These posts are recaps of my weekly Twitter space with the amazing @cryptobesties! They take place every Monday @ 8:30 PM EST so if you can’t make it to one or don’t prefer learning from recordings, refer to this for a rundown.
Last week, we discussed the basic building blocks of web3. This week, we’re talking about how transactions take place on the blockchain: through cryptocurrencies. In a lot of ways, owning cryptocurrency can transform the way you navigate and understand web3 functions and communities. They’re also the gateway to help you be active members of some DAOs as it allows you to purchase their NFTs or tokens for voting and governance, participate in staking, or support their cause.
what are crypto exchanges?
A crypto exchange has two primary purposes:
- It will enable the purchasing, selling, and trading of cryptocurrencies, and
- It can hold or stake your cryptocurrency if you do not wish to transfer it to your own wallet.
They reflect the current trading market process of the listed cryptocurrencies (this is important: while common coins like BTC and ETH are on nearly every exchange, smaller-cap coins will not be available to purchase or trade everywhere.)
Security tip: don’t keep large quantities of your money in an exchange. If you’re buying anything for a long-term hold, transfer it to a wallet. As exchanges act as custodians for your money, they hold the assets that you keep in your exchange account- they just hold it for you.
Think of exchanges as the bridge between fiat currency and crypto. In terms of financial operations, you can use exchanges to trade in the same way you would on a stock market. Effectively, they can act as custodian wallets: not ideal for long-term holding, but if you need to store some crypto for a short amount of time or do some margins or futures trading, an exchange is quick and easy. You could create an account at a centralized exchange and buy 1 ETH, but that 1 ETH is best kept in your wallet if you intend to hold it for a long time or purchase NFTs or other tokens with it on a decentralized exchange.
centralized exchanges
Centralized exchanges (CEXs) are basically bridges or third-parties between buyers and sellers. They’re operated and controlled by a central company or organization, hence “centralized.” In some ways, they offer more reliability as there’s someone to hold accountable if things go awry. Most crypto transactions take place on CEXs like FTX, Kraken, Binance, Coinbase. There are many more.
Unfortunately, because of their centralized nature, not every exchange is available in every state or country. Binance US is a good example: it was created separately so that Binance could operate in the United States, but it still cannot technically be used in certain states like New York, Hawaii, or Texas.
CEXs may also require identity verification if you plan to transact or withdraw above a certain limit – the KYC process is detested by some because it is counterintuitive to the original ethos of cryptocurrency, wherein you don’t need to have verified state identification to transact.
To assess the security of a CEX, look into how much of its assets are in cold storage (offline). Similar to regular users, an exchange benefits from keeping large quantities of its holdings in an offline wallet because it makes it much harder for hackers to gain access to those – an exchange only needs to keep a percentage of its holdings online to facilitate trading. This is even more important as the value of cryptocurrencies grow – the higher the value, the more lucrative for cybersecurity attacks.
decentralized exchanges
Decentralized exchanges (DEXs) operate on a peer-to-peer execution system: transactions don’t need a third-party or intermediary. The blockchain effectively does all the work here. You also don’t need user identification to use a decentralized exchange, which would make these ideal. However, DEXs don’t support the trading of fiat currencies for crypto, which almost necessitates the use of a centralized exchange in most cases. If you keep your transaction volumes and withdrawals relatively small, you won’t need to worry about KYC. Popular DEXs include Uniswap, Pancakeswap, and dYdX.
Most DEXs use liquidity pools for the P2P transaction system and this has a couple of potential problems – namely price slippage, wherein large movements of currency can heavily impact the trading price especially with small liquidity pools, and low trading volume, which can made it hard to buy or sell a token.
what are stablecoins?
A stablecoin is a digital currency pegged against a “stable” fiat currency – their main purpose is to reduce volatility when purchasing cryptocurrency like BTC or ETH. They use smart contracts to facilitate transactions without much human oversight. Stablecoins usually have reserves that are vital for monitoring the supply of the coin. They’re also run differently based on how the contract is optimized; for examples, while USDT was first, USDC was later created to speed up funds transfer times and can be stored in an ERC wallet. DAI is another stablecoin created by MakerDAO and can accept other cryptocurrency as collateral.
what is a crypto wallet?
As the name suggests, a crypto wallet is literally a wallet. There are some vital physical differences, but the core is the same: they’re used to store your money or assets as well as identification. If you’re new to the space, your online wallet address can act as a unique identifier that allows you to log in to various decentralized applications – not the same as having an email address and password for each different website as your wallet credentials don’t have to change across platforms if you’re using the same one for everything. Wallets work through private and public keys: more on cryptographic keys in last week’s post.
why are people comfortable sharing wallet addresses?
If you’ve been on web3 twitter for any period of time, you would have seen the frequency with which people drop their public wallet addresses or ENS domains in replies and tweets. The reason people feel safe doing this is because you can’t really do much ***just ***with a public address if you’re using a secure wallet.
Public addresses are simply the face of your wallet. You can log someone’s address into any of the chain trackers and see the transactions they’ve been conducting, but you don’t actually have any edit access to the wallet. That is possible only with a secret phrase or private key – those are how you can sign into your wallet on a different device. They should be kept absolute secrets.
Unlike passwords, you can’t just reset your wallet key if you forget or lose it (or accidentally leak it) – once lost, a private key can never be regenerated or recovered, especially if you don’t have a recovery phrase either. This can be a double-edged sword, as it can make them more secure yet more risky. If someone gains access to your secret phrase or private key, they can immediately access your wallet and drain it.
There are two primary types of wallets: hot and cold. There are also different wallets for different chains.
what is a hot wallet?
A hot wallet is an online wallet – this is what connects to the internet and allows you to conduct everyday transactions. Popular wallets include MetaMask, Rainbow, and Phantom (for Solana). Some can ask as browser extensions, others are isolated applications, some can be both.
Hot wallets are best used for purchases and transfers because of their convenience. However, because they can be susceptible to cyberattacks, it’s a good habit to not keep the bulk of your money in a hot wallet. If you own a lot of cryptocurrency for long-term holds or have NFTs that are very special or rare, it’s more secure to transfer those to a cold wallet.
what is a cold wallet?
A cold wallet is an offline wallet – these are hardware devices. Popular cold wallets include Trezor and Ledger. They are not connected to the internet and are therefore extremely hard to break into. This is the best option for long-term holding – if you know you’re not going to sell or transfer certain assets for a long time, transfer them over to a cold wallet. Having a hot and cold wallet together can keep your assets extremely secure as long as you keep up with maintaining and tracking everything you have.
Psst: make sure you purchase your hardware wallets from the manufactorer’s website. Amazon may not be the safest bet.
what are multi-signature wallets?
Multi-sig wallets are hot wallets that require multiple addresses to sign off on a transaction. These are great for pooled resources or DAOs but can also be used by individuals for heightened security as a transaction would require multiple signatures from other addresses – think of this as the web3 version of multi-factor authentication for signing into an account.
what are social recovery wallets?
This is a fairly newer experiment with wallets – the idea behind social recovery wallets is that friends or family would be able to help recover your wallet if you lose or forget. your recovery phrase or private key. The way this would work is that if you need to update or regenerate your private key, the wallet would require pre-specified addresses to sign off on the update. The pre-specified addresses would hypothetically belong to trusted people who would be ready to help if you lost your private key. Once you have access to the wallet, all transactions would function normally – the only difference is that you would actually be able to regain access to this wallet if you lost any data whereas you wouldn’t be able to do so for traditional hot wallets.
to summarize
Wallets are the main financial and operating tool that will facilitate a large chunk of your transacting on web3 platforms, whether it be purchasing, selling, or just signing in to dApps. You can purchase cryptocurrencies through crypto exchanges, but make sure you send them to your wallet if you don’t want to just margin, futures, or spot trade.
Next week, we’ll be covering cryptographic proofs (the tech that allows coins to circulate and is the main consideration for assessing environmental impact). If you can’t join the Twitter space at 8:30PM EST on Monday, stay tuned for the recap that will follow!
In case you’d like to correct anything in this post, reach out to me on Twitter and I’m happy to make the correction! We’re all learning together so let’s keep it collaborative and encouraging.