Cryptocurrency wallet vs exchange – what’s the difference?

It often happens that someone comes to Parallel Polis with a “wallet”, from which they have trouble paying at our terminal. In fact, the user is confused by the term wallet and exchange (or “custodial wallet”). In this article, I will try to describe the difference between these applications.

Wallet

A cryptocurrency wallet is an application that manages private keys (and addresses) and allows you to make cryptocurrency payments. Examples of wallets include Coinomi (supports various cryptocurrencies including Bitcoin and Litecoin), Phoenix, or Breez (supports Bitcoin, including the new Lightning Network payment extension) or Trezor OneTrezor T or Ledger S or Ledger X (hardware crypto wallet).

IIf you want to see how the payment with the Coinomi cryptocurrency wallet works (including the purchase of cryptocurrencies directly into the wallet), we have prepared an illustrative video for you, also with instructions for installing this wallet.

Exchange

The cryptocurrency exchange is a place where you can exchange cryptocurrencies for other cryptocurrencies, but also euros, dollars, etc. Some exchanges also allow the purchase of cryptocurrencies using a credit card or other form. Well-known exchanges include SimplecoinCoinmateBinanceKrakenCoinbaseBitstamp, and many others.

These exchanges are operated mostly by a licensed company, but some (such as Bisq or  Hodlhodl) are also decentralized or peer to peer.

Cryptocurrency exchange applications allow you to send and receive cryptocurrencies and often euros, but there is a big difference in what that means. First of all, cryptocurrency balances are not your cryptocurrencies – as we in cryptocurrency community says, “if you don’t have private keys, cryptocurrencies don’t belong to you.” Many clients of the cryptocurrency exchanges were disappointed when someone broke or went bankrupt and they lost the cryptocurrencies they thought they owned. A simple analogy is between a physical wallet and a bank – if I have a banknote in my wallet, it is my euro, if I have one in my account, I have stored it in the bank. I can instruct the bank to send them somewhere, but there are circumstances in which this is not possible (for example, banks in Greece or Cyprus have also shown this problem to users of traditional banking products).

Most cryptocurrency exchanges have written conditions (thanks to the so-called “FATF travel rule”) that you can withdraw cryptocurrencies only in your wallet.

Although the form (I scan the QR code) is similar, there are more significant differences:

  • The exchange does not have to process the withdrawal immediately. Some exchanges process withdrawals once a day, or they can ask for additional documents for the selection (for example, they want to know what activity the sources for which you bought cryptocurrencies come from, or they need an additional identification document). So if you are standing with a full basket in the e-shop or at the bar and you want to drink the coffee that you ordered and are waiting for payment, you can wait a long time.
  • Exchanges do not respect the “required amount”. The address and amount are in the payment QR code. However, since you have to collect cryptocurrencies in your wallet, not use them for payment, any fees (which can easily be equivalent to € 5 in a given cryptocurrency at some exchanges) can be deducted by the exchange from the amount sent. Therefore, if you wish to pay for lunch and the merchant received 5€ less, the payment will be considered incomplete and will not be processed. 
  • The exchange may be suspended for a longer period. It is similar to banks, downtime of payment cards, vending machines, or shutdown of systems often occurs. The bitcoin network never shuts down (nor can it be shut down), and if you have a real wallet, you can always pay.

How to recognize a wallet and an exchange

To make matters worse, many wallets (including Coinomi or Trezor) have integrated access to exchanges. So not all apps where you can change cryptocurrencies are automatically exchanged. In Coinomi or Trezor, you can exchange Litecoin for Bitcoin, for example, through cryptocurrency market integration. However, the difference is that the currency sold on the exchange will go to the moment of the transaction and the selection of the purchased cryptocurrency will come to your wallet immediately. The exchange, therefore, has access to your money only for the duration of the transaction. This still doesn’t necessarily mean that the transfer will take place immediately (even such an exchange will wait for the transaction to be confirmed and may sometimes ask for additional documents).

The easiest way to distinguish an exchange from a wallet is to “not invent” and use the wallets we recommend. Of course, this does not mean that you should not use exchanges – exchanges are very useful for buying and selling cryptocurrencies. But the right way to use and exchange is to send to exchange what I want to sell (such as euros), make a change and choose what I bought. It is not reasonable to hold a “balance” on the exchange or to pay with, not at all.
However, if you want to distinguish the exchange from your wallet, the easiest way is to “log in” and how you created your account. A pure wallet does not want personal information from you (not even an email address) and will allow you to make a backup of your private keys – in many cases, it will either force you or at least allow you to write 12-24 (depending on your wallet) English words representing the private key. We recommend making this backup.
If you install the exchange application, create a username and password, you confirm transactions with the exchange, which often sends you a confirmation link by e-mail. They very often ask for identification documents.

But I trust the exnchange “XY”

It is nice. We also trust some exchanges. But that doesn’t mean they work well as a wallet for payments. On the contrary, most exchanges explicitly forbid in their terms and conditions the use of withdrawals for anything other than your address (ie the wallet you own). For example, most exchanges do not have a license to send money (money transmitter), only to exchange one asset for another.

In this blog, we don’t want to convince you to uninstall all exchanges apps. We persuade you not to pay with them, but to withdraw the balance to your wallet, which you can use for payment. This will avoid waiting, stress, fees ,and unexpected disappointments.

If you are new to cryptocurrencies and have your heroes who started exchanges or your friends recommended a super-cool wallet or exchange for you, that’s fine. At Parallel Polis, we have many years of experience with payments, we use them daily – and our experience is: paying from the cryptocurrency market is problematic and the result is many disappointed and angry users. Therefore, try to build on our experience and use the procedure we recommend.

Author: Juraj Bednár

Source: https://paralelnapolis.sk/kryptomenova-penazenka-vs-burza-aky-je-rozdiel/

4 thoughts on “Cryptocurrency wallet vs exchange – what’s the difference?

  1. I have a question regarding your article. I noticed that in the article, you had said, and i quote:
    “To make matters worse, many wallets (including Coinomi or Trezor) have integrated access to exchanges. So not all apps where you can change cryptocurrencies are automatically exchanged. In Coinomi or Trezor, you can exchange Litecoin for Bitcoin, for example, through stock market integration. However, the difference is that the currency sold on the exchange will go to the moment of the transaction and the selection of the purchased cryptocurrency will come to your wallet immediately. The exchange, therefore, has access to your money only for the duration of the transaction.”

    It made me think about the system design there and what you were suggesting. I did not include this in the video for i was thinking the system design would work in the following way:
    – Wallet interacts with third party app, such as changelly (for exchange reasons).
    – Third party app returns with a response on the overall fees and exchange rates in accordance to your set amount.
    – Once confirmed, the third party app requests permission from the wallet, i.e your private key to send the amount to the exchange. This can only occur with your approval and signature (via password or pin)
    – Once the transaction is done, the amount that you have requested is sent back to your designated address.

    Am i wrong in assuming this is the case? Because if that is the case, i do not see any security issue there and i do not see it as you not be in a non-custodian situation, as the transaction would not be any different to scanning a QR code and sending funds with your permission. Is this something you can confirm for me?

    Like

    1. It works exactly like this, but there are security issues with this design. The main one being that
      the exchange has the custody of the funds for the duration of the transaction and can literally
      lock you out – for example by requiring proof of identity and source of funds. That happened to some people that
      either exchanged Monero or coinjoined btc, or simply did too high of a volume. You never know in advance if
      the exchange flags your transfer.

      Compare this with more decentralized designs, where the exchange either happens in one transaction or does
      not happen at all. For example incognito.org has something that approaches this (and one of the values of
      the creators is no KYC ever).

      The main reason for writing this in the article is that people can differentiate between wallet and an app with access
      to your account on the exchange. For example a Coinbase or Kraken app is not a wallet. It used to be easy to differentiate
      at least very superficially – does the app offer exchange services? No? => it’s a wallet. Now it’s not that clear, because
      wallets offer exchange services. There’s nothing wrong with that, but you should know the risks if you choose to use them.
      Of course that does not make the use-case as a wallet less secure, Trezor is a great wallet, if you don’t touch the exchange
      tab.

      Like

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