What is a hardware wallet and how does it work?

Hardware wallets are one of the most secure methods for storing cryptocurrency. Read on as we break down what they are, how they work, and why you should be using one.

Hardware Wallets

A type of cryptocurrency wallet, hardware wallets are physical devices used to store the crypto assets’ digital keys. Before we dive into what exactly a hardware wallet is, we first need to discuss public and private keys.

Public and Private Keys

Public and private key pairs are a core component of public key cryptography, an encryption mechanism designed to protect data from unauthorised access. Together, the keys are used to encrypt and decrypt messages and transactions.

These keys are not physical keys, but long lines of numbers that are mathematically related to one another. Because of this link, data that has been encrypted with a public key can only be decrypted with its corresponding private key.

Why Are Private Keys Important?

Composed as a long, alphanumeric code, private keys enable you to access, receive, and send cryptocurrency in a trustless manner, where a third party is not required to verify the transactions. Private keys convey final ownership and control over your cryptocurrency.

This concept of trustlessness is a core component of blockchain technology. It seeks to reduce the level of trust participants must place in other individuals, organisations, and even governments, while ensuring that no single bad actor can compromise this system. When you hold your own private keys, you and only you are in control of your finances. No single person or group can tamper with transactions or take control.

Unlike a public key, which is both searchable and shareable, a private key must be kept, well, private. Bottom line is, if you lose your private key, you lose access to your wallet, where your crypto is held. If someone else learns your private key, then they can perform transactions from your wallet on your behalf. For that reason, it’s always advisable to keep your private key offline to limit any risks of hacking.

Where to Store Your Private Keys

Here’s an overview of some of the most secure methods for storing your private keys:

  • Hardware wallets — Widely considered to be the most secure option for storing private keys, hardware wallets are physical devices that keep private keys offline
  • An encrypted storage device — For those who don’t want to invest in hardware wallets, offline flash drives can offer a good temporary solution
  • Paper wallet — Less secure than hardware wallets, paper wallets are pieces of paper with your keys printed on it. For maximum security, it’s recommended that you laminate and store these pieces of paper in a safe or safety-deposit box
  • Stainless steel — If you’re concerned about your paper wallet getting destroyed in the event of a fire or flood, consider engraving your private keys on stainless steel

Now that we understand the importance of keeping your private keys safe, let us delve deeper into one of the most popular and trusted methods of storing private keys — hardware wallets.

What is a Hardware Wallet?

There are two main types of crypto wallets: software-based hot wallets and physical cold wallets. Hardware wallets provide the most secure way to store cryptocurrencies. They work by storing your private keys in an external, physical device (usually a USB or Bluetooth device).

Advantages of a Hardware Wallet

  • Control — Hardware wallets allow you to manage your own private keys, granting you full ownership and control of your funds.
  • Maximum security — Since the private keys are kept offline at all times, they are immune to malicious software, except in a scenario where the device is defective. As they are able to sign transactions without the private keys ever leaving the device, they are more secure than a software wallet.
  • Backup options — If you do happen to lose your wallet, you can make use of the seed phrase (also known as recovery phrase) to re-generate your private key and recover access to your funds using a different wallet. Like your private key, it’s crucial that you keep your seed phrase safe and offline, ideally in a safety-deposit box.

Disadvantages of a Hardware Wallet

While the security advantages of a hardware wallet are clear, there are some disadvantages that you should be aware of:

  • Upfront cost — There’s no two ways about it: Hardware wallets are expensive.
  • User experience — The setup process can be quite cumbersome for beginners.
  • Accessibility — Hardware wallets are less convenient for day-to-day transactions, as they require you to physically plug them into a device before you can access your crypto. Hardware wallets are best suited to those planning on holding their assets long term, and not for trading.

How to Choose a Hardware Wallet

  • Security features — Does it offer two-factor authentication and multi-signature? Does it have a backup feature, such as a recovery seed phrase?
  • Interface and ease of use — Some wallets are better suited for beginners, others for more advanced users. Do your research first to avoid disappointment.
  • Supported currencies — Ask yourself, are the coins and tokens you want to store actually supported by the wallet?
  • Supported operating systems — Not all wallets are compatible with all operating systems, so check before you buy.
  • Platform compatibility — Can you connect the wallet to the exchanges you regularly use? Does it offer decentralised app (dapp) and decentralised exchange (DEX) integration?
  • Portability — Consider how easy it would be to carry with you on a day-to-day basis.
  • Reputation — The reputation and longevity of the wallet maker is of the utmost importance. Check customer reviews to get a better picture of what to expect.

Popular hardware wallets include devices by Ledger and BC Vault.

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How to Use a Hardware Wallet

Every hardware wallet is a little different, but the steps are generally the same:

  1. Connect the hardware wallet to a computer or smartphone
  2. Upon setting up the device, you will need to set a PIN code to add an additional layer of security on the device
  3. The app of your hardware wallet will provide you with a wallet address (public key) for sending and receiving crypto
  4. When you send tokens from your hardware wallet to another address, confirm the transaction by physically inputting the PIN on the device
  5. Wait for confirmation of the transaction

Final thoughts

Although hardware wallets are very secure, they are not suitable for everyone, especially not for inexperienced users. Typically, a hardware wallet is cumbersome and includes relatively complex operations and settings that are not beginner-friendly. A hardware wallet user has to back up their information regularly in case of loss, theft, or destruction.

However, if it is peace of mind that you are after and you don’t require the flexibility that comes with hot wallets, then a hardware wallet is usually the best solution.