What is a Bitcoin wallet? How to set up

When you buy Bitcoin, even though it exists solely in digital form, you still need a secure place to store it. Whether you plan to use Bitcoin for everyday transactions or as a long-term investment, safeguarding your digital assets is essential.

This is where a Bitcoin wallet comes into play. Much like a traditional wallet that holds your cash and cards, a crypto wallet is designed to store your cryptocurrencies securely. It not only tracks the Bitcoin you own but also holds the private keys, which are crucial pieces of information that prove your ownership of the tokens. Without these keys, you wouldn't be able to access or use your Bitcoin, making the wallet an indispensable tool for anyone involved in the world of cryptocurrency. 

Beyond just storage, some wallets offer additional features such as easy access to exchanges, portfolio tracking, and even the ability to earn interest on your holdings. Choosing the right wallet can therefore be a critical decision, especially if you're planning to actively engage with the crypto market.

Understanding a Bitcoin wallet

A Bitcoin wallet is a type of digital wallet specifically designed to store Bitcoin, but it can also hold other cryptocurrencies like Ethereum, XRP, and more. 

According to Alexandre Kech, CEO of Onchain Custodian, a digital asset custody service, "A Bitcoin wallet, or any crypto wallet, is essentially a digital tool that stores the encryption materials needed to access a Bitcoin public address and facilitate transactions." This means that a Bitcoin wallet does more than just store your digital coins; it also secures them with a unique private key. This private key is akin to a password for an online bank account—it ensures that only you, or anyone you share the key with, can access your Bitcoin wallet.

With a crypto wallet, you have the ability to store, send, and receive various coins and tokens. While some wallets are limited to basic transactions, others offer advanced features such as integrated access to decentralized applications (dapps) on the blockchain. These additional features can be particularly useful; for example, they may allow you to lend out your cryptocurrency and earn interest on your holdings, thus expanding the functionality of your wallet beyond simple storage and transactions.

Understanding how a Bitcoin wallet works

Since Bitcoin operates on a secure digital ledger known as the blockchain, using a Bitcoin wallet involves more complexity than simply opening a physical wallet. To better understand how it functions, Sarah Shtylman, a fintech and blockchain counsel at Perkins Coie, suggests comparing a Bitcoin wallet to an email account.

Just as you would need a password to log into your email, access your inbox, and send a message, you need a coded key—essentially a password—to access your Bitcoin wallet. To send Bitcoin, you’ll also need the recipient's Bitcoin wallet address, which works similarly to an email address. This address directs your cryptocurrency to the correct destination.

On the Bitcoin network, your public address acts as an identifier that links to a specific entry on the blockchain ledger—essentially your Bitcoin balance. Your private key, on the other hand, is what allows you to authorize changes to that ledger entry, such as transferring your Bitcoin to another address, explains Shtylman.

It's crucial to safeguard your private key because anyone with access to it can potentially hack into your wallet and transfer your Bitcoin to their own wallet. Additionally, if you lose your private key, you could permanently lose access to your cryptocurrency. Many cryptocurrency wallets are decentralized and secured through cryptographic methods, meaning there’s no central customer support to help recover a lost key. This has led to a significant portion of Bitcoin—around 20% of the total in circulation, worth billions of dollars—being locked away in wallets that users can no longer access.

Key factors to consider when choosing a Bitcoin wallet

Selecting the right Bitcoin wallet can be a challenging process, but there are several important factors to consider as you evaluate your options. Remember, you’re not locked into one type of wallet forever; you can use multiple Bitcoin wallets to take advantage of the different features they offer. For instance, you might keep a small amount of cryptocurrency in a mobile wallet for everyday transactions, while storing the majority of your holdings in a more secure hardware wallet.

1. Consider how you intend to use cryptocurrency

The primary decision often boils down to a tradeoff between security and convenience. As Adrian Przelozny points out, if you frequently trade or spend tokens, a mobile or web wallet connected to an exchange may be the best option due to its convenience and speed. On the other hand, if you’re holding a significant amount of cryptocurrency as a long-term investment, a cold storage wallet, which is less convenient but more secure, might be a better choice. Keep in mind that moving your cryptocurrency from the exchange where you purchased it to another wallet may incur withdrawal fees.

2. Investigate a wallet’s reputation

You’re not obligated to use a specific brand or type of wallet, so take the time to research different options. Read reviews focusing on user experience, security features, and any additional functionalities. It’s crucial to note whether a wallet has ever been hacked and to steer clear of those with a history of serious security breaches.

3. Look into wallet backup options

Some wallets offer backup options, allowing you to recover your data in case your device fails. This can be done through online backups or by using a physical device. If you plan to hold a significant amount of cryptocurrency, you might prioritize wallets that provide comprehensive backup solutions to ensure you can always regain access to your funds.

4. Understand key management

The management of private keys varies from one wallet to another, which can have significant implications for users. Sarah Shtylman explains that some wallets are managed by the service provider, which means they maintain control over the private keys. In this case, if you lose your key, the provider might help you regain access.

Other wallets place full responsibility on the user, meaning even the manufacturer doesn’t know the private key securing the wallet. If you lose your key in such cases, it may be impossible to recover your cryptocurrency. If you’re concerned about being locked out of your wallet, you might prefer a wallet where the provider retains custody of the key. Conversely, if you value the decentralized nature of cryptocurrency, you might opt for a wallet where you maintain full control of your private key—and, consequently, your assets.

Exploring different types of Bitcoin wallets

Just like physical wallets, Bitcoin wallets come in various forms, each balancing convenience with security in different ways.

Mobile wallets

Mobile wallets, such as Mycelium and Edge, are apps designed for smartphones, tablets, and other mobile devices. These wallets offer the convenience of easily sending funds to other wallet addresses, often by scanning QR codes, as noted by Adrian Przelozny, CEO of Independent Reserve, a crypto exchange in Asia and the Pacific. While mobile wallets are portable and user-friendly, they are also among the least secure. Not only are they susceptible to hacking, but if your device is lost or stolen, your digital coins could be at risk as well.

Web-based wallets

Web-based wallets, like those offered by Coinbase and Blockchain.com, allow you to store your cryptocurrencies through an online third party. These wallets provide easy access to your funds from any internet-connected device, making transactions straightforward. Often linked to cryptocurrency exchanges, web-based wallets let you trade and store your assets all in one place. However, they share similar risks with mobile wallets—being online makes them vulnerable to hacking. While such breaches are rare and losses are usually covered by insurance, the risk remains. Additionally, if the exchange associated with the wallet shuts down, you could lose access to your coins.

Desktop wallets

Desktop wallets, such as Atomic Wallet, Electrum, and Exodus, are software programs that you download onto your computer, storing your cryptocurrency on your hard drive. This setup adds a layer of security compared to web and mobile wallets since your assets aren't stored with a third party. However, since your computer is still connected to the internet, the risk of hacking persists.

Cold wallets

Cold wallets are physical devices, like USB drives, that are not connected to the internet. To make transactions, you must first connect the cold wallet to the internet. According to Przelozny, hardware wallets like these make transactions more cumbersome because you need to physically connect the device to the web to authorize outgoing transactions. Despite this inconvenience, cold wallets are ideal for long-term investors who prioritize security over ease of access. They often require an additional password, enhancing security but also posing the risk of being locked out of your cryptocurrency if the password is lost.

Paper wallets

A paper wallet involves printing your private key, typically as a QR code, onto a physical piece of paper. This method eliminates the possibility of online hacking but introduces the need to physically protect the document. However, as Alexandre Kech points out, paper wallets have fallen out of favor due to their high risk of being lost, destroyed, or stolen, which could result in the permanent loss of your private key and, consequently, your Bitcoin.