Cryptocurrencies have revolutionized the financial landscape, providing individuals with an alternative method for storing and transacting value. Two essential components of the cryptocurrency ecosystem are cryptocurrency exchanges and cryptocurrency wallets. While both serve critical functions within this digital realm, they are distinct in terms of their features, purposes, and modes of operation. In this article, we will delve into 10 key differences that distinguish cryptocurrency exchanges from cryptocurrency wallets.
10 Major Differences between crypto wallets and exchanges
#1. You use a wallet to store your assets
The main difference between wallets and exchanges is that wallets are self-custodial.
This means that you have access to the private keys of your crypto address. As a result, you have complete control of your digital assets.
It’s equivalent to having cash in your wallet at home as opposed to having it in a bank account.
Only you have the keys to your house. If the cash goes missing you are responsible.
The money in a bank account is yours but you don’t have full control of it. The bank could do weird stuff like lend it or lose it.
If the bank goes bankrupt for example it might not be able to pay you back.
It’s exactly the same situation with a crypto wallet.
You have the access codes (private keys) to your funds and you are responsible for them.
In contrast, if you leave your crypto assets on an exchange the exchange manages those assets on your behalf.
If they lose your crypto then you can’t get it back.
An exchange uses custodial wallets i.e. it takes custody of your crypto for safekeeping. But no one guarantees they will be responsible.
Your digital currency is still there for you to see but you can’t withdraw it without the exchange’s approval in case something goes wrong (like the exchange imploding).
Insight: Wallets are considered safer because you hold the private keys. However, both exchanges and wallets have been known to get hacked in the past.
#2. You can’t use fiat currency with a wallet
As a rule, at the time of writing, you can’t buy crypto using fiat currencies in your wallet.
For instance, you can’t open a crypto wallet and just transfer some dollars to it and buy Bitcoin.
To buy a cryptocurrency on a wallet you would first need to transfer funds from your bank account to a crypto exchange platform.
From there you would need to convert your fiat currency to a cryptocurrency. Only then would you be able to transfer your cryptocurrency to your wallet and trade it for whatever you want.
Update: Wallets are in the process of integrating third-party payment processors so that you can directly onboard your fiat currency to the wallet and exchange it for crypto. A notable example is Metamask which has partnered with a platform called Moonpay.
Insight: you are going to be using both an exchange and a wallet when you set up a wallet.
#3. You need a wallet to use DeFi
One of the aspects of crypto that gets crypto enthusiasts most excited is the field of Decentralized Finance (DeFi).
In a nutshell, DeFi refers to an ecosystem of apps that have been built on top of various blockchains.
They have no central entity managing day-to-day operations and operate automatically with a central authority.
For this reason, people have nicknamed them DApps (decentralized apps).
There are all sorts of Dapps from lending and borrowing protocols to decentralized exchanges.
In order to participate in these apps you need a wallet. For example, if you want to lend your Ethereum you can hook up your wallet to Compound and earn interest by lending it to others.
Wallets are a core feature of Web3. Just like Web 2 used Javascript to add more functionality such as forms and buttons to websites, Wallets have added digital payment functionality in Web3.
To really understand DeFi I recommend you take my free Crypto 101 tutorials.
Insight: if you want to participate in Web3 and DeFi you need a wallet.
#4. Trading pairs are more restricted on wallets
Most crypto wallets allow you to trade cryptocurrency. They do this by plugging into decentralized exchanges. If you don’t know what these are I suggest you read my tutorial series on Uniswap.
The problem is that most exchanges only allow you to trade between assets on the same blockchain.
So for example, if you want to swap DAI for USDC you can because they live on the same blockchain.
However, if you want to trade the Bitcoin in your wallet with Ethereum you can’t because they each sit on a different blockchain.
Wallets and decentralized exchanges are working on the problem as I type. There exists a technology called a bridge to do this.
But bridges are getting hacked left right and center and I don’t know of a wallet that has successfully done this yet
Insight: you are better off using an exchange to trade cryptocurrencies and then moving your crypto to a wallet for storage or to participate in Web3.
#5. Exchanges offer more tweaking options
When you first start trading you just hit the buy or sell button and accept the prevailing market price.
But as you become more experienced you’ll want to set conditions. For example, you might want to set a rule to buy a crypto coin only when it falls below a certain price and then have another rule to sell if it reaches a specific threshold.
Exchanges offer customizations such as limit orders and stop orders that allow you to do this.
In addition, exchanges offer features like order books and charting tools enabling users to engage in active trading activities.
These features are only available when you trade digital currencies on an exchange. The swapping feature in Wallet apps doesn’t offer these features.
Insight: as you become a more mature trader you will find that exchanges have more options to customize your trade.
#6. Exchanges are easier to use
Exchanges usually provide user-friendly interfaces, enabling novice users to navigate the platform easily and execute trades efficiently.
Moreover, exchanges will often have two settings. One for novices where you just press a “buy” button and a pro version for more experienced traders.
On the other hand, wallets may require users to set up and maintain the software or hardware device. It also takes some time to get used to the user interface of wallets and the various DeFi apps they can be used with.
#7. Exchanges require KYC
Exchanges must adhere to KYC (Know Your Customer) and AML (Anti-Money Laundering) regulations, which require users to verify their identity and provide relevant documentation. This means that the exchange and tax authorities know who you are and how much you have in digital assets.
On the contrary, wallets often don’t require KYC. Usually, you don’t even need an email address to use a wallet.
All you need is a 12-word seed phrase which is generated when you open a wallet account
#8. The sign-up process is different on an exchange and wallet.
To sign up for a wallet you either download a mobile app or a web browser extension.
In both cases, the sign-up process is super fast.
You just need to write down a 12-word seed phrase that will be generated when you open an account.
The wallet will not ask you for any email or other identification.
Step-by-Step Guide to Setting Up and Using a Cryptocurrency Wallet
- Research and select a suitable wallet based on your security requirements and preferred features.
- Download the wallet software from the official website.
- Install the wallet on your device and set up a new account
- Note down the seed phrase somewhere safe (preferably not online).
- Create a unique password.
- You can now receive funds by sharing your wallet’s public key with the sender.
- When sending funds, enter the recipient’s wallet address or scan a QR code using your mobile wallet and review the transaction details.
- Confirm the transaction and wait for it to be included in a block on the respective blockchain.
The sign-up process for an exchange is slightly different:
Process of Buying and Selling on a Cryptocurrency Exchange
- Create an account on the exchange by providing the necessary registration information.
- Complete any required verification processes, such as identity verification and proof of address.
- Set up two-factor authentication
- Deposit funds into your exchange account, typically through bank transfers or other supported payment methods.
- Navigate the trading interface to select the desired cryptocurrency and trading pair.
- Choose the type of order you wish to execute, such as a market order or a limit order.
- Review and confirm the order details.
- If selling, wait for the order to be matched with a buyer, and the funds will be credited to your account.
- If buying, wait for the order to be executed, and the purchased cryptocurrency will be added to your account balance.
#9. Wallets charge different transaction fees to exchanges
A crypto exchange will charge fees for trading and fiat withdrawals. This is how the exchange generates profit.
A crypto wallet does not charge fees for sending crypto from one address to another.
However, you will still need to account for network-related fees which are used to pay developers who validate cryptocurrency transactions.
In addition, you will also pay some fee to the decentralized exchange that the wallet uses should you decide to swap cryptocurrencies.
#10. No customer service on wallets
As a rule, wallets do not offer customer service. You are solely responsible for your private keys and should they go missing no one can recover them for you.
Exchange types
There are two main types of exchanges: centralized and decentralized exchanges
- Centralized exchanges are managed by a for-profit company. An exchange is like a large marketplace with buyers and sellers on either side ready to make a trade. You can think of the exchange as a middleman facilitating the transactions and taking a cut.
- Decentralized exchanges work on their own. Sure someone writes and maintains the code but the actual entity itself is not managed by a for-profit entity. Here too, buyers and sellers can participate and trade but there is a third party involved as well: Liquidity providers offer their assets so that traders can swap from one asset to another. To really get to grips with how decentralized exchanges work I recommend you read my explanation of Uniswap.
Types of Wallets
There are multiple types of crypto wallets available, each catering to different user preferences and security needs. The most common types include software wallets and hardware wallets.
Software wallets, also known as hot wallets, are mobile apps or desktop wallets that use browser extensions and have an internet connection. These wallets are easier to use and aimed at people who participate in DeFi and gaming more actively.
Some popular software wallets are Coinbase Wallet, MetaMask, Trust Wallet, Guarda, and Atomic Wallet.
However, whatever is connected to the internet is prone to the risk of being hacked.
In this case, it is better to use a hardware wallet.
Hardware wallets also known as cold wallets, are not connected to the internet. If someone wanted to hack them they would need access to the physical device which is much harder to get.
The risk with a physical wallet is that you yourself may lose the device.
There is a third type of wallet called a paper wallet. Paper wallets are not that common but they can be used. With a paper wallet, the owner just types their public address and private key on a piece of paper and stores it somewhere safe like in a security box at a bank.
FAQs
Is it better to keep crypto in a wallet or exchange?
If you plan to hold large amounts of cryptocurrency with a long term horizon you are better off keeping them in a reputable hardware wallet. Exchanges have been known to go bust from time to time. In this scenario you would not be able to retrieve your crypto because it would be in a custodial wallet meaning you wouldn't have the keys to it. Online Wallets and exchanges are equally likely to get hacked. Users with sizeble amounts of crypto should consider taking out insurance and diversifying between multiple wallets.
What is the difference between a digital wallet and an exchange wallet?
A digital wallet is one to which you have the private key to. An exchange wallet allows you to send crypto from and to your account with the exchange but you don't have custody of the funds in that account. Just like how you don't actually have custody of the money in a bank. The bank does. And they lend it out and so on.
Does crypto lose value in a wallet?
Crypto can lose value regardless of wether it is kept in a wallet or not. Crypto prices are volatile and the value of your holdings can change abruptly. One way to increase your holdings using a wallet is to plug in to a DeFI Dapp and earn a yield by lending your crypto. This too entails risk though.
Is Coinbase a wallet or exchange?
Coinbase operates both a decentralized wallet and a centralized exchange. The wallet is independent from the exchange in that you don't need one to have an account with the other. However its the same team who have written the code for both.
Does it matter which crypto wallet you have?
Yes, you should choose your wallet carefully. If you plan to hold large amounts of crypto then you are better off with a hardware wallet. However, if you are the type of person who keeps losing stuff you probably don't want to keep your life's savings in a device that you might lose. The other alternative is to store your crypto in a software wallet. This too entails risks. Storing large amounts on exchanges is the riskiest option.
Why shouldn't you leave crypto on an exchange?
When you leave crypto on an exchange you don't have the keys to that crypto. It's not directly available to you. It's available to the crypto exchange who hold it on your behalf. Just like with a bank. If the bank or crypto exchange go bust you can't get your money back. The most recent example of a crypto exchange going bankrupt is the FTX debacle which blew up $400Bn worth of investors' assets.
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