When it comes to securing your Bitcoin, the type of wallet you use is crucial. The terms "hot" and "cold" wallets refer to the wallet's connectivity to the internet, while "custodial" and "self-custodial" refer to who holds the private keys. Here’s a comprehensive guide to understanding the different types of Bitcoin wallets.
Key Terms:
Hot Wallet: Connected to the internet.
Cold Wallet: Offline.
Self-Custodial: User controls the private keys.
Custodial: Third party controls the private keys (e.g., institutional cold storage services).
Types of Wallets
Custodial Wallets
Custodial wallets involve a third party holding and managing the private keys. These are typically used for convenience and ease of use, though they come with increased security risks since the user does not control the private keys.
Custodial or Exchange, No Keys, Hot Wallet: In this setup, the third party, such as an exchange, holds the private keys, and the wallet is connected to the internet. This allows for easy access and quick transactions. Examples include wallets provided by Coinbase, Binance, and Kraken.
Custodial or Third-Party, No Keys, Cold Wallet: Here, a third party holds the private keys and keeps them offline for enhanced security. This is less common but is used by institutional services like BitGo or Coinbase Custody, which store assets in cold storage on behalf of clients.
Self-Custody Wallets
Self-custody wallets give the user full control over the private keys. This means the user is responsible for managing and securing the keys.
Self-Custody Single-Key, Hot Wallet: The user controls the private keys, which are stored on an internet-connected device. This type of wallet is convenient for frequent transactions. Examples include software wallets like Trust Wallet, Mycelium, and Electrum.
Self-Custody Single-Key, Cold Wallet: The user controls the private keys, which are stored offline, offering enhanced security against online threats. Examples include hardware wallets like Ledger and Trezor, and paper wallets.
Self-Custody, Multi-Signature, w/ Hot Keys: The user controls multiple private keys, with at least some of these keys stored on internet-connected devices. This setup increases security by requiring multiple keys to authorize a transaction. Examples include multi-signature wallets like Kevlar, which provides an extra layer of security.
Self-Custody, Multi-Signature, w/ Cold Keys: The user controls multiple private keys, all stored offline. This setup combines the security of cold storage with the added security of multi-signature. Examples include multi-signature setups using hardware wallets like Ledger or Trezor, or services like Casa and Nunchuck.
Seed Phrase Wallets
Seed phrase wallets are a type of self-custody wallet where the private keys are derived from a seed phrase. The seed phrase can be written down or memorized.
Paper Wallet, Seed Phrase Written Down Only: The user writes down the seed phrase on paper, which can be used to regenerate the private keys if needed. This method is highly secure as it is completely offline but is vulnerable to physical loss or damage.
Brain Wallet, Seed Phrase in Mind Only: The user memorizes the seed phrase, which can be used to regenerate the private keys. This method eliminates any physical trace of the keys but relies entirely on the user's memory.
Summary
Understanding the different types of Bitcoin wallets is crucial for securing your assets. Custodial wallets offer convenience but come with higher security risks since the user does not control the private keys. Self-custody wallets provide greater security and control, with options for both hot and cold storage. Multi-signature setups add an extra layer of security by requiring multiple keys to authorize transactions. Finally, seed phrase wallets offer a unique approach to security, relying on either written or memorized phrases to regenerate private keys.
By choosing the right type of wallet and understanding the associated risks and benefits, you can better protect your Bitcoin and ensure its security.