Crypto Wallet: Hot Wallet vs. Cold Wallet
One of the first questions that beginner crypto users may ask is where to store your precious digital coins. The issue may be rather challenging. The diversity of options that are now available in the market can be confusing, while not taking appropriate security measures may potentially result in the loss of your funds, with no chance of recovery.
There are two basic storage methods at the disposal of users: hot, or cold wallets. Depending on your situation, and at different times, one type of wallet may be more appropriate for you than the other.
What Is a Crypto Wallet?
A crypto wallet is a piece of software designed for storing cryptocurrencies. Though it is named a “wallet”, it isn’t a wallet in a literal sense.
A crypto wallet stores public and private keys that determine each unique wallet. The software generates the data that helps users to manage their own digital assets, and send and receive cryptocurrencies through blockchain transactions. When transfering cryptocurrencies, a user has to provide a digital signature that is generated mathematically with the help of a private key. The signature is not valid if the provided key is wrong.
The public key is the address that you can freely share with other participants of the network to receive funds as this information doesn’t provide access to the third party to your wallet. The situation is different with a private key.
The private key is a succession of symbols that serves as a secret code providing the access to the cryptocurrency. With the loss of a private key, you lose access to your crypto wallet as well as all the funds you store there with no chance of recovery. There is no third party to help a cryptocurrency holder to restore access as it happens in a bank, for instance, or with any other centralized payment service.
Protecting a private key is essential for the security of your funds. You may take full responsibility yourself and implement all the possible precautions, or you may entrust your funds to a centralized service. This is the key aspect that differentiates cold and hot wallets.
What Is a Hot Wallet?
A hot wallet is an online wallet that is used for storing and managing cryptocurrencies. In the early years of Bitcoin when it was just created, this was the only option available for cryptocurrency enthusiasts and adopters.
Hot wallets are provided online via special platforms which offer services for storing crypto. In this case, users have to entrust both their private keys to the service. Hot wallets can be found on numerous cryptocurrency exchanges offering this service for the convenience of users. Thus, members of the platform get wallets by default after they sign up.
Types of Hot Wallets
The following types of wallets fall under this category:
- Desktop wallets (e.g. Electrum, or Coinbase).
- Mobile wallets (e.g. Trust Wallet, or Edge).
- Web wallets (e.g. Blockchain.com, or MyEtherWallet).
- Browser wallets (e.g. Jaxx, or Metamask).
Hot wallets can be non-custodial or custodial depending upon the policy of the service. Non-custodial wallets provide users with the possibility to control their private keys. With custodial wallets, on the contrary, the private keys are controlled by a third party.
This brings on the following question: are hot wallets safe? Generally yes, but there is the potential of hacks, which could result in users losing their funds. Therefore, for long-term investors, who are holding their funds, hot wallets might not be the best option.
When Hot Wallets Should Be Used?
Despite reduced security, there are several situations when a hot wallet is the best option, so there’s no reason to give up on them. Here are some of the most popular use cases:
- Small transactions: use hot wallets if you need to send a small sum to another user.
- When fast access is a priority: these wallets are convenient for immediate settlements.
- When convenience is preferred: a hot wallet is a good choice for multi-platform access.
Pros of a Hot Wallet
The convenience of use is indisputable in many aspects. With that said, hot wallets come with the following advantages:
- Easy to set up. An online wallet can be created in a couple of minutes.
- Immediate access to cryptocurrencies. This feature makes the wallet ideal for frequent transactions.
- User-friendly interface. Their functionality is generally clear even for novices.
- Multiple levels of security. Reputable services do their best to protect hot wallets from hacking attacks and implement the best security measures such as multi-factor authentication and other additional layers of protection.
- Numerous backup options. Hot wallets usually provide users with various methods of restoring their funds thus protecting them from accidental losses of private keys.
- Capability to accept numerous tokens. The feature makes hot wallets suitable for traders and investors with a versatile investment portfolio.
- Free of charge. While hardware wallets can be costly, hot wallets are available for free.
- Insurance. Online services such as Coinbase usually have their own insurance funds to be able to refund users in case of a hack.
Cons of a Hot Wallet
Though hot wallets are a preferred choice for millions of users thanks to their convenience, the option comes with some serious drawbacks:
- Poorer protection. Despite multiple levels of security, even leading cryptocurrency exchanges remain vulnerable to malware and hacking attacks.
- Centralized storage of funds. This feature results in 2 serious drawbacks. For one, centralized servers often fall victim to cybercriminals. Secondly, huge centralized servers can take longer to process transactions when there is a user influx.
- The lack of access to your private keys. When keeping funds in a hot wallet, users often don’t have access to their private keys and, consequently, can’t fully control digital assets stored in the wallet.
Let’s now look at cold wallets.
What Is a Cold Wallet?
The key difference of a cold wallet compared with a hot one is that it is not connected to the internet. This characteristic turns cold wallets into the most secure storage options, as it makes them unreachable for hacking attacks and malware. The connection is required only during transactions.
A cold wallet most often comes in the form of a physical device resembling a flash drive that should be plugged into the computer to access the funds. Are cold wallets safe? If we talk about hacker attacks, then the answer is obviously positive. Even when a cold wallet is connected to the internet, it’s almost impossible to steal funds as the signing of transactions is done in-device. However, it may still be stolen if thief gets physical access to the device and the private key. For this reason, it’s recommended to store cold wallets as securely as possible.
A cold wallet is usually applied for storing digital assets on a long-term basis. This is a reliable and secure solution for those who move their cryptocurrencies around often. Therefore, it may be best for long-term investors to resort to this medium to store their cryptocurrency funds.
Types of Cold Wallets
The two most popular types of cold wallets include hardware and paper wallets.
Hardware wallets are specifically designed physical devices that hold public and private keys in a digital form. There are several popular hardware wallets offered in the market such as Ledger Nano X, Ledger Nano S, Trezor, KeepKey, and others. Their cost usually varies between 60 and 200 USD.
If you look for a free alternative, paper wallets may be a solution. To use a paper wallet, you should have its print-out on a piece of paper and keep it in a secure place. In terms of security, it is considered to be an obsolete method now, as it is not that reliable in comparison with other options. Paper can be easily damaged and destroyed. Besides, it’s necessary to be tech-savvy to use this storage method correctly.
Some people use reserve mobile devices as a cold storage device, turning them on for transactions only. During the transaction, the phone must be connected to the primary phone via wifi or Bluetooth to transfer funds from it to your hot wallet. Once the transaction is complete, the reserve phone is disconnected and turned off again to keep your digital assets safe. Old laptops may serve in the same fashion, too.
Pros of a Cold Wallet
Security is the primary feature that distinguishes a cold wallet from its hot alternatives. It is not connected to the internet, therefore only the wallet owner has access to the data contained in it. With that said, the main benefits of cold wallets include:
- Resistance to hacking attacks. It is basically impossible to get hacked using a hardware wallet.
- Limited USB connection. The feature was incorporated for the protection of private keys even if your mobile device or a computer is compromised.
- Regeneration of private key. With hardware wallets, a seed phrase allows you to recover your assets and regenerate private keys even when the wallet itself is lost. Moreover, it can even recover the transaction history.
Cons of a Cold Wallet
Despite advanced security, cold wallets feature many drawbacks that prevent their widespread adoption.
- Price. As has been mentioned above, cold wallets are rather expensive. The most affordable options cost about 60 USD, while the advanced models can reach 500 USD per item.
- The difficulty of use. Trading crypto from a cold wallet requires additional steps to be performed which can complicate the procedure.
- Not suitable for traders. Using cold wallets for trading may be very risky due to the high volatility of prices. Since the withdrawal of funds from a cold wallet does not happen instantaneously, the price may change in the process and result in an unprofitable trade. Hot wallets are thus a much better fit for this purpose.
- The difficulty of installation. Hardware wallets are often used by experienced cryptocurrency investors with a technical background while beginners can face problems setting up a wallet for the first time.
- Inconvenience. It is necessary to plug the cold wallet into a PC each time when you are going to make a transaction.
Though the number of drawbacks exceeds the number of advantages, cold wallets still remain the best option for storing crypto long-term due to the enhanced level of security they provide.
The Bottom Line
The choice of a wallet depends upon the particular circumstances and activities of cryptocurrency holders. If you are a cryptocurrency newbie that requires the convenience of use, a trader that needs fast access to your funds, or if you simply pay with crypto on a daily basis, the hot wallet may well be the best option for you.
However, if you are an investor who is keen on storing crypto long-term and values security above all other features, then a cold wallet is probably better because of its increased level of safety.
It is important to think through your crypto goals and choose the type of wallet that fits your requirements best.