Depending on the blockchain, the way to generate addresses will vary but the basic concept remains the same for all wallets: Enabling the ability for users to initiate transactions on a peer-to-peer basis.
It is important to clarify a few concepts beforehand:
The number of wallet type is so large that today we can classify them into different categories. Some are easy to use but not very secure. Others are hard to use but are very secure. Again, we encounter the blockchain trilemma where a balance needs to be found among decentralization, security and scalability that suits the individual user and their needs.
Custodial wallets make use of the blockchain as easy as possible for the end-user by generating and/or keeping your private keys. Therefore, transactions sent as well as their follow-ups are technically managed by a third party.
The downside of this type of wallet is the lack of control over its funds as most of them are fully configured by the service that provides them to you.
Therefore, the security of your data is not up to you and should there be any concerns with your funds, it will depend on the seriousness of the third party service to return them to you.
Unlike custodial wallets, non-custodial wallets put the user at the center of the security policy.
As soon as the address is created, the private key (also called ‘secret key’) and seed phrase are generated and sent to the user. In this process, there is supposedly no third party that sees the keys or seed phrase.
It is therefore impossible for the wallet developers to find out your private key or seed phrase if you ever lose it.
In addition to the custodial or non-custodial classification that determines who generates the private keys, there is a second classification for wallets: ‘hot’ or ‘cold’.
This term indicates whether the wallet has been designed to be permanently connected to the internet in order to function, or if its purpose is to remain offline to increase its level of security.
Depending on your wallet usage, you can choose your preferred option:
Generally, ‘cold wallets’ are used to store large amounts of money or rare assets. Assets transferred require the physical action of the owner in the real world, making the hacking of this type of wallet almost impossible.
‘Hot wallets’ are much easier and faster to use, but they have the disadvantage of being more exposed to hacking and phishing risks. This includes malware sneaking into your computer while you’re installing your wallet, or even worse, the replacement of the address in the clipboard at the time of a transaction.