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Wallets and Custody Solutions

Interacting with digital assets within the crypto economy (and the broader blockchain industry) has grown in scope considerably over the past several years. For users to buy, hold, and sell digital assets, digital wallets and custody solutions were required as a form of evolving technology. Today, there are countless options on the market to fill the need for digital wallets on behalf of blockchain users that fill in different categories and types depending on their design.

Source

There are two key classifications that fill this technology need: non-custodial and custodial. Non-custodial or self-custodial wallets mean that digital assets (e.g., cryptocurrencies) are held directly by the user. This represents the majority of popular on-chain wallet solutions like MetaMask, Trust Wallet, and more. On the other hand, custodial solutions mean that a third party, typically an exchange, takes custody of the assets on behalf of the user. This is similar to a traditional bank where the user has access to the funds when they are needed, but the funds are ultimately held and utilized by the bank itself.

Self-custody represents one of the core philosophies behind the creation and utilization of cryptocurrencies, starting with Bitcoin. When users control their own funds outright, they cannot be easily confiscated, misused, or frozen by any external parties like governments or institutions. This is the primary directive of decentralized, stateless currencies.

When cryptocurrencies are handed over to an entity like a centralized exchange (CEX) such as FTX, control over those funds is forgone, and the user no longer has possession of the crypto. This is where substantial risk has been introduced into the crypto economy over the past year with the collapse of CEXs and loss of customer funds.
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Wallet 

A digital “wallet” represents a blanket term that refers to anything in which crypto can be stored. Wallets, specifically, hold a user’s private keys that enable the user to access the funds on the blockchain. This grants the ability to buy crypto, use crypto (i.e., yield farming, staking, etc.), and any other functionalities available via on-chain applications. This can come in the form of a hot wallet (internet-connected) or a cold wallet (offline and secured).

Crypto wallets don’t actually store funds. Instead, they store two keys:

• A public key links to an address that lets you send and receive transactions. Think of it as your email address.
• A private key proves that you own the tokens associated with your public address. Think of it as your email password. Since a private key is hard to remember (it’s a very long string of random numbers), wallets also give you a 12-24 word seed phrase. Private keys signify complete ownership of all digital assets. Therefore, protecting them is imperative.

Downloading a cryptocurrency wallet from a wallet provider to a computer or phone does not automatically mean that the owner is the only one who has a copy of the private keys. For example, with Coinbase, it is possible to install a wallet on a phone and to also have access to the same wallet through their website.

For crypto wallets, conventional wallets utilize a seed phrase and hierarchical structure to create and denote private keys, public keys, and the front-facing on-chain addresses to identify the wallet. Private keys are used to sign and execute transactions, while the public key is what external users are given to send crypto to the wallet.

Seed Phrase

A seed phrase is a phrase of 12 to 24 words that corresponds directly to a private key. Seed phrases are employed since private keys are typically large strings of letters that appear unreadable to humans. Words are much easier to remember and transcribe as opposed to a string of random letters and numbers.

As shown below, each word in a seed phrase corresponds to a specific string of characters. Because there are 2048 potential words and 12 or 24 randomly generated words in a private key, it is nearly impossible to crack your wallet.

IMPORTANT!  Record your seed phrase in the correct sequence and protect it at all costs! You must keep your seed phrase/private key protected. They are nearly impossible to hack or penetrate unless you get it stolen or give it to someone.

Do NOT share with anyone! If someone sees these words, they CAN steal all your crypto.

Do not try and save these words on anything digital. Do not screenshot these words.  Do not store these words on your computer or mobile device. Your security is only as strong as your 12-word seed and passphrase. Check your work twice, and then confirm that you have acquired your 12 words.

All wallets have different characteristics depending on their underlying designs. Typically, there is some form of give and take with a number of identifiers, including the following:

• Security
• Privacy
• Cost
• User Experience
• Recoverability
• Extensibility

Security is generally considered to be one of, if not the most important attributes of any crypto wallet. Secure wallets have a higher degree of protection from external, sophisticated attacks and are harder to break. This means that user funds are less susceptible to hacks and attack vectors, keeping funds safe. In a similar manner, privacy helps to protect the identity of the user behind the wallet. This can be utilized for many different reasons, such as an organization wanting to remain anonymous or an individual wanting to keep their identity confidential when making sensitive transactions.

Cost is a big factor when considering adoption and ease of use (user experience). Some wallets may be expensive to obtain (typically hard wallets like Ledger) or transact with. This goes along with user experience, which refers to the permissions, controls, and accessibility of the wallet. As crypto wallets become more in demand from the mainstream adoption of blockchain technology, recoverability has grown into a far more significant quality. Recoverability refers to the ability to recover assets in the event of a compromise, loss of life, or some other factor. 

Lastly, extensibility refers to the level of access and compatibility that the wallet allows. Different blockchains and ecosystems have compatibility with different wallets. Some chains, like Fantom, even have their own native DeFi wallets that users can open to interact with that specific ecosystem. Many universal wallets like MetaMask are accepted nearly everywhere and even support many different networks. ​