Crypto Exchanges vs Crypto Wallets? Learn the difference through a Bitcoin exchange

Exchanges vs crypto wallet?

The question of exchanges versus wallets is a common one that arises frequently in online discussion forums. It's understandable that people may be confused about the distinction between these two terms because, on the surface, it may seem like storing coins in an exchange is the same as storing coins in a wallet. However, this is not the case. An exchange and wallets serve different purposes in the world of cryptocurrency, and it's important to understand the differences between them.

What is a cryptocurrency wallet?

A crypto wallet is a software tool designed to provide a secure access to your cryptocurrency. Wallets allow users to manage their crypto and keep track of their balances, and they offer various levels of security and convenience, depending on the type of wallet. Your crypto tokens are nothing more than an entry in the blockchain ledger, and your wallet is what provides access to your accounts (where your tokens are settled) in the blockchain ledger.

A crypto wallet can consist of one or more crypto token accounts. For each crypto token or coin, there is an account, pretty much as if you had an investment  portfolio account in a bank with several currencies, and each currency would have its own separate account. For example, you could own a Metamask (a very popular wallet) and have an Ethereum account that holds Ethereum but also holds several other crypto tokens that move through the Ethereum blockchain. Your Metamask wallet could have several Ethereum accounts, each one with different groups of crypto token accounts.
The crypto wallet, besides creating a transaction and communicating with the blockchain, holds what is called a “private key”. Holding the "private key" is the most important feature of a wallet as this is what is needed to sign any type of transaction on your accounts.

What are private keys?

Private keys are a fundamental component of cryptocurrency ownership. They are essentially a series of random characters that provide a unique digital signature for each transaction. Private keys are necessary for signing and verifying transactions on the blockchain, and they allow users to securely access and manage their digital assets.

A private key is created by a wallet when a user sets up their account. The key is then used to sign and verify cryptocurrency transactions on the blockchain, which is a decentralized ledger that records all transactions. The private key is the only thing that allows users to access and manage their crypto assets, which is why it's crucial to keep it secure.

Private keys should never be shared with anyone, and they should be stored in a secure location, such as a hardware wallet or an encrypted digital file. If a private key is lost or stolen, there is no way to recover the associated crypto assets, so it's essential to take necessary precautions to ensure the security of your private keys.

“the crypto wallet's main purpose is to safe-keep your digital assets, not by storing the assets themself, but by safeguarding the access to them, your private key”

Wallet Security: a word of advice

Wallet security is a critical aspect of cryptocurrency ownership, as the decentralized and digital nature of cryptocurrency makes it vulnerable to theft or hacking. To ensure the security of your crypto assets, it's crucial to take necessary precautions when using a crypto wallet.

One of the most important things you can do to improve crypto wallet security is to keep your private keys secure. Private keys are necessary for signing and verifying transactions on the blockchain, and they are essentially the passwords that allow you to access and manage your digital assets. Therefore, it's important to keep them safe and secure. This can be done by storing them in a hardware wallet or an encrypted digital file.

Additionally, using two-factor authentication whenever possible can provide an added layer of security. Two-factor authentication requires users to provide an additional form of identification beyond just a password, such as a code sent to their mobile device. This helps to prevent unauthorized access to your wallet.

It's also advisable to avoid using public Wi-Fi networks when accessing your crypto wallet, as these networks can be vulnerable to hacking attempts. Keeping your devices and software up-to-date with the latest security patches and protocols can also help to minimize the risk of theft or hacking.

Types of crypto wallets

There are several types of cryptocurrency wallets available, each with its own benefits and drawbacks. Here are the three main types of crypto wallets:

Hardware Wallets

Hardware wallets are physical devices that store private keys offline, making them one of the most secure options for storing cryptocurrency. They are often small and portable, and they connect to a computer or mobile device via USB. Examples of hardware wallets include Trezor and Ledger.

Software Wallets

Software wallets are digital programs that can be downloaded onto a computer or mobile device. They offer a range of security features, but they are often considered to be less secure than hardware wallets because they are connected to the internet. Examples of software wallets include Exodus and Electrum.

Web Wallets

 Web wallets are online wallets that can be accessed through a web browser. They are generally the least secure option for storing cryptocurrency because they are connected to the internet and can be vulnerable to hacking or security breaches. Examples of web wallets include MyEtherWallet and MetaMask.

Cold Wallets:

Then there are the “hot” and “cold” denominations for crypto wallets. Any of the 3 types of wallets can fall into the “hot” or “cold” category. Hot, refers to the wallet being accessed through the internet, while “cold” refers to the inability for anyone to access the crypto wallet through the internet.

Hot wallets can be accessed through a web browser or mobile app, and they are often provided by a cryptocurrency exchange. While they are convenient for trading and transferring cryptocurrencies, hot wallets are generally considered to be less secure than cold wallets.

An example of a cold wallet is a hardware wallet such as Trezor or Ledger. These devices are physical devices that store private keys offline, providing a high level of security for storing crypto assets over an extended period of time. The private key can never be accessed from an external source, not even while connected through the computer.

When choosing a cryptocurrency wallet, it's important to consider factors such as security, convenience, and ease of use. Hardware wallets are generally considered to be the most secure option, but they can be less convenient for users who need to access their cryptocurrency frequently. Software wallets and web wallets can provide a good balance of security and convenience, but users should be aware of the potential risks associated with these types of wallets.

Is a Crypto Exchange the same as an Exchange Wallet?

No, a crypto exchange and an exchange wallet are not the same things. While both allow users to buy, sell, and trade crypto assets, they operate in different ways and serve different purposes.

A cryptocurrency exchange is a digital platform that facilitates the buying, selling, and trading of crypto. Users can deposit fiat currency or other crypto assets into their account and use those funds to purchase or trade crypto assets. The exchange acts as an intermediary between buyers and sellers, and it takes a fee for each transaction.

An exchange wallet, on the other hand, is a crypto wallet provided by a cryptocurrency exchange that allows users to store their crypto assets on the exchange. However, it's important to note that storing digital assets on an exchange wallet can be risky, as the exchange is vulnerable to hacking and security breaches. If an exchange is hacked or goes bankrupt, users could lose their crypto  holdings.

“crypto exchange lets you buy and sell cryptocurrencies”

Types of Crypto Exchanges:

There are two main types of cryptocurrency exchanges: centralized exchanges and decentralized exchanges.

Centralized Cryptocurrency Exchange:

A centralized cryptocurrency exchange is a digital platform that is operated by a company or organization. These crypto exchanges are typically more popular and user-friendly, and they often offer a wide range of crypto tokens to trade. Centralized exchanges act as intermediaries between buyers and sellers, and they take a fee for each transaction. They often require users to go through a verification process before they can start trading, which can involve providing personal information such as a government-issued ID.

However, centralized exchanges are vulnerable to hacking and security breaches, which can put users' funds at risk. In addition, they can be subject to government regulations and restrictions, which can impact the availability and trading options for certain crypto assets..
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When you hold cryptocurrency in a crypto exchange wallet your tokens are settled in the "exchange ledger" and not in the "blockchain ledger".

Decentralized Cryptocurrency Exchange:

A decentralized cryptocurrency exchange, also known as a DEX, is a platform that operates on a decentralized blockchain network. This means that there is no central authority controlling the exchange, and trades are conducted peer-to-peer, rather than through an intermediary. Decentralized exchanges often offer more privacy and security than centralized exchanges, as users do not need to provide personal information to trade. They are also not subject to government regulations, which can provide more flexibility in terms of trading options.

However, decentralized exchanges can be less user-friendly than centralized exchanges, and they often have lower liquidity and fewer trading options. In addition, they can be slower and more expensive to use due to the decentralized nature of the blockchain network.

Overall, the choice between a centralized or decentralized cryptocurrency exchange will depend on individual preferences and needs. While centralized exchanges are more popular and user-friendly, they can be more vulnerable to security risks and government regulations. Decentralized exchanges, on the other hand, offer more privacy and security, but they can be less user-friendly and have fewer trading options.

Do you need a private key to access the accounts in an exchange?

When using a centralized cryptocurrency exchange, you do not need a private key to access your crypto account, because your cryptocurrency is in the exchange custody and is settled in the exchange ledger. Instead of creating a private key, you create an account with a username and password, and you may also need to go through a verification process to comply with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulations.

While users do not need a private key to access their accounts on a centralized exchange, they still need to take necessary precautions to protect their accounts from unauthorized access. This includes using a strong and unique password, enabling two-factor authentication whenever possible, and avoiding sharing login information with others.

It's important to note that while users do not need a private key to access their account on a centralized exchange, they do not have complete control over their crypto assets. The exchange is the custodian of the user's crypto assets, which can be a security risk. If the exchange is hacked or goes bankrupt, users could lose their crypto assets.

In general, it's recommended that users store their crypto assets in a crypto wallet that they control rather than on an exchange wallet. This provides greater security and control over their digital assets. While exchanges can be useful for buying, selling, and trading cryptocurrencies, it's important to be aware of the risks and take necessary precautions to protect your crypto assets.

Lets explain these definitions using Bitcoin:

Step 1: You buy Bitcoin at a centralized exchange

So let’s say you want to buy Bitcoin at a centralized exchange (a CEX like Binance, Coinbase, etc), You complete the following steps:

1. You create an account in the exchange
2. You provide sensitive personal information (passport, driver’s license, photo, etc) to comply with the KYC policy
3. You transfer FIAT money (US Dollars, Euro, etc)  from your bank account into the exchange
4. Then, you place an order to buy 1 Bitcoin with your FIAT money.

Your Bitcoin is now in the exchange, in your account. The exchange is the custodian of your Bitcoin, in the same way that the bank is the custodian of your Fiat money. 

Step 2: You want to withdraw Bitcoin from your exchange account:

Since the exchange is the custodian of your coins, you do not have a private key to sign and approve transactions. Instead, you use their app interface and create a withdrawal, and if the exchange approves, you can get your Bitcoin out of the exchange to whatever destination you want. But if you did not meet the requirements for KYC, the exchange will forbid you from withdrawing your Bitcoin.

Let’s assume you purchased a hardware wallet to store crypto safely vs leaving your BTC in the exchange custody, a Ledger, and you want to deposit your Bitcoin into your hardware wallet to keep your Bitcoin safe. The Ledger will provide you an unique address where you can deposit the Bitcoin (BTC) from the exchange (CEX).

So in the exchange you will create a withdrawal order where you put as a destination the address that the Ledger wallet provided you. The address looks something like this:

3FZbgi29cpjq2Gjdw V8eyHuJJnkLtktZc5

‍You copy the address from the Ledger to use it (paste it) as a destination when you create a withdrawal order in the exchange.

Step 3: You deposit Bitcoin into your crypto hardware wallet

After a few minutes, your Bitcoin arrives to your Ledger wallet, now you have managed to secure your Bitcoin, in a safe place, where you do not need anyone’s approval to use. The only thing you need to use your Bitcoin is to approve with your Ledger the transaction you wish to accomplish, no need for anyone’s permission to send it to a friend, trade it (in a decentralized exchange) or spend it in whatever way you choose.

Let’s assume then, Bitcoin market price went up to $60K USD, and you decide that it would be a good idea to take some profits, in your Fiat currency…In order to exchange your crypto you have to deposit the Bitcoin into a centralized exchange that offers the possibility of exchanging crypto assets with Fiat currencies (USD, GBP, Euro, etc). This process of exchanging crypto assets with Fiat, is called a “ramp”.

Step 4: You deposit your Bitcoins back into the exchange in order to sell them for US Dollars.

You use your ledger wallet to initiate a transaction to send your Bitcoin back to the Bitcoin exchange as you want to convert it into a Fiat currency (USD, GBP, Euro, etc). The exchange will provide you with a Bitcoin account number that you will use to instruct your Ledger wallet where to send the Bitcoins. But remember, you do not have the private key to this account, so it is only a reference for the exchange to assign the asset to you. 

You copy the Bitcoin address the exchange provided, and paste it into Ledger Live (the software provided by Ledger), and create a “send” transaction by signing with your hardware device.

You decide to only send half of your Bitcoins…A few minutes later, your Bitcoins arrive. Then you decide that maybe it will go higher and you decide not to sell yet. Days go by and your Bitcoin is just sitting there, in the exchange. Then…

Step 5: The exchange declares bankruptcy:

You probably lost half a Bitcoin, there will be a lot of bureaucratic processes, that will take a long time..you might get back cents on the dollar, or nothing at all. Fortunately, you still keep the half Bitcoin in your Ledger wallet, at least! And the lesson here is that, there is no counterparty risk when you hold your coins. Hence, the phrase, very popular in the crypto world:

“Not your key, not your coins”

This has happened to many people, and the purpose of this story is just to make you aware of the danger of centralized exchanges. 

Use them for what they are best, to convert Fiat into Crypto and vice versa, but never trust them to guard your crypto

FAQs

What is one potential risk associated with a cryptocurrency hot wallet?

One potential risk associated with a cryptocurrency hot wallet is that it is connected to the internet, making it more vulnerable to hacking attempts and security breaches. If a hacker gains access to the hot wallet, they could potentially steal the cryptocurrency holdings stored within it.

Is Crypto.com a wallet or exchange?

Crypto.com is both a wallet and an exchange. It provides a mobile wallet app that allows users to store, buy, sell, and trade cryptocurrencies. It also offers a cryptocurrency exchange platform where users can buy, sell, and trade cryptocurrencies.

Do exchange wallets exist?

Yes, exchange wallets do exist. Many cryptocurrency exchanges provide wallets that allow users to store their cryptocurrency holdings on the exchange. However, it's generally recommended that users store their cryptocurrency in a wallet that they control, rather than on an exchange wallet.

What are some examples of exchange wallets?

Some examples of exchange wallets include Binance, Coinbase, Kraken, and Bitstamp. However, it's important to note that storing cryptocurrency on an exchange wallet can be risky, as exchanges are vulnerable to hacking and security breaches.

Is Exodus a wallet or exchange?

Exodus is a software wallet that allows users to store, buy, sell, and trade cryptocurrencies. It is not an exchange, as it does not facilitate the buying and selling of cryptocurrencies through a platform.

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