What is a crypto wallet?
Much like a physical wallet, crypto wallets store money that is owned by the holder. However, the money in crypto wallets just happens to be digital.
All crypto wallets come with a set of “addresses” known as public and private keys. Since cryptocurrencies live on their respective blockchains, wallets don’t literally (and physically) store crypto. Instead, these keys grant users access to whatever crypto they receive on the public address.
Private keys, commonly represented by seed phrases, provide access to crypto in any wallet. Even if you break your phone, computer, or hardware device, you can gain control of your crypto wallet and the assets inside by remembering this seed phrase. For simplicity, you can think of private keys as the password to your email account. Public keys, however, are similar to your email address. Just as you can safely share your email address with friends, family, and businesses, you would never give away your password. Similarly, using public keys to transfer crypto is fine, but you should always safeguard private keys by keeping them secret.
Several crypto wallet options exist, but they all fit into the following categories:
- Hot wallets: Any software app that stores crypto is a hot wallet. They’re “hot” because they’re always online. Examples include Trust Wallet, Phantom, and MetaMask.
- Cold wallets: Cold wallets refer to any device that stores your private keys offline. Today, the most common cold wallets are USB-like hardware devices like Trezor and Ledger.
- Custodial wallets: Custodial wallets users don’t have access to their private keys. Instead, a third-party safely guards your seed phrase. Binance is a common example.
- Self-custodial wallets: A self-custodial wallet gives you access to your private keys. You’ll see your seed phrase whenever you set up one of these wallets. Once you unlock a self-custodial wallet, you fully own your crypto.
What is a CEX?
A centralized crypto exchange (CEX) is any public or private company that offers crypto trading services. While CEXs allow you to transfer, deposit, and withdraw crypto and fiat, they always take on the responsibility of storing digital assets. Most CEXs have to abide by strict regulatory standards in the countries they operate in. They also need to use order books and market makers to improve liquidity on their platforms. A few examples of CEXs include Binance, Coinbase, and Gemini.
Crypto wallet vs. exchange
The primary difference between a self-custodial crypto wallet and an exchange wallet is private keys. CEXs control your private keys much like banks of today whereas with a wallet you control your private keys.
Although CEXs always hold the private keys to their wallets, that’s not the case on decentralized exchanges (DEXs). Unlike CEXs, DEXs use blockchain technology to facilitate peer-to-peer crypto trades without a centralized party. If you use a DEX, you can swap compatible cryptocurrencies with your self-custodial crypto wallet, which means you’ll always have control of your private keys.
In summary, if users want to custody their assets they will use a crypto wallet and trade assets with a decentralized exchange.. If they are fine with others’ custodying their funds they will both put their money and transact on a centralized exchange.
Storing crypto on an exchange vs. in a wallet
For crypto purists, it’s always better to take full custody of digital assets. However, there are potential advantages to leaving crypto on an exchange. Although exchanges won’t give you your private keys, they sometimes offer custodial services that are attractive to institutional investors.
Pros: Exchange accounts
- The simplest option for non-tech-savvy investors: If you’re uncomfortable with securing your seed phrase, you can trust an exchange. Leaving crypto on an exchange means you don’t need to learn about transferring crypto or using a self-custodial wallet.
- Insurance protections: While crypto is never FDIC-insured, some large exchanges like Binance and Coinbase offer insurance protections. Also, many U.S.-based exchanges offer FDIC in USD. While there are no guarantees an exchange will make good on its promises, some users feel more comfortable with these protections.
- Better user experience: CEXs such as Coinbase, Gemini, and Kraken have easy-to-navigate websites and user-friendly apps. If people are familiar with using fintech apps like PayPal or Venmo, they probably won’t struggle adapting to a CEX platform. Plus, since CEXs have high liquidity, it’s simple to connect buyers with sellers whenever someone wants to make a trade.
Cons: Exchange accounts
- Asset freezing: Since you don’t control the private keys to an exchange account, a CEX can pause withdrawals at a moment’s notice. From Mt.Gox to FTX, many crypto exchanges have gone bankrupt. There’s no telling when a CEX could suddenly pause withdrawals.
- Not DeFi-friendly: If you’re interested in using your crypto in DeFi (decentralized finance) or purchasing NFTs, you need to transfer your coins to a self-custodial wallet. Exchange accounts can’t link dApps (decentralized apps) on blockchains like Ethereum or the BNB Smart Chain. This is because they don’t actually interact with the blockchain.
- KYC requirements: Most regulated exchanges require you to submit personal details, such as your social security number and driver’s license number.
Pros: Crypto wallets
- Complete control of crypto: Users who store their crypto in a self-custodial wallet have access to their private keys. Therefore, there’s no need to fear a CEX will suddenly go bankrupt or freeze your account.
- Web3 interaction: A self-custodial wallet gives you access to hundreds of Web3 dApps. You’ll need a self-custodial wallet to use your crypto in DeFi, play-to-earn games, or NFT trading.
- Virtually hack-proof (cold wallets): Hardware wallets from reputable manufacturers like Trezor and Ledger are tough to hack. Since these devices store private keys offline, they’re almost invulnerable to cyberattacks.
Cons: Crypto wallets
- Increasingly technical: Although UI/UX on software wallets is improving, understanding how to use a crypto wallet can be challenging for newcomers. Those new to crypto will need time and practice to understand how to transfer and store crypto.
- Vulnerable to hacks: Hot wallets are always online, which means there’s always a risk of cyberattacks.
- Zero insurance protections: Once you take control of your crypto, you won’t be able to rely on third-party insurance protections if you make a mistake when transferring tokens, suffer a hack, or misplace your seed phrase.
Is it safe to use an exchange wallet?
In crypto circles, exchange wallets have a reputation for being less safe than self-custodial wallets. With an exchange wallet, you have to trust a CEX. Also, since exchanges hold many digital assets, they tend to be attractive targets for hackers.
There are many examples in the history of crypto of CEXs that went bankrupt, mishandled users’ funds, or suffered hacks. For example, hackers stole 740,000 bitcoins from the Mt.Gox exchange in 2014. In 2022, the $32 billion crypto exchange FTX filed for bankruptcy.
While serious security risks are associated with leaving crypto on an exchange, it doesn’t mean they’re less safe than a self-custodial crypto wallet. Just because users have access to their private keys doesn’t mean they can’t get hacked or misplace their seed phrase.
Choosing whether to leave crypto on a CEX depends on your preferences. If you feel comfortable securing your seed phrase, a crypto wallet may be for you. But, if you feel confident entrusting your crypto to a third party, you may feel “safer” on an exchange.
How to move crypto off an exchange
Before transferring crypto off an exchange, you must set up a self-custodial crypto wallet. You can download a software wallet application like the Worldcoin app. When setting up your wallet, you’ll see your private key. Remember to write it down a few times and store it in a secure place.
Once you have access to your self-custodial crypto wallet, log into your preferred CEX and choose the crypto you want to transfer. For example, if you want to move Bitcoin off your CEX, you’ll need to copy the Bitcoin wallet address in your self-custodial wallet. Next, select “withdraw” by Bitcoin in your CEX account, enter how much you want to transfer, and paste your self-custodial wallet’s BTC address. After you confirm the transaction, you’ll see the Bitcoin appear in your crypto wallet.
Storing crypto on a CEX is convenient but comes with significant third-party risks. While self-custodial wallets also have security concerns, you receive the private keys to your crypto. Experts always suggest evaluating your risk tolerance before choosing the storage option.
At Worldcoin, we aim to provide everyone equal access to cryptocurrencies, for which we’re putting a share of our crypto in your hands for free. We’re also airdropping free DAI stablecoins to anyone who downloads our app. Subscribe to our YouTube channel to learn more.