Types of Blockchain Wallets: A Guide to Securing Digital Assets

Wallets have been a hot topic in the Web3 world due to the collapse of major exchanges such as FTX. The phrase “not your keys, not your crypto” is especially resonant as users are transferring funds off exchanges in record numbers. In this article we’ll give a high-level overview of what a wallet is, explore hot vs. cold wallets, custodial vs. non-custodial wallets, and the offerings Kaleido has for enterprise use cases.

What is a wallet?

A wallet allows a user to interact with the blockchain. It is either a piece or software or specialized hardware device that gives the user an on-chain identity to view and manage cryptocurrency as well as make transactions.

While there are many types of wallets, all wallets contain keys. A public and private key are generated whenever a wallet is a created and each key is a randomized alphanumeric string. The public key can be shared with anyone and acts as a receiver, or address where anyone in the world can send cryptocurrency to.

The private key on the other hand should not be shared and acts as the signing mechanism to confirm the validity of a transaction out of the wallet. Thus, anyone who knows the private key has complete control over the holdings within the wallet.

Hot vs. Cold Wallets

The key difference between hot and cold wallets is that a hot wallet is connected to the internet while a cold wallet is stored offline.

Hot wallets are typically web or mobile based which makes it easy for users to access and manage their crypto holdings. However, because they are always connected to the internet, vulnerabilities to hacking exist. Additionally, many hot wallets are managed by third parties such as Consensys for Metamask and Coinbase for Coinbase Wallet. This means that users must trust third parties to keep their crypto secure.

Cold wallets are more secure than hot wallets since they aren’t connected to the internet. Because of this cold wallets are typically stored on a physical device such as a Ledger. This means that users must have the physical device with them in order to make a transaction and thus is not as convenient as a hot wallet. There’s a bit more upkeep and responsibility to the user but cold wallets are ideal for those with a large amount of assets or are experienced.

Custodial vs. Non-Custodial Wallets

The other distinction between wallets is who holds custody of the assets. Custodial wallets are those whereby a user’s private keys are held by a third party exchange while for non-custodial wallets private keys are held by the user. Both are generally in the form of cold wallets and there are tradeoffs between each implementation.

Custodial wallets are good for those who don’t want to deal with the hassle of security and trust third-parties with their private keys. Exchanges such as Binance are considered custodians and there are also dedicated custodial companies. These companies such as BitGo generally have various security measures such as multi-tiered approval structures, direct trading from cold storage, and enterprise-grade compliance such as SOC1 Type 2. That being said, there are still risks of hacks or exchanges going bankrupt.

Non-custodial wallets are ideal for those who want complete control over their private keys however it puts a lot of responsibility on the user. If the private key is lost or compromised then there is no recourse. Assets are non recoverable.

There is also a type of non-custodial wallet called the MPC wallet, or multi-party computation. This is a technology that allows multiple parties to jointly manage the private key for a wallet. No one party has access to the keys as they are broken into multiple encrypted shares. Each party can independently store and a preset number of parties must sign a transaction for it to be approved. This is extra secure as hackers must attack multiple parties in order to gain control over a user’s wallet.

Kaleido’s Approach to Asset Management

Kaleido makes it simple to submit transactions anonymously, mask your identity, and manage accounts with Hierarchically Deterministic (HD) Wallets. With an HD wallet, you can submit anonymous transactions, mask your identity and manage accounts. It also allows you to leverage an endless key tree for account management, identity masking and anonymizing transactions.

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But our platform is not limited to a single type of custody solution. We are focused on building a platform that makes it easy to build high-throughput blockchain applications with the tools familiar to your developers. We can integrate third-party custody solutions like Fireblocks and help you use HSM-based key management tools like Azure Key Vault Signer, AWS CloudHSM Signer, and Hashicorp Vault Signer.

Schedule a talk with one of our blockchain experts if you're interested in designing a wallet or custody solution to fit your business needs.