What are crypto wallets?
As the name suggests, a wallet is a type of purse that stores your access keys to crypto coins and tokens. Such an application works like an online bank account for cryptocurrencies and tokens with the significant difference that there are no intermediaries. Everyone can create and use a wallet (“bank the unbanked”) without signing up or authenticating.
Many blockchains operate with their native cryptocurrency, like Ether for Ethereum. Transactions of these cryptocurrencies are managed through keys and are securely stored in a decentralized ledger. For usability and security purposes the keys can be used and stored within a wallet. Each wallet has two keys: a public key, similar to a bank account number, that is publicly visible, and a private key, similar to a password and signature, usually consisting of letters and numbers. The password opens the virtual vault to the blockchain where the coins and tokens are stored.
Since these private keys are long and difficult to remember, wallets usually link them to a seed or recovery phrase. This phrase consists of a sequence of 12 or 24 words used as the master password. Wallets store the keys and work as a frontend application allowing easy transaction handling and a good overview of one’s cryptocurrencies and digital assets.
Not your keys, not your coins
There are different types of wallets, which differ mainly in usability and security. Software wallets – desktop or mobile – are the most user-friendly and fall into the category of “hot wallets” (because they are online). On the other hand, the so-called “cold wallets” – hard and paper wallets – have lower usability but are highly secure because they are offline and storable with utmost security.
A third wallet type is the so-called “custodial wallet.” In such a scenario, third parties, i.e., exchanges or CeFi providers, look after and store the private keys. This is often the easiest and most user-friendly way to handle a wallet, do transactions or to generate yield with the tokens in the wallet.
However, it represents the lowest security level because one does not control the private key, and therefore – like keeping money in banks – the owner loses access to his tokens in the event of the counterparty’s bankruptcy, for example.
Secure enough for business purposes?
A solid wallet strategy and thought-through governance are necessary if businesses consider investing in cryptocurrencies, run crypto transactions and payments on a regular basis, or buy and hold NFTs.
One of the first questions a company needs to answer is whether they intend to hold and secure tokens in a wallet by themselves or transfer them to a professional, regulated custody provider. If tokens are not needed regularly and have a high value, a custody provider might be the right choice. However, if tokens are transferred regularly and may be needed on short notice, then self-custody within the company is the way to go.
In a self-custody scenario, a company needs to implement a governance approach in which not only one employee but different employees with different roles and responsibilities are involved in approving transactions through a multi-signature wallet. In this case, transactions can only be executed if, for example, three out of four responsible employees sign and confirm a transaction. Additionally, handling the private key or seed phrase is critical if only one person is responsible for storing it securely.
The location determines the regulation?
Investors know what to expect when trading stocks since this sector is heavily regulated, protecting investors from fraud or other risks. On the contrary, there is still an international regulatory patchwork with cryptocurrencies or NFTs. You should be aware of the regulatory differences between markets as a business. Especially if you decide to work with a custodial service, you should check the regulations at the domicile of the service. It is strongly advised to consult the expertise of lawyers specializing in this service.
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