Wallets play a crucial role on any crypto platform as they are the gateway between the crypto and the physical world. Anyone taking part on these platforms will either have crypto holdings or be on the verge of acquiring some. Most of these platforms are centralized, adopting custodial wallet features for ease of use. Similarly, the increasing adoption of crypto assets across the table means even individuals and other businesses today are in need of sound crypto wallets that offer them a combination of convenience as well as security.
An obvious question everyone has on their mind is “Which wallet do I pick to secure my crypto assets?”
In our recent blog post, we mentioned the three basic types of crypto wallets — hardware, software, and paper wallets. But the story of wallets does not end there. Crypto wallets can be further classified based on the type of security features used to authenticate transactions. While the choice is often straightforward for individuals handling low volumes of crypto assets, things are quite different for crypto institutions and other crypto-supporting businesses of scale.
Now, let us take a look at different types of wallets based on transaction security, which is an important aspect never to be ignored. We will also outline how a combination of such wallets is used by crypto platforms in an enterprise setting to deliver optimum results while safeguarding the assets in custody.
If you haven’t read our earlier blog post on crypto wallets, you can read it here.
Single Signature Crypto Wallets
The most widely used category of crypto wallets, these single signature crypto wallets have a single private key to authorize transactions. On these wallets, a single user with just one wallet application can access the respective stored crypto assets on the blockchain and initiate transactions.
It is a convenient, considerably secure setup with one disadvantage. The presence of just one private key creates a single point of failure where in an unfortunate circumstance it gets compromised, and all the funds associated with the wallet may be lost.
To eliminate such risk, users holding a considerable amount of assets and crypto platforms holding custody of a large volume of funds tend to opt for better alternatives like Multi-Signature wallets or Multi-Party Computation wallets.
Multi-Signature Crypto Wallets
Multi-Signature or MultiSig crypto wallets require a combination of two or more private keys to sign a transaction. These keys can be held by a single person, or multiple people to ensure redundancy and even accountability in a business setting. These wallets can be set up in 2 of 3, 3 of 4, 4 of 5, or any other configuration that decides the total number of associated private keys and the minimum number of signatures required to access the funds. MultiSig wallets are like a safe with multiple locks that need to be opened by more than one key to access what’s stored inside.
This makes wallets more secure, and highly improbable for hackers to obtain multiple private keys at once. And in the event, that one of the keys is indeed compromised, the funds will still be safe. Due to the multi-level authorization structure, multisig wallets also find use in setting up escrow transactions. A simple escrow transaction can be set up with a 2 of 3 multisig wallet where one of the keys held by a third party can be used to mediate a transaction between 2 parties.
Multi-Party Computing Wallets
Commonly referred to as MPC wallets, these crypto wallets are among the most secure applications where a single key is split across multiple devices by a specialized algorithm. The algorithm uses the inputs provided by parties to the transaction to generate an entire private key that is necessary to transfer funds.
Although the functioning of MPC wallets is like that of multisig wallets, they are different. MPC wallets produce dynamic keys, and at no time does any single machine have in its possession the entire key. Instead, they are created as distributed key shares, retained on the machines on which they were generated, which further enhances the security in comparison to multisig wallets.
Based on the needs, individuals, as well as crypto businesses, use a combination of these different types of wallets to strike a balance between security and usability to ensure seamless transactions. It also opens an additional classification criterion based on the roles played by each wallet type in a comprehensive enterprise wallet infrastructure.
Major Parts of an Enterprise Wallet Infrastructure
A typical exchange wallet infrastructure will have three distinct types of wallets to support smooth operations and quick, interrupted service to its users.
Hot wallets
These are online wallet applications that support all the deposits and withdrawals happening on a platform. They are always-online software wallets with private keys under the control of the platform and stored on the internet. By always ensuring the availability of private keys, hot wallets can execute near-instant transactions to meet hundreds of withdrawal requests in no time.
However, storing the private keys online provides ample opportunity for cybercriminals to look for vulnerabilities and exploit them. As a result, platforms incorporating such infrastructure tend to limit the funds held in hot wallets at any point in time.
Cold Wallets
Unlike hot wallets, the private keys of cold wallets always remain isolated from the internet. They are connected to online devices only when a transaction must be carried out. As a result, they are the most secure form of wallet with private keys protected from the risk of being compromised by cybercriminals. Individuals and businesses use cold wallets to secure the majority of their crypto assets. Hardware wallets and paper crypto wallets are good examples of cold wallets.
Crypto exchanges and trading platforms periodically sweep excess funds received in their hot wallets to cold wallets. Similarly, whenever the need arises, they refill hot wallets with funds drawn from the cold wallets in a process known as wallet refill. Wallet refills are generally manual processes involving large wallet refill teams to monitor fund levels in the hot wallets and refill them when it falls below a threshold.
Warm Wallets
Warm wallets are mostly software wallets that act as a bridge between hot and cold wallets, especially during the refill process. A software wallet with multiple levels of authentication. While initiating wallet refills, platforms transfer funds from the cold wallet to the warm wallet, which will be subsequently used to replenish hot wallets whenever necessary. The wallet refill team will have access to the warm wallet, while cold wallets are managed only by trusted representatives and top-level executives of the organization.
Liminal Presents the Ideal Way to Store and Manage funds
We have seen the variety of crypto wallet applications out there, each with its own advantages and disadvantages. It offers enough evidence to conclude that there is no one-size-fits-all approach while adopting the right wallet solution to ensure the safety of funds without compromising on convenience.
Liminal offers a tailormade suite of solutions to combine the best of security and usability for both individuals and enterprise users. The Liminal suite incorporates secure and scalable decentralized crypto storage and smart automation solutions for businesses, helping them potentially save a considerable amount of time and resources. A good example is the Liminal Smart Wallet Refill, which automates the entire hot wallet refill process to secure it against potential vulnerabilities while allowing the platforms to allocate their workforce for better things than monitoring and replenishing hot wallets.
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by Liminal
