Wallet Types — Hot vs Cold

By: Jack Nelson, Defy Trends

Introduction

Within the crypto space, there are two main forms of digital asset storage you should be aware of. These include “hot” wallets and “cold” wallets. There are numerous pros and cons to using either option, but at the end of the day it will depend on what kinds of security preferences you prefer, along with what exactly you are trying to accomplish in the digital asset world.

Ultimately, if you buy any quantity of cryptocurrency and want to store it yourself, you must select between using a hot wallet, cold wallet, or a mix of the two. Although a hot wallet is more convenient and makes it simpler to trade or use cryptocurrency, it is always connected to the internet and may be vulnerable to hacking or other online attacks. While a cold wallet is generally more secure, it is often not online, making it less practical for quick usage and mobility of assets. Given these differences, you may be wondering if you should use a hot wallet, cold wallet, or combination of both. Learn more by reading on.

What exactly is a Crypto Wallet and how does it work?

When deciding between what form of wallet to use, one must first understand the basics of what crypto wallets are and how they work. In short, a cryptocurrency wallet is where the public and private keys of a particular crypto user are kept. These keys are needed in order to complete transactions on the blockchain.

Public Key — This cryptographic key is made to enable anonymous sending and receiving of cryptocurrency to and from other wallet addresses. A public key is kind of like an account username or email address.

Private Key — This consists of personal data that you use to prove that you are the wallet’s owner. Think of it as a PIN or password to your wallet. You may use your private key to access or “log in” to your wallet and see what’s going on.

These keys can be kept on a sheet of paper, but it’s crucial to keep them safe. If you forget or misplace your keys, you may no longer be able to access any of the funds in your account. Therefore, it’s crucial to keep these numbers secure, which is why many cryptocurrency investors choose to utilize a hot or cold wallet.

Image Source: Arcana

Hot Wallets vs Cold Wallets

In simple terms, hot wallets and cold wallets differ in the fact that a hot wallet is linked to the internet while a cold wallet is not. A hot wallet, like a Coinbase Wallet, is often easier to access and can be linked to the trading platform you use. This makes hot wallets much more practical to utilize in online transactions, and they are also generally free to use. A hot wallet, however, can be more susceptible to hacking and theft of your digital assets.

In contrast, a cold wallet provides storage that isn’t always accessible online. Although today’s traders prefer specialized hardware made to store cryptocurrency (such as a Ledger wallet or USB drive), paper wallets or an offline PC are still technically regarded as cold wallets. Due to their offline nature and limited accessibility, hardware wallets are made to be “impenetrable” to theft. However since you need the private key for each transaction, they are a slightly less practical than a hot wallet.

Hot Wallets — Pros and Cons

Hot wallets typically come in three forms: web-based wallets, mobile wallets, and desktop wallets. Although all kinds of hot wallets are susceptible to online attacks, web wallets are the least secure of them all.

Ease-of-use is one of the main benefits of hot wallets. They never go offline, therefore switching between offline and online is not necessary when conducting a cryptocurrency transaction. For instance, a lot of investors utilize mobile hot wallets to exchange or buy cryptocurrencies. This same action would be somewhat tedious to accomplish with a cold wallet, as you would first need to transfer the necessary amount of cryptocurrency to a hot wallet, which you would then have to plug your cold wallet into.

Users that possess high dollar amounts of cryptocurrency won’t normally maintain a significant portion their holdings in hot wallets. Traditionally speaking, keeping a lot of cash on you is typically a poor idea, even though a hot mobile wallet is a bit different from a conventional analog wallet in that regard. When your balance gets low, you can send more cryptocurrency to your hot wallet just like you can withdraw money from an ATM.

Most trustworthy exchanges retain the vast majority of their customers’ cash offline in a network of cold wallets and then reserve a specific amount in hot wallets for withdrawals. If you plan to store a sizable amount of Bitcoin or other cryptocurrency online, make sure to look into the standing and reputation of the exchange you plan to use.

Image Source: Alchemy

Cold Wallets — Pros and Cons

Cold storage wallets are generally quite secure. A cold wallet would typically need to be in your physical possession, along with any PINs or passwords (private keys) needed to gain access to your funds. The majority of hardware wallets on the market today are cold wallets and are housed in devices that resemble small to medium-sized USB drives. Other possibilities for cold storage wallets include paper wallets, physical Bitcoins, or an additional offline device (such as a computer or smartphone) used to store cryptocurrencies. However, despite still being fairly safe, these procedures are no longer widely used and have been supplanted by trustworthy, high quality hardware wallets or extremely secure cold-storage options that are offered on exchanges.

Hardware wallets are made to be resistant to hacking. Depending on the storage technique, even when a hardware wallet is hooked into your computer or connected through Bluetooth, the funds kept on the device are nearly impossible to steal. Although your computer is theoretically linked to the internet, transactions are signed “in-device” and then subsequently broadcasted to the network via the computer’s internet connection. You can transfer ownership of a cryptocurrency transaction to the recipient by using this “signature.” However, because your private keys never leave the device, even if top-notch hackers tried to steal your money by fraudulently “signing” a transaction started in your hardware wallet, the transaction would fail because the signature was incorrect.

One of the most popular cold storage wallet providers in the industry today is Ledger, who has also worked with with Defy Trends in the past. Shown below is one of Ledger’s most popular products, the Nano S Plus hardware wallet which retails for $79.

Product Link: Ledger Nano S Plus

At first glance, cold wallets may seem to many as just a fancy “flash drive” or simple USB-port thumb drive. Some might ask, “Why cant I just use one of my old flash drives to cold store my crypto?” The answer lies in the fact that a USB drive cannot sign a transaction for you and does not safely store your private keys. As mentioned previously, a hardware wallet is nearly hack-proof due to the encryption features that come with. If you use a regular USB-drive this way to store your crypto, your funds are dangerously susceptible to theft whenever you plug it in to your computer and connect it to the internet.

Because they need to be turned on and then connected to the internet, hardware wallets are far less handy than hot wallets. Furthermore, most hardware wallets range between $50 and $200, while hot wallets are typically free. Before buying more cryptocurrency, you might want to consider investing in a hardware wallet if you have more than a few hundred dollars in your account. To protect yourself from the possibility of losing your money, it’s a very small price to pay.

Finding the Best Solution for You

Like any valuable asset, storing cryptocurrency involves a personal decision on how best to keep your money safe while striking the ideal balance between functionality and security.

Over the past few years there has been a convergence of sorts, with cold wallets becoming more practical and hot wallets becoming more safe. The trend is moving toward keeping money in hardware cold wallets for people who decide to have personal custody of their own cryptocurrencies. For those who save the majority of their cash in a hot wallet or crypto exchange wallet, it’s important to choose and abide by an exchange with a solid reputation for security.

Given the trade-offs associated with using either form of crypto wallet, a combination of cold and hot wallets is typically best practice. Ultimately, you want to find a happy medium between a hot wallet’s accessibility and a cold wallet’s safety and peace of mind. Many people will eventually have many copies of each type, including hardware cold wallets, mobile hot wallets, and exchange account hot wallets. The ability to utilize each cryptocurrency wallet for a specified function strikes a balance between usability and security when using and exchanging cryptocurrencies.

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Defy Trends provides advanced analytics and actionable insights for cryptocurrencies and NFTs. Created by a female-led team of data scientists and global markets experts, Defy Trends brings together crypto, NFT trading, and research operations. The goal is to empower everyday individual investors and institutions ranging from exchanges and marketplaces to research firms. Defy Trends is committed to making crypto accessible to all. Dare to Defy.

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Disclaimer: This article is for educational purposes only and must not be treated as financial or legal advice.

Please conduct due diligence and manage your risks accordingly.

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