypto as money in a vault at the bank (the blockchain). Your wallet is like your keyring—it doesn't hold the money, but it holds the key that opens your box. Lose the key, and you can't access your money. Give someone your key, and they can take everything.
Types of Wallets
| Type | What It Is | Best For | Risk Level |
|---|---|---|---|
| Hot Wallet | App on phone/computer, connected to internet | Small amounts, daily use | Higher |
| Cold Wallet | Hardware device, offline storage | Large amounts, long-term storage | Lower |
| Exchange Wallet | Account on a crypto exchange | Trading, converting between coins | Highest |
| Paper Wallet | Keys printed on paper | Long-term cold storage (outdated) | Medium |
📊 Wallet Architecture
Your Wallet contains: Private Key (secret, proves ownership) + Public Key (derived from private key) → Wallet Address (shareable, like an email address). The blockchain stores your balance. When you send crypto, you sign the transaction with your private key to prove you authorized it.
How Wallets Work
1
Wallet generates a key pair
When created, the wallet generates a private key and derives a public key from it using cryptography.
2
Public key creates your address
Your wallet address (what you share to receive funds) is derived from your public key.
3
You receive a seed phrase
Most wallets give you 12-24 words that can recreate your private key. This is your backup.
4
Transactions are signed
When you send crypto, your wallet uses your private key to create a digital signature proving you authorized it.
5
Network verifies the signature
The blockchain verifies your signature matches your public key without revealing your private key.
Custodial vs Non-Custodial
Custodial wallet (exchange wallet): Someone else holds your private keys. Convenient but risky—if they get hacked or go bankrupt, you lose access.
Non-custodial wallet (your own wallet): You hold your own private keys. Full control but full responsibility—lose your keys, lose your crypto forever.
"Not your keys, not your coins" is a common saying for good reason.
Critical Wallet Safety Rules
- •NEVER share your private key or seed phrase with anyone—no legitimate service will ask for it
- •Write your seed phrase on paper, not digitally—screenshots and cloud storage get hacked
- •Test your backup before storing significant funds—make sure you can actually restore
- •Use a hardware wallet for large amounts—hot wallets are convenient but vulnerable
- •Exchange wallets are not for storage—move funds to your own wallet after purchasing
Key Takeaways
- Wallets store keys, not coins—your crypto lives on the blockchain
- Private key = ownership. Lose it and your funds are gone forever
- Hot wallets are convenient but less secure; cold wallets are safer for large amounts
- Exchange wallets mean someone else controls your keys (custodial)
- Your seed phrase is the master backup—protect it like cash