Understanding Crypto Wallets: Hot vs Cold Storage

Selecting a crypto wallet is a crucial decision any investor must make. As cryptocurrencies gain popularity and more people start using them, it is vital to know the difference between hot and cold wallets. 

Both are used to store your digital assets, but they are done in a way that suits your requirements for access and security. Both have advantages and disadvantages, which will be discussed in this guide to enable you to make the right choice depending on your preference.

What Are Crypto Wallets? 

A cryptocurrency wallet is an application that enables users to manage their digital assets, such as Bitcoin, Ethereum, and other cryptocurrencies, by allowing them to send, receive, and store them.

Wallets do not hold cryptocurrencies like a physical wallet holds cash. Instead, they save your public and private keys—long sequences of characters that open access to your digital assets. 

There are two main types of wallets: hot wallets and cold wallets. Each has its characteristics, strengths, and weaknesses and can be used depending on the trader’s and investor’s preferences. 

Hot Wallets: Definition & Characteristics 

A hot wallet is any wallet connected to the internet; in other words, it can be accessed and used online. These wallets provide fast and convenient access to your cryptocurrencies, which are suitable for active traders and those who frequently use their digital currencies. 

Hot wallets come in various forms, including: 

• Web wallets: Accessible through a browser.

• Mobile wallets: Installed on your smartphone.

• Desktop wallets: Installed on your computer

Hot wallets are always connected to the Internet and are therefore ideal for constant use due to their convenience in trading. However, they are also easily attacked by hackers and other cybercriminals.

Pros of Hot Wallets

1. Convenience: It is suitable for short-term use, daily operations, and trading activities since it gives instant access to the funds. 

2. User-friendly: All hot wallets are relatively easy to use, especially for those new to cryptocurrency. 

3. Variety: There are various categories of hot wallets, including features such as two-factor authentication (2FA) and biometric access. 

Cons of Hot Wallets

1. Security risks: They are more vulnerable to hacking because they are always connected to the Internet. 

2. Risk of malware: If your device is infected, all your private keys can be stolen. 

3. Not ideal for long-term storage: Due to security concerns, hot wallets should not be used to store a large amount of cryptocurrency. 

Cold Wallets: Definition and Characteristics 

In simple terms, a cold wallet is a wallet that is not connected to the internet. Cold wallets are also known as ‘offline wallets’ and are considered highly secure compared to hot wallets. They keep your private keys completely offline, which minimizes the chances of hackers and cybercriminals attacking your accounts. 

There are two main types of cold wallets: 

• Hardware wallets: Hardware devices that keep your keys off the internet. 

• Paper wallets: Your private and public keys are in hard copy format. 

Cold wallets are considered the best for storing large amounts of cryptocurrency in the long run. However, they are unsuitable for frequent use because you need to reconnect the device to the internet to transfer money.

Pros of Cold Wallets

1. High security: They cannot be hacked because they do not have an internet connection like the other operating systems. 

2. Ideal for long-term storage: Hodlers are ideal for storing a large amount of cryptocurrency for an extended period, and cold wallets are the best example of holders. 

3. Protection against malware: As you continue using them, they do not connect to the internet; hence, viruses in your computer or phone will not harm them. 

Cons of Cold Wallets: 

1. Less convenient: Cold wallets require you to connect to the Internet to make transactions, which may take time and effort. 

2. Potential for physical loss: The disadvantage of using a hardware or paper wallet is that if you misplace it, you may have a hard time or even be unable to get your money back. 

3. Learning curve: Creating a cold wallet could be more challenging for the learner than creating a hot wallet. 

Hot vs. Cold Storage: Main Differences Elaborated 

Before choosing between hot and cold wallets, knowing the differences that define how your cryptocurrencies are stored and how to use them is essential. Here’s a breakdown of the main contrasts:  

Accessibility 

Hot wallets are connected to the Internet, making them very convenient for fast operations. You can use them instantly to purchase, sell, or exchange assets.

Cold wallets, on the other hand, are offline. They are more secure than randomly generated addresses. Still, one needs to reconnect to the Internet to gain access to the funds, making them less suitable for daily usage. 

Security 

Hot wallets are more exposed to cybercriminals, phishing scams, and hackers because they are mostly found online. As the name suggests, cold wallets are more secure since they don’t connect to the internet. Cold storage is generally considered safer if you hold large amounts of cryptocurrency for the long term. 

Usage 

Hot wallets are ideal for people who actively trade or use their cryptocurrencies. They are suitable for dynamic trading where the trader requires quick access to their money. Cold wallets are ideal for long-term investors wishing to ‘HODL’ their coins without exposure to risks.

Storage Amount 

Hot wallets hold relatively small amounts of cryptos for daily or temporary use. Cold wallets are intended for large amounts of cryptocurrency to be stored for an extended period and are more vulnerable to cyber threats. 

Ease of Setup 

Hot wallets are convenient and require little learning, so they are popular among new investors. Cold wallets, such as hardware or paper wallets, are slightly more complex to use but offer the highest levels of security.

Selecting the Right Wallet for You 

Choosing between a hot and a cold wallet depends on your requirements and how you interact with your cryptocurrency. Here are a few questions to ask yourself before making a decision: 

• Do you trade often? 

If so, it is advisable to use a hot wallet, which enables you to easily purchase, sell, or swap assets without re-establishing a device’s connection to the internet. 

• Will you intend to ‘hold’ a lot of cryptocurrency in the future? 

A cold wallet is safer because it provides the ultimate level of protection for the user’s funds. 

• Do you value convenience or security more?

Cold wallets keep the funds secure at the expense of user convenience, while hot wallets are convenient but could be more secure. 

Most investors should integrate both wallets in some way. A hot wallet can be used daily, while most crypto coins and tokens can be stored in a cold wallet. 

This strategy is the best of both worlds since it can provide flexibility in trade while safeguarding the investment. 

Real-world Example: The Mt. Gox Hack

A famous cryptocurrency hack in history is the 2014 hack of the Japanese Bitcoin exchange Mt. Gox. About 850,000 Bitcoins, which in today’s terms are several billion dollars, were stolen. The exchange kept most of its money in hot wallets, making it vulnerable to hackers. 

This event shows why storing a significant portion of one’s cryptocurrency in a hot wallet is unwise and why cold storage could be a more secure option for long-term investments. 

 Read CoinDesk’s article on Mt. Gox Hack to learn more about this historical hack. 

Security Best Practices for Both Hot and Cold Wallets

In both cases, choosing a hot or a cold wallet, there are measures you can take to enhance the security of your assets.  

1. Enable Two-Factor Authentication (2FA) 

Enabling 2FA increases hot wallets’ security, and using hot wallets is convenient and fast. Even if a hacker manages to get your password, they will still require your phone or email to complete the login process.  

2. Use a Secure Backup 

The good thing about using a wallet is that you should always make a backup if anything goes wrong. This could mean moving your private keys to secure storage for hot wallets. For cold wallets, the safety and security of the recovery phase are paramount.  

3. Keep Software Updated 

Hot wallets are generally updated with security features crucial in avoiding new threats. Ensuring that your wallet software is the latest version is always essential. 

4. Avoid Public Wi-Fi 

You should only connect to your hot wallet in public areas that use Wi-Fi, which is usually safe but can be a source of attacks.  

5. How to Keep Your Hardware Wallet Safe 

If you have a hardware wallet, keep it secure and protected from water, fire, and other damage. 

Conclusion 

Your trading plan and how you intend to utilize your digital currency determine whether you use a hot or cold wallet. Hot wallets allow easy access to your coins and are suitable for trading, but they are more prone to hacking. 

While cold wallets provide the highest level of protection for storage, they are not ideal for daily use when making transactions. 

While certain risks are associated with hot and cold wallets, the information discussed above will help you decide based on your goals. 

Whether you are a short-term or position trader, protecting your investments is essential in this age of cryptocurrencies. 

To read more about cryptocurrency security, check out the Blockchain Council, a worldwide informative blockchain and cryptocurrency platform.