Storing your digital coins is essential to investing in and using cryptocurrencies. Think of wallets as a “digitized” version of your banking account. You’re able to buy and store your cryptocurrency and as well as transfer them to other parties. Unlike a “real” wallet, cryptocurrency wallets do not store the currency nor do they get stored in one single location. Additionally, the coins do not exist in physical form. Rather, digital wallets are programs that store your private and public keys and interacts with blockchain. Consequently, users are able to monitor their cryptocurrency balance, as well as conduct transactions.
Here’s how a cryptocurrency transfer works: When one party sends digital coins, it is transferring the ownership of those coins to another party’s wallet address. Now, the private key of the wallet must coincide with the public address of the wallet in which the funds were sent to.
Generally, when you purchase digital coins on an exchange, they are “stored” there. When you “hold” your digital currency on an exchange, your coins are vulnerable. Exchanges are always connected and are easy to hack. For example, in early 2018, hackers attacked a Japanese cryptocurrency exchange and fell under government scrutiny. The users, who were affected by the hack, were only going to be partially refunded. However, users could potentially lose their entire investment. Moreover, exchanges could fall into bankruptcy just as Mt. Gox did back in 2014 .
That said, you generally do not want to store all your digital coins in an exchange. You should only store the amount of digital tokens you are willing to lose, in case of a potential hack, bankruptcy proceeding or any other event that could threaten your holdings.
You would want to hold a bulk of your digital coins in a wallet. Cryptocurrency wallets come in multiple forms, each with varying levels of security.
Now, there are two main types of wallets: hot storage and cold storage. Think of hot storage wallets as cash in your pocket, it’s easier to use but there are some vulnerabilities. On the other hand, cold storage wallets are more related to savings accounts, these are generally harder to access but are more secure.