Since the first digital coin Bitcoin appeared for public use in 2009, more and more governments have recognized crypto trading as a legitimate market. Given this, some governments are still in two minds, considering how to build a clear and coherent regulatory framework for crypto. Others prefer to stay away from the issue and simply ban its use in their countries like China and Egypt. Meanwhile, the number of people and businesses who give their attention to cryptocurrencies and inquire how to trade them effectively is expanding daily.
A must-have instrument for performing crypto investments is a crypto wallet. It allows users to hold currencies of various types as well as track their balances, and make transactions. In this article, you’ll find out the essentials of crypto wallets, how they work, and why cryptocurrency regulation is necessary today.
What Is a Crypto Wallet?
Just like any wallet that holds banknotes and coins, crypto wallets keep the data about digital currencies in one place. Crypto wallet either keeps information about cryptographic keys required to perform operations with assets, or authenticates its user to access services provided by a platform.
Crypto wallet also gathers information about addresses associated with a user and related activity, such as list of assets linked to the user, its balances, history of transactions and more.
Crypto wallets represent information recorded in blockchains in a form convenient for the user, by collecting only information from blocks which correspond to the user’s addresses.
Private keys are the crucial part of this process, which have to be kept securely. Public keys and addresses are derived from the private keys, and only the owner of the private keys can sign transactions with these addresses as inputs before they go to the mining pool or finally to a block in the related blockchain.
The receiver of funds follows the same procedure but using their own private keys to distribute assets from their addresses. All these operations finally form a chain of blocks, or blockchain. There are many cryptocurrencies with their own and unique blockchains, while a huge variety of crypto assets are utilizing the existing blockchains of other currencies.
Crypto Wallet Types and Categories
Crypto wallets come in diverse types and categories. They differ by accessibility, level of security, how users store their keys, and even the type of cryptocurrency they accept. Here are the main features users need to consider when choosing a crypto wallet.
Custodial and Non-custodial Wallets
This feature defines how a user wants to store their keys. The wallets where users entrust their keys to third parties or custodians are known as “custodial wallets”. Custodians are responsible for storing cryptographic keys and funds and provide an interface for users to handle crypto. This type of wallet is typically web-based, so users can access their wallets via a phone or a web browser by signing into their accounts. In case a user forgets their password, all they need to do is just remember a recovery phrase or to follow another simple recovery procedure provided by the custodial service.
Non-custodial crypto wallets work quite differently – users take full responsibility for their public and private keys to remain secure. Losing a wallet or forgetting a password means losing digital coins. At the same time, users don’t have to refer to third parties for managing their keys, instead, they use special software that generates public and private keys for them. Therefore, these wallets are considered as more secure than the custodial ones.
Generally, those who only start using crypto wallets prefer a custodial type of wallet. Users don’t have to bother with storing their private keys, can quickly access their wallets, and perform transactions more seamlessly. Meanwhile, non-custodial wallets could be more secure as the owners of crypto assets manage their keys themselves.
Hot and Cold Wallets
Hot and cold wallets differ in the amount of time they remain online. Hot wallets are almost always connected to the internet. Users can access their hot wallets using mobile, web, or desktop applications. Although hot wallets are protected with advanced encryption, they are the most prone to security vulnerabilities.
Cold wallets are offline wallets. They typically operate as a special kind of hardware that connects to a computer via a USB port or Bluetooth. A device stores a user’s address and a private key and requires installing compatible software on a computer to perform transactions and interact with the blockchain. Though cold wallets are less convenient than hot wallets, they are the most secure as most of the time they remain disconnected from the internet. Read more about hot and cold wallets.
Mobile/Desktop, Web-Based, or Hardware Wallets
Mobile/desktop, web-based, or hardware wallets determine software applications and devices users utilize to access them.
- Web-based wallets can be accessed from a mobile phone or a computer via a web browser. They don’t require installing any apps. Most web-based wallets are custodial, though recently there appeared non-custodial options.
- Mobile/ desktop wallets require downloading and installing software apps on a computer or smartphone. This software must be compatible with the devices’ operating systems. Therefore, there is a wide range of wallets available for Linux, Windows, Mac, iOS, and Android. This type of wallet is better secured than their web-based analogs and most often is non-custodial.
- Hardware wallets are special devices used for storing keys offline. When users sign transactions in hardware wallets, they don’t have to send their keys anywhere and the process of signing happens on the device within a limited time frame, making it more resistant to hacker attempts.
Cryptocurrency Regulation: Why Is It So Important?
While some users are readily investigating the world of Bitcoin, Ethereum, and Tether, others are concerned about the high risks involved and poor law regulations. For this reason, some countries have started working on legal frameworks that could adapt cryptomarkets to their economic system. The US, most European countries, India, and Australia are among them.
For example, the US government has already taken important steps toward crypto legislation. A cryptocurrency exchange in the US is legal and regulated by the Bank Secrecy Act (BSA). However, the legal framework isn’t consistent yet, and every year there appear more laws that regulate digital currency trading. Among the recent ones was proposed by FinCEN. This regulation requires collecting data on cryptocurrency exchanges and wallets and is expected to be enforced by fall 2022.
Why are regulations in crypto trading necessary and how can this benefit the world of digital currency exchange? Here are the main reasons.
Increased Investor Protection
Despite the fact that blockchain technologies have proved to be of high security, there are frequent attempts of attacks on crypto wallet software. This mainly happens due to users’ poor understanding of how crypto wallets work, e.g. hackers can lure their private keys out and steal coins from wallets or implement other security threats. Apart from that, there may emerge some hidden risks such as a crypto platform going bankrupt or being hacked.
Prevention of Money Laundering and Tax Evasion
As blockchain provides some level of anonymity to its users, it attracts illegal payments which turn regular coins into “dirty” ones. If crypto platforms verify the identities of the trade participants through know-your-customer (KYC) and know your business (KYB) procedures, control their source of funds, monitor their transactions, deals and operations, it’s much easier for governments to prevent illegal money transfers through such platforms, or attempts of tax evasion in their countries.
Increasing Impact on Global Economy
Blockchain technology and currency trading is constantly developing. There appear new types of payments and currencies, and the number of users is continuously growing. All this has more influence on the global economy. For example, there emerged a new type of currency – stablecoins. These coins are pegged to other assets, usually of well-known reputation and value, such as fiat money like US dollars or other valuables like gold. Recently stablecoins have started to have a deeper effect on economies, e.g. FitchFatings warns that stablecoins can increase risks in a short-term credit market.
While some governments are indecisive about whether to legalize cryptocurrencies in their countries and others even ban them, crypto trading is gaining popularity at a breakneck speed. In the near future, digital currency trading will become an integral part of the global economy, yet many governments are already considering how to adjust their legislation to adopt it.
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