Disclaimer: This article assumes that you already have basic crypto knowledge covering cryptocurrencies and and blockchain. If you would like a primer, the investopedia pages on cryptocurrencies and blockchain are great starting points. I would also recommend reading these articles written by PwC and IBM, for some information on the value prop, benefits and industrial applications of blockchain and crypto*
Over the last year, I’ve had various friends and family ask me whether I invest in crypto. Why my network has seemed to gravitate towards me when beginning to explore investing in crypto has spanned the reasonable (“you work in financial technology, so you must know about this stuff”), the stereotypical (“you’re asian, so you must be good at investments”) and the downright bizarre (“just looking at you I can tell that you know about cryptocurrencies”).
As more and more people have asked me for advice, I’ve been realising there are people who are crypto curious and want to invest, but don’t start because they’re in a state of analysis paralysis, scared of doing it “the wrong way” and getting hacked, or getting caught up in a rug-pull and losing all their money. As I’ve helped people in my network get an awareness of crypto, I’ve noticed that starting with a brief terminology lesson often demystifies things, removing a lot of the confusion and fear, and getting people to a point where they’re comfortable enough to make a start.
This article provides definitions for the two most common things I end up explaining, wallets and exchanges, as well as some guidance for those starting their investment journey.
Wallets
A wallet holds your cryptocurrencies. In practice, a crypto wallet is a combination of two things; (1) a wallet address (this is what anyone can use to send you money) and (2) a private key (this is what you use to move money out of the wallet).
Wallets, using an analogy:
One analogy for a wallet is a P.O. box. Anyone that knows the address for a P.O. box can send a letter there. To open a P.O. box and retrieve the letters that have been sent, I would need to use a key (which nobody else has access to).
Hot and Cold Wallets
Wallets can either be hot or cold:
Hot Wallets: Hot wallets are connected to the internet. If someone wants to make a transaction or withdrawal from a hot wallet, all they need is knowledge of what the private key for the wallet is, and an internet connection.
Cold Wallets: Cold wallets are not directly connected to the internet. With a cold wallet, the the private key is stored offline on a physical device (typically in a piece of hardware such as a “Ledger” device). If someone wants to make a transaction or withdrawal from a cold wallet, they need the physical device that contains the private key.
Analogy Time
Let’s extend the original analogy. The P.O. box could be considered analogous to a cold wallet. Anyone can send a letter to my P.O. box if they have the address, but I can’t access the mail inside unless I have the physical key to the box. In the same way that a P.O. box is similar to a cold wallet, An email account is similar to a hot wallet. If someone knows the password to my email account, they can access my emails.
Non-custody wallets and Self-Custody Wallets
Wallets can also either be non-custodial or self-custody:
Non-Custodial Wallets: If you have ever heard the phrase “not your keys, not your coin”, this is a reference to non-custodial wallets. Non-custodial wallets exist for you to use, but you don’t actually own the wallet. With a non-custody wallet, a third party (for example, a crypto exchange) has knowledge/access to the wallet’s private key. This means that you have to trust that the third party won’t steal your cryptocurrency
Non-Custodial Analogy Time
Let’s imagine that the Post Office keep hold of the key for my P.O. box. If I want to access the contents of the P.O. box, I go to the Post Office and a staff member there opens the box for me. If they employ a criminal, that person could steal my mail whilst I’m not there, because they have the key
Self-Custody Wallet: A self custody wallet is a wallet that only the owner has the private key to. For example, If I locked my P.O. box using a padlock that I bought, and made sure nobody else had a copy of the key. This would mean even the criminal postman can’t access my mail.
A note on wallets: Wallets are not universal, and depending on what cryptocurrencies I want to hold, I will need to create different wallets. As an example, I cannot store Bitcoin in my Ethereum wallet and vice versa. If I want to hold both cryptocurrencies, I will need to create a wallet to store my Bitcoin, and a different wallet to store my Ethereum.
Exchanges
An exchange is an app or platform that allows you to convert from one type of cryptocurrency to another (for example, converting Bitcoin to Ethereum). This is similar to a foreign exchange shop / bureau de change, which allow people to convert between fiat currencies (e.g. US dollar to Euro). Crypto exchanges typically also provide non-custody wallets, to allow people to store their converted crypto. Some well known examples of exchanges include Coinbase and Nexo.
Wrap-up
If you’re new to crypto and to get a grasp of the basics, hopefully this article has given you an idea of what Wallets and Exchanges are, the different types of crypto wallet and why it’s better to use the Post Office instead of Emails.
Some guidance and advice
If you’re thinking of investing in cryptocurrencies, I’ve listed some guidance that I would have found when I was starting out:
- There are good investment opportunities, but there are also a ton of scams and pump-and-dumps happening. If an investment sounds too good to be true, it most likely is and you will lose your money
- If you’re planning to hold cryptocurrencies, invest in a cold wallet. The last thing that you want is to find out that someone stole all your crypto because they managed to work out your private key.
- When setting up a new wallet, you will need to create a “recovery phrase” (this allows you to recover your cryptocurrencies if you forget your private key). Write this down on paper and store it somewhere safe (like a safety deposit box or a safe). DO NOT store it online anywhere. If someone knows your recovery key, they can access your wallet
- If you’re thinking about investing in Trump Coin, don’t.
Help me write interesting content
I hope you enjoyed this article. I want to write articles that people find informative and interesting. If you liked this article, or if you want me to write about something else, please do get in touch with your feedback and comments.
* Thanks to my friend Vinay for helping source some good primer links for the disclaimer
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