If you are like me, you probably thought that crypto wallets store your actual coins in them. Well, this is a very common misconception made by almost everyone when we first here of crypto wallets. Through this guide, we will discuss what crypto wallets hold, types of crypto wallets, their various pros and cons, and what inspired me to start this blog assembly. Hint: I am building my own hardware wallet:) Also, going forward, we will be focusing mainly on Bitcoin wallets.
Ready, set, go!
A hardware wallet does not hold any Bitcoin. Neither do software wallets or an exchange like Binance or OKX. Bitcoin exists as entries in a public ledger, the blockchain, that is copied across thousands of computers around the world. Therefore, there are no coin files on your device. Instead, the ledger says that this said amount of Bitcoin is owned by person X and can only be spent by him/her.
So, how do you show ownership over your Bitcoin? Unlike traditional finance, you do not register your details with an organization so as to open an account. Instead, what you are given as proof of ownership my all wallets is a private key.
Before moving on, it is prudent for us to understand the meaning of some jargons:
Private key - This is a long string of letters and words that shows your ownership over a specific wallet.
Public key/Address - This is your account number. You give it to people so that they know where to send their payments. It is derived from your private key.
Signature - This is proof that you approved a specific transaction. Your wallet uses your private key to produce it. Anyone can use the signature to verify the authenticity of any transaction and do not need to know your private key so as to do so.
To help us understand all these, let us imagine we have a box with a glass front. Everyone can see what's inside the box and can drop money through a slot at the top pf the box. However, only your key can open the box and gain access to the money deposited in it. The box is your public key and the key that opens it is your private key.
Therefore it is important for us to keep our private key safe and private. This is because anyone with it can open the box and get to spend your money.
That's why the Bitcoin community repeats the phrase "not your keys, not your coins". Whoever holds the key controls the money. There's no bank behind it, no password reset, and no one to call. Once a transaction is confirmed by the network, it generally can't be reversed.
Where can your private key live
1. With an exchange or other company.
They hold the key and show you a balance to your wallet. This is the easiest option, and where almost everyone starts their journey in crypto. However, you are trusting them to stay solvent, be honest, and not get hacked. This is because they have full access to your private key and when they are compromised, so are you. Therefore, you have to trust that they will keep your money safe. This trust has failed more than once in the past. Mt. Gox halted withdrawals and filed for bankruptcy in 2014, with hundreds of thousands of bitcoins reported lost. FTX halted withdrawals and filed for bankruptcy in November 2022. And most recently, at the time of writing, $6.3 billion worth of crypto was stolen from Binance on October 2026. This is why there is this phrase in the Bitcoin community: not your keys, not your coins. Whoever holds the keys holds the money.
2. In a software wallet on your phone or computer.
You hold the key yourself, which removes the company behind the wallet out of the picture. This is often called a hot wallet. The catch is that your key now lives on a device that is online, can be compromised and have the keys stolen from.
3. On a dedicated device.
This is a hardware wallet, commonly known as a cold wallet. You still hold the key, but on a device that has security features on it which make it extremely hard to be compromised
What can go wrong on a normal software wallet?
Computers and phones are useful because they can run almost anything. This is also the problem with them as they can give bad actors various opportunities to steal your funds in the following ways:
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Steal the key or recovery words
If your key exists on an infected machine, malware can look for it and copy it. Once copied, the thief can spend your money without you getting any warning.
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Swap the address
When you copy a friend's address and paste it into your wallet, malware can replace it with the attacker's address from the clipboard. Clipboard hijacker malware has been documented for years, and security reporting describes samples that watch for wallet addresses on the clipboard and swap them. Addresses are long, random-looking strings, and few people check every character.
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Lie on the screen
If the computer is compromised, you really cannot fully believe what it shows you. It could display your friend's address and the amount you expected, while the transaction it asks you to approve sends the money somewhere else.
What a hardware wallet does differently
A hardware wallet splits the job of building and signing a transaction into two parts:
1. The computer does the online work
It runs wallet software that knows your addresses and balances, and it prepares transactions. However, it does not know your private key. This is why these wallets are reffered to as a watch-only wallet. It can keep track of your money but cannot move it.
2. The hardware/cold wallet does the signing
The private key stays on the cold wallet. A typical payment flow goes like this:
- On the computer, you enter the address and amount, and the watch-only wallet prepares an unsigned transaction.
- The transaction is sent to the cold wallet.
- The cold wallet works out for itself where the money is going and shows on its own screen the transaction details.
- You compare what you see and press a button to approve or reject it the transaction.
- If approved, the cold wallet signs and hands back the signed transaction to the watch-only wallet. The private key does not leave the cold wallet.
- The watch-only sends the signed transaction out to the network.
Now let us look at the three attack vectors again:
- Stealing the key from the computer doesn't work because the key isn't there.
- Lying on the computer's screen doesn't help much, because the device shows you what's actually being signed. This is because it rebuilds by itself the transaction details from source.
- Swapping the address gets caught if you happen to confirm the transaction details on the cold wallet's screen.
Why the cold wallet's screen is the most important part
People tend to assume the main security feature of a cold wallet is that it keeps the private key offline. That's part of it. The other part is its screen.
Suppose a wallet kept your key perfectly safe but signed whatever the computer sent it. An attacker would not have any use for your private key. They would just get you to approve their transaction. Therefore, it is very important to compare the transaction details on the device against the details you expect.
Your recovery phrase as the backup
When you set up a hardware wallet, it shows you a list of ordinary words, usually 12 or 24. This is your recovery phrase, also known as a seed phrase. Most devices follow a standard called BIP39 words are drawn from a fixed list of 2,048.
This phrase is the master secret and all your private keys are calculated from it. Therefore, if you happen to lose your cold wallet, or it breaks, you can buy a new wallet and key in your recovery phrase. This should give you access back to your wallet.
The other side of that is just as true. Anyone who gets your recovery phrase gets access to your money, without ever having to get physical access to your device.
Most losses of funds from a cold wallet comes from a few avoidable mistakes with how you handle the recovery phrase:
- Taking a photo of it, or saving it to the cloud or email. This moves your most important secret back onto the exact kind of device you were trying to avoid.
- Typing it into a website or app because a message or somebody on a call told you to. Support staff never need your phrase. Anyone asking for it is trying to scam you.
- Keeping one copy on a piece of paper. Natural disasters such as fires or floods can rid you of it. Or you can misplace the piece of paper. Many people keep more than one copy in separate places, and some stamp the words into metal.
- Never testing the backup. Most wallets let you check the recovery phrase even after setting up the wallet. Finding a mistake on how you recorded the phrase while the device still works is far much better than finding it afterwards.
Telling no one.
Many wallets also offer an optional passphrase. This is an extra secret added to the words. Under BIP39, each passphrase simply gives you a different wallet, other than that the original recovery phrase would have given you. This gives you extra protection if someone happens to find your words.
The different kinds of hardware wallets
Hardware wallets mostly differ in how the device communicates with the computer and in how it stores the private key.
1. USB or Bluetooth
You plug in the device or pair the device over Bluetooth to the computer. The transaction details passes over that connection. This is the most convenient way of communication and widely used. The compromise is that there is a direct connection between the device and a computer you don't fully trust. Therefore, the wallet has to treat everything arriving over it as suspect and rebuild anything from source wherever possible.
2. Air-gapped
The device never connects to the computer. Data crosses by QR codes shown on one screen and scanned by a camera on the other, or by a memory card you carry across. Air-gapped means that there is literally a gap of air between the hardware wallet and computer. This allows you to can see and inspect each piece of data as it moves across the devices. This means of communication is usually slower and a little more fiddly.
3. Stateless
Most devices store your private key behind a PIN. A stateless device does not store your key at all. You have to enter the recovery phrase each time you use it, often by scanning a QR code version of it or by entering the recovery phrase. The key is erased from memory when the power goes off or after a timeout. SeedSigner, an open-source DIY hardware wallet works like this. A stolen device therefore has nothing on it to steal. However, your recovery phrase/QR now has to come out every time you sign, so looking after it matters even more.
Some devices also include a secure element. This is a special chip designed to resist physical attempts to pull secrets out. It especially helps if someone gets physical access to your wallet. But it does not help if you approve a malicious transaction.
What a hardware wallet cannot protect you from
1. Scams
If you willingly send Bitcoin to a fraudster, the wallet will go ahead and sign the transaction. Therefore, be aware when dealing with "crypo investments" and do not give away your recovery phrase to anyone who asks for it.
2. Approving without verifying the transaction details
If you tap through the transaction flow without confirming the transaction details, you have thrown away the main benefit of having a hardware wallet.
3. A lost/exposed recovery phrase
If you happen to lose your recovery phrase and the wallet fails, and you are locked out of your funds. And if you happen to expose it, a fraudster can gain access to your funds without needing physical access to your wallet.
4. Fake or tampered wallets
Buy directly only from the manufacturer or a trusted seller. Be very wary of any device that arrives with a recovery phrase already written down or set up. A genuine one has you create your own. Also, when installing/updating firmware on the wallet, most companies have a method for you to confirm the authenticity of the firmware. Read through the wallet's documentation to learn how to.
Do I need a hardware wallet?
That depends on how much you hold. If you own a small amount of Bitcoin that you can afford to lose, the cost and learning curve may not be worth it yet. A good phone wallet or a reputable exchange might be a reasonable place to learn.
If you hold an amount that would really hurt to lose, or you plan to keep it for years, a hardware wallet is worth considering. The device itself is usually much cheaper than the problems it helps you avoid.
Whatever you choose, start small. Send a tiny amount, make sure you can receive and spend it. Also, practice restoring from your recovery phrase before you trust the setup with anything meaningful.
Why I wrote this
I wrote this post in the aim of explaining what a Bitcoin hardware wallet is. This is the first part of my hardware wallet series whereby I will be documenting my progress and learnings as I build my very own hardware wallet.
The hardware wallet series
- What Exactly Is a Hardware Wallet And What Problem Does It Solve? (this post)
- Building an air-gapped signer on an ESP32
- Teaching a camera to read animated QR codes (will be available soon)
- Getting secrets out of RAM (will be available soon)
I will open source the source code very soon! Be sure to check back here for the GitHub link. I will really appreciate code audits and any other kinds of contributions!
Also, feel free to donate through Bitcoin to bc1q0huq5e7ypz4l4pk8hvanl0clqhh99h5evhk0q9 or through Lightning to muchai254@cake.cash Your support will go a long way in enabling the support of even more hardware, thereby enabling further financial Sovereignty and help support Bitcoin education. This project will remain as a Free and Open Source through out.