How to Set Up a Cryptocurrency Wallet Outside a Centralized Exchange

You should never store all of your cryptocoins on a centralized exchange

A cryptocurrency smartphone wallet and a real wallet
You can create a Bitcoin wallet almost anywhere.  GrafVishenka / iStock / Getty Images Plus

It can be very tempting to keep all of your Bitcoin, Litecoin, and Ethereum on a centralized cryptocurrency exchange such as Coinbase or Binance but this method of crypto storage isn't as safe as you would think and could potentially expose your funds to hackers and data breaches.

Anyone who's heavily invested in cryptocoins needs to be looking at storing their coins in a wallet disconnected from a centralized exchange. Here's how to get started.

What is a Cryptocurrency Wallet?

A cryptocurrency wallet is a piece of computer software that grants access to cryptocurrency funds on a blockchain. There are two types of wallets; a software wallet and a hardware wallet.

  • A software wallet is essentially a wallet program on a computer or an app for a smartphone or tablet. Exodus Wallet is one example of a software wallet designed for computers. The official Bitpay app is one that works on mobile phones.
  • Hardware wallets are physical devices that contain software wallet programs but require the manual pressing of buttons to confirm a transaction. This added layer of real-world security makes it very hard for the wallets to be hacked or infected by malware.

If a wallet is misplaced, deleted, or destroyed, the cryptocurrency funds are not lost as they aren't actually stored on the wallets. Remember, the wallet only grants access to the funds. When setting up a wallet, a user is given a series of numbers or words to write down. Using these codes, funds can be accessed on a new wallet even if access to the original wallet is lost.

What is a Centralized Exchange?

A centralized exchange is an online service that allows users to buy, store, and sell cryptocoins. These services are usually hosted on web servers like a traditional bank website and users can store their cryptocurrency on the website in virtual software wallets.

Many people choose to use centralized exchanges as they work in a similar way to traditional banking services. Coinbase is the most-popular example of a centralized exchange while CoinJar is another. Some centralized exchanges, such as Binance, allow for the proper trading of cryptocoins in a near identical way to how stocks are traded.

Are Wallets on a Centralized Exchange Safe?

Centralized exchanges may be convenient but it is never recommended to store large amounts of crypto on them as, like any website, they are susceptible to hacking. Almost all of the Bitcoin hacking scandals mentioned on the news involve the security breach of a centralized exchange. Both individual accounts and an entire userbase can have funds stolen if compromised and, due to the nature of cryptocurrency, there's no way to get funds back after they're sent to someone else such as a hacker.

To minimize your risk when using a centralized exchange, limit your exhcnage wallet funds to between $500 and $1,000 worth of cryptocurrency while using the rest for for trading and spending. All additional funds should be kept elsewhere in a secure hardware or software wallet.

Cryptocurrency Wallet Alternatives

Storing funds on a software wallet on your computer, tablet, or smartphone can be convenient but it's important to remember that they can still be lost if your device is hacked or infected with a virus or malware. Some recommended software wallets are Exodus Wallet, Bitpay, and Electrum.

Hardware wallets are significantly more secure than software wallets and are highly recommended for storing large sums of cryptocurrency. Popular cryptocurrency hardware wallets are the Ledger Nano S and the Trezor.

What to Expect When Setting Up a Software Wallet

After installing your chosen software wallet on your smartphone or computer, a wallet for storing your cryptocoins should be automatically created within the app. Upon its creation you will be provided with a series of random words. These words are your wallet's security keys and can be used to restore your wallet and its funds on another device if the current one is lost.

  • Write these words down on a piece of paper and store it in a safe place.
  • Don't take a screenshot of these words on your computer or phone. If your device is infected with malware or gets hacked in the future, this data could be stolen and used to steal your wallet funds.
  • Don't write down these words in a program such as OneNote, Evernote, or Microsoft Word. Malware can also access this data.

What to Expect When Setting Up a Hardware Wallet

When setting up your hardware wallet, you will need to do the following.

  • Install the latest firmware updates. You will need to connect your hardware wallet device to your computer to set it up. During this process it's incredibly important to install the latest firmware update to protect it from modern malware and hacks. You can check to see if your hardware wallet has the latest firmware on the official Trezor and Ledger websites.
  • Secure your software wallet privacy keys. A hardware wallet will still need to set up a software wallet on itself for managing crypto funds. Be sure to protect the series of security words given to you upon the wallet's creation via the tips for the software wallet above.

Using a Cryptocurrency Decentralized Exchange

Decentralized cryptocurrency exchanges are services that are usually hosted by web servers in a variety of locations and often act as an automated system for trading cryptocurrency. In general, decentralized exchanges don't host user data or crypto funds and instead act as a method for direct peer-to-peer trading.

Because funds are not stored on most decentralized exchanges, they are not a practical alternative to centralized exchanges for storing cryptocurrency. Using a decentralized exchange still requires cryptocoins to be stored and sent from either a software wallet or a hardware wallet.