Every owner of cryptocurrencies needs a wallet. And there are so many different options to choose from when it comes to securing your digital assets. It can be a confusing one and even a worrying process trying to decide which method to use. It’s your money, after all.
When you are making your storage decision, it’s important to know about the two terms: ‘hot wallet’ and ‘cold wallet’.
So, what do you mean by a hot wallet and cold wallet? Well, they are the cryptocurrency wallets. Just like a conventional wallet where you keep your cash, a cryptocurrency wallet is a means by which you store your digital coins.
Before we go thorough discussions about the hot wallet and cold wallet, let’s see the definitions of these two terms.
A hot wallet refers to any cryptocurrency wallet that is connected to the Internet. It is a tool that allows a cryptocurrency owner to receive and send tokens. Unlike traditional currencies, there are no dedicated banks or physical wallets that can be used to keep cryptocurrency holdings secure. On the other hand, a cold wallet refers to any cryptocurrency wallet that is not connected to the Internet. It is also known as ‘cold storage’. It is an offline wallet used for storing Bitcoins. As the digital wallet is stored on a platform that is not connected to the Internet, protecting the wallet from unauthorized access, cyber hacks and other vulnerabilities to which a system that is connected to the Internet is susceptible.
Now, let’s discuss in details, what are the differences between hot wallet and cold wallet, as each wallet has its own advantages and disadvantages.
The digital cryptocurrency storing wallets have been around ever since the inception of Bitcoin. They come in two forms – online and desktop wallets. Mobile wallets are also considered digital, but because of their mobility, they could probably be classified as a hybrid wallet.
The two huge perks that digital wallets have are their ability to hold any cryptocurrencies and that they are free.
As such, hot wallets are perfectly convenient for everyday use (for example, buying goods and services, transferring small amounts of crypto to friends or family, etc.), and comes in the form of easily accessible software.
- A hot wallet is a tool that allows cryptocurrency users to store, send, and receive tokens.
- Hot wallets are linked with public and private keys that help facilitate transactions and also act as a security measure.
- Because hot wallets are connected to the Internet, they tend to be somewhat more vulnerable to hacks and theft than cold storage methods.
Advantages of Hot Wallet
- Easy to set up.
- Convenient to access funds for trading since it is already connected to the Internet.
- It is highly intuitive and easy to use.
- Quick access to your cryptocurrency (many hot wallets are accessible through your cell phone)
- It is user-friendly.
- Trades are instantaneous and much easier with an online wallet.
Disadvantages of Hot Wallet
- Vulnerable to hackers as seen in the numerous hacks on cryptocurrency exchanges.
- If exchanges close, traders will be left with no recourse to recover their funds.
Types of Hot Wallet
- Exodus: There are many crypto-wallets in the market, especially hot wallets. One feature which allows Exodus to stand out is highly intuitive and easy to use the platform. It also has an attractive graphic design and a readily-available customer service team.
- Coinpayments: This hot wallet supports over 75 cryptocurrencies, an astounding feat by any measure. Like most hot wallets, it is free and not cumbersome to navigate. Another reason for this wallet’s widespread acceptance is the ability to use it for making purchases online.
- Electrum: Electrum is one of the oldest brands known for storing cryptocurrencies. If age is anything to go by, you can trust Electrum with your life’s savings. It works as a desktop wallet and still provides the user with every functionality required. Also, if you plan to change the PC on which it was installed, you just need to reinstall the software on a new PC and then input the seed (a string of random words) generated at first.
- Blockchain.info: Blockchain.info, with 100 million transactions completed and 15 million users, might just be the most popular cryptocurrency wallet available. This is popular because of transparency. They give you a double layer of security and they are impervious to the generated seed used to access the account.
There are different reasons why an investor might want their cryptocurrency holdings to be either connected to or disconnected from the Internet. Because of this, it’s not uncommon for cryptocurrency holders to have multiple cryptocurrency wallets, including both hot and cold wallets.
How does Hot Wallet work?
After an investor decides to buy or mine digital currency, they must then determine where and how to store their tokens. Although they are called wallets, the name is somewhat misleading because hot wallets don’t actually store cryptocurrency in the way that traditional wallets store currency. The role of hot wallets is to help facilitate any changes to the record of transactions stored on the decentralized blockchain ledger for whatever cryptocurrency is being used.
For the cryptocurrency investor, the cryptographic public keys and private keys are the most important elements of a cryptocurrency wallet. Public keys are similar to account usernames; they identify the wallet so that the user can receive tokens without revealing their identity. Private keys are similar to pin numbers; they allow the user to access the wallet and check balances, initiate transactions, and more. Without either of these keys, the wallet is effectively useless.
How is Hot Wallet secure?
The safety and security of a hot wallet are largely dependent upon the user’s behavior. Any items stored in a hot wallet are vulnerable to attack because the public and private keys are stored on the Internet.
Experienced cryptocurrency investors will only keep a small portion of their holdings in their hot wallet because it’s less likely that a hacker will break into a hot wallet for a small number of tokens. For example, they may only keep the amount they plan to spend in the near future in their hot wallet. Their remaining assets will stay in the cold wallet until they are needed for specific transactions.
Some investors choose to keep their cryptocurrency tokens in accounts linked to popular exchanges like Binance, Bitstamp, or Poloniex. These companies will store your funds in their infrastructure and can be considered hot wallet providers. If an investor keeps their tokens in a Binance, Bitstamp or Poloniex account, and an attacker gains access to one of these company’s servers, they could suffer a loss if the hacker is able to infiltrate their customer accounts.
Because many of the top digital currency exchanges allow users to transfer between various fiat currencies and cryptocurrencies, it’s common for users to hold small amounts of various currencies in their accounts. If they maintain a substantial balance of any currency, there is more risk of drawing the attention of hackers or, in the event of a theft, loses a substantial portion of their holdings.
In other words, the security of the hot wallet is dependent upon the security habits of individuals and third parties. They are vulnerable to theft because they are constantly connected to the Internet. As long as something is connected to the Internet, it is vulnerable to attack. But keeping very small amounts of digital currency in hot wallets is fine because of a hacker probably will not waste resources trying to gain access to small amounts of money.
Cold wallets are specifically designed devices that are designated physical cryptocurrency storage. In most cases, contrary to hot wallets, cold wallets are physical hardware devices designed for far more secure, long-term cryptocurrency storing for those that have significant amounts of digital assets that require strong security measures to protect.
Cold wallets usually come in the form of hardware similar to a USB stick. These encrypted and highly secure devices store your private keys entirely offline and have a PIN number as an additional security measure. Simply plug it in your computer, and you are ready to make a transaction.
Even if someone managed to steal your cold storage device, it still wouldn’t mean that your funds are lost as the hacker would need to decrypt it and hack your PIN number, which is proven nearly impossible to do.
However, cold storage doesn’t necessarily have to be a piece of hardware. In fact, even a plain piece of paper with a handwritten private key can serve as a cold wallet. As long as you keep it in a secure, fire-proof place, it does its job, even though it’s not as convenient as other options.
One of the biggest benefits that the cold wallets provide is that you can have your cryptos beside you – wherever you go. You could never take the device out of your pocket – these wallets are usually small and compact, which enables both comfort and discreteness while transferring or simply carrying them around.
- Most cryptocurrency wallets are digital, but hackers can sometimes gain access to these storage tools in spite of security measures designed to prevent theft.
- Cold storage is a way of holding cryptocurrency tokens offline.
- By using cold storage, cryptocurrency investors aim to prevent hackers from being able to access their holdings through traditional means.
Advantages of Cold Wallet
- It is the most secure option.
- As it’s completely offline, this provides a greater level of safety.
- It is much less susceptible to hacks.
Disadvantages of Cold Wallet
- It can be expensive as prices can range from US$59 for the Ledger Nano S to US$170 for the Trezor Model T.
- Extra steps required for trading. Save for the KeepKey which is partnered with ShapeShift exchange, users must first send their cryptocurrencies from their cold wallet to exchange before they can trade. And when cryptocurrency prices fluctuate by the minute, this can have a profound effect on your gains.
- It is harder to use. It requires at least 10 minutes for the initial set up, and you will need to plug in your device every time before sending your cryptocurrencies.
- It’s inconvenient even with the Ledger Nano X’s mobile feature allowing you to connect the device to your mobile phone via Bluetooth, it’s still not as convenient as a mobile wallet which is simply an app on your phone.
- It is much more of a task to store cryptocurrencies on a cold wallet.
Types of Cold Wallet
- Paper wallet: Storing your coins in a paper wallet is likened to storing your coins on a computer that has never been connected to the Internet. These are extremely secure due to the fact that the computers used to generate the private keys are not prone to cyber-attack. It is as good as free and it gives you confidence that your funds will remain safe for a very long time.
- Hardware wallets: When you compare cold wallets with hot wallets, the former might probably come out superior because of the security features of hardware wallets. They are powerful, convenient, and equally expensive. Although they are not as ubiquitous as their hot counterparts, these wallets are an excellent choice.
There are three main hardware wallet brands: Trezor.io, Ledger Nano S and KeepKey.
Each one has different features. For example, the Trezor customer service has been very good, the communication is outstanding and it supports many different currencies: Bitcoin, Dash, Ethereum, Ethereum Classic, ZCash, Litecoin, Namecoin, Dogecoin, and Testnet.
When a checking, savings or credit card account with a traditional bank has been compromised, the bank is able to refund the lost or stolen money back to the account holder. However, if your cryptocurrency account or wallet has been compromised and your Bitcoins have been stolen, the owner would be unable to recover his coins. The reason for this is that most digital currencies are decentralized and do not have the backing of a central bank or government. Hence, there is a need for a safe and secure medium of storage for Bitcoins and altcoins.
How is Cold Wallet secure?
Private keys stored on a wallet connected to the Internet are vulnerable to network-based theft. These wallets are known as hot wallets. With a hot wallet, all the functions required to complete a transaction are made from a single online device. The wallet generates and stores private keys; digitally signs transactions using private keys; and broadcasts the signed transaction to the network. The problem is that once the signed transactions have been broadcasted online, an attacker crawling the networks may become privy to the private key which was used to sign the transaction.
Cold wallet resolves this issue by signing the transaction with the private keys in an offline environment. Any transaction initiated online is temporarily transferred to an offline wallet kept on a device such as a USB, CD, hard drive, paper, or offline computer, where it is then digitally signed before it is transmitted to the online network. Because the private key does not come into contact with a server connected online during the signing process, even if an online hacker comes across the transaction, he/she would not be able to access the private key used for it. In exchange for this added security, the process of transferring to and from a cold storage device is somewhat more burdensome than the process for a hot wallet.
Comparison of Hot and Cold Wallets
Now, let’s go briefly about both wallets, which were built for different purposes, hence, this comparison will be as objective as possible.
- Safety: When we talk about safety, a hot wallet is not totally the best choice. This is because it is always connected to the Internet and this makes it vulnerable to hacking, phishing, etc.
- Speed of transactions: Hot wallets are specifically made for instant payments, fast transactions, and flexible operations. Cold wallets, on the other hand, are made to hold large amounts of coins for a long period of time. When we compare cold wallets vs. hot wallets, the latter offers faster transaction times.
- Support and integrations: Because of the nature of hot wallets, they are made to support a variety of coins, work well with APIs and other third-party integrations required.
- Amount of funds operable: We have adequately established that hot wallets should not contain more funds than necessary while cold wallets are able to hold as much cryptocurrency as possible. This makes cold wallets superior for storing in bulk.
We recommend keeping small amounts of cryptocurrencies in hot wallets for day to day trading or spending only, while the bulk of your cryptocurrencies should be kept in cold wallets. If you obtain any gains from trading, you should also consider how much you want to retain for further trading and immediately transfer the rest to cold wallets.
Cover Image: Your Charisma BV