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Cryptocurrency wouldn’t work without wallets. Beyond sending and receiving tokens, these revolutionary digital wallets decrypt and encrypt data on the blockchain. Using sophisticated cryptographic technology, wallets can verify transactions without a central authority.
While you could store your tokens on a centralized exchange, you can’t honestly say they’re yours until you send them to an external wallet. Keeping coins in a non-custodial wallet ensures you have complete control over your digital assets.
When searching for a non-custodial crypto wallet, investors will soon discover two options: hot wallets vs. cold wallets. Choosing between these wallets will largely depend on how you like to use your crypto. But before we tackle the differences between hot wallets vs. cold wallets, let’s run through the basics of how crypto wallets work.
|A hot wallet is a device connected to the internet that stores private keys in an online environment
|A cold wallet is a device not connected to the internet that stores private keys in an offline environment
|> Highly accessible funds
> Connected to the internet
> Vulnerable to phishing and hacking
|> Highly secured
> Less accessible funds
> Not connected to the internet
|Cryptocurrency users who want to make quick online payments or transactions
|Cryptocurrency users who want to store their crypto assets with the highest levels of security
|Available through crypto exchanges like Coinbase and Binance or through third party providers like Exodus, Trust Wallet and MetaMask
|Cold wallets can be in the form of a paper wallet or a hardware wallet like the ones offered by Trezor and Ledger
|Vulnerable to hacking as they are connected to the internet
|More secured as private keys are kept offline which in turn improves security
How Do Crypto Wallets Work?
Whatever wallet you have, it will come with public and private keys. These strings of letters and numbers allow users to send, receive, and store tokens without third-party verification.
Although these keys work together, the private key is more consequential from a security standpoint. It’s the private key that gives you full custody of your crypto assets. Please remember that your wallet stores your private key, which gives you access to your cryptocurrencies.
By contrast, you could use the public key to send and receive cryptos. If you’ve ever sent crypto off of an exchange, then you’ve probably seen this address in the form of a QR code. The public key is connected to your private key, but it won’t reveal your wallet’s sensitive data.
Even if someone copies your public key, they can’t access your wallet. A true crypto thief would need to know your private key to hijack your identity and get into your funds.
While private keys are long lists of binary code, you don’t have to remember this string of numbers. Instead, you’ll learn your private key’s code in the form of a “seed phrase.”
These seed phrases usually contain 12 or 24 short words. While they look random on the surface, these words are the “magic formula” that corresponds with your private key. When you’re setting up a crypto wallet, you must copy these words on a few pieces of paper and keep them in a secure location (preferably a fireproof safe).
Since there’s no FDIC in crypto, you need this seed phrase to prove your identity and recover lost funds. For instance, if your phone dies and you have to download a wallet app on a new device, you must input this seed phrase to get your crypto back. On the downside, anyone who knows your seed phrase could quickly get into your wallet.
No matter which wallet you use, it’s imperative you write your seed phrase on a few pieces of paper and keep them locked away. Please never share your seed phrase with anyone you don’t 100 percent trust.
In short, you can share your public keys with individuals in order to receive transactions. On the other hand, your private keys must be kept secret at all times. If anyone has access to your private keys, they will also have access to any cryptocurrency associated with those keys.
What Are Cold Wallets?
The main distinction between hot wallets vs. cold wallets is that the latter aren’t connected to the Internet. You may also see cold wallets described as “air-gapped,” which means they store private keys offline.
Since a cold wallet’s private keys aren’t on the Internet, there’s no risk of a cyber attack. If someone wanted to steal the funds in your cold wallet, they’d need the physical device as well as your private key or PIN.
Thanks to this additional level of security, cold wallets remain the premier choice for secure crypto self-custody.
How Do Cold Wallets Work?
The most commonly used cold wallet is called a “hardware wallet.” Appearance-wise, these devices look similar to a standard USB flash drive and they’re designed to plug into your desktop’s USB port.
Since your hardware wallet’s private keys are in this physical device, you can’t initiate a transaction unless it’s plugged into your computer. Usually, hardware wallets also require users to set up a PIN code for additional security.
Nowadays, hardware wallets are the most popular choice for cold storage. However, in the early days of crypto, some investors used “paper wallets” to secure their Bitcoin. Just as it sounds, paper wallets keep the public and private keys plus transaction details on a piece of paper. While this helps take your keys offline, it creates many novel security risks.
It’s pretty easy to tear, smudge, or lose a piece of paper, which could make recovering lost funds virtually impossible. Also, since you first need to generate the keys for your paper wallet online, a smart hacker could see your private key, especially if you’re using a corrupted computer.
While paper wallets are still around, they’re not as widely used or supported as hardware wallets.
Cold Wallets Pros
- The safest way to store crypto
- Ideal for long-term crypto investors
Cold Wallets Cons
- Costs more upfront
- Difficult to use on the go
- Inconvenient for active traders or DeFi users
Never share your private keys with anyone. Private keys give individuals the ability to prove ownership or spend the funds associated with a public address.
When Should You Use Cold Wallets?
Security is the top-selling point for cold wallets. So, if you’re someone who plans on holding a lot of crypto for the long haul, it’s worth investing in one of these units. You’ll feel a lot more relaxed knowing your private keys are stored offline.
Yes, these units are more expensive and cumbersome than hot wallets—but that’s a part of their extra security! If you’re primarily interested in investing in cryptocurrency, then the inconveniences of hardware wallets aren’t that big of a deal.
What Are Hot Wallets?
Hot wallets aren’t “hot” because they’re trendy. These wallets have “hot” in their name because they’re always connected to the Internet.
Unlike cold storage options, hot wallets are always online. While this makes hot wallets more vulnerable to cyberattacks, it also makes them easier to use when making purchases, trading, or using dApps.
How Do Hot Wallets Work?
Hot wallets work the same as cold wallets, except the private keys aren’t stored offline. Instead, a hot wallet’s private and public keys are in your digital app, hence they’re on the Internet. In technical terms, all hot wallets are “non-air-gapped.”
Hot wallets are available in a few forms, but the two most common include desktop and mobile apps. As long as these applications work on your preferred device and browser, you can download them as you would any other app.
However, you could also set up a Web-based hot wallet URL. If you set up a Web wallet, you’ll need to create a username and password to access your funds on your chosen website.
There are dozens of high-quality hot wallets on Google Play and the App Store, but here are a few noteworthy names:
Hot Wallets Pros
- Easier to actively trade and send cryptos
- Seamlessly integrates with Web3 dApps
- Usually free to download
- Gives traders more security and ownership than an exchange wallet
Hot Wallets Pros
- They aren’t hack-proof
- Not an excellent option for large sums of crypto
- Some Web wallets don’t provide you with private keys
When Should You Use Hot Wallets?
No matter how hi-tech a hot wallet is, it will never be as safe as a high-quality cold wallet. While hot wallets are “safer” than crypto exchanges, their primary benefit is convenience.
If you’re someone who loves to trade or spend your crypto, then hot wallets are a must because you need specific hot wallets to interact with popular sites like Uniswap, OpenSea, or Pancake Swap.
However, it’s never a good idea to store the bulk of your crypto in a hot wallet. Only put the amount of crypto you want to use on your hot wallet at any given time.
FAQs About Hot Wallets vs. Cold Wallets
We’ve found some of the most frequently asked questions with regards to hot wallets and cold wallets. Here are our answers:
Is Coinbase a Hot Wallet or a Cold Wallet?
If you have crypto in your Coinbase account, you’re using a custodial hot wallet. Although Coinbase claims it keeps most of its crypto in cold storage, you have to interact with Coinbase’s website to access your funds. Also, please never forget that Coinbase holds your private keys as long as you keep your crypto on the exchange.
However, if you’re talking about the Coinbase Wallet, that’s a different story. While Coinbase created this app, the Coinbase Wallet is a non-custodial mobile wallet. So, if you send your crypto from Coinbase to the Coinbase Wallet, you have control over your private keys.
Is a Hot Wallet Safer than an Exchange Wallet?
As long as you’re using a highly-rated hot wallet, it’s usually safer than an exchange wallet. If your crypto is on an exchange, you don’t have control over your private keys. Also, it’s more likely hackers would target a big business like Binance than external software wallets.
Besides the increased risk for cyberattacks, there’s always a chance your chosen exchange could go bankrupt. In less extreme cases, your crypto exchange could temporarily block your account or crash due to heavy volume.
The only possible safety-related benefit of using an exchange wallet is insurance. Some exchanges like Gemini and Coinbase offer FDIC protection on USD. There are even a few exchanges like Binance that have SAFU reserve funds in case of a crypto cyberattack.
Despite these insurance perks, an external hot wallet usually provides a higher degree of security than an exchange. Of course, this assumes you’re using a hot wallet with a solid track record, and you have your “seed phrase” in a locked safe. If you’re using a shady software wallet, then it may be safer to keep your funds on a high-quality exchange.
Please never assume any old hot wallet is safer than an exchange. Please do plenty of research before choosing which hot wallet to use.
Can Cold Wallets Be Hacked?
Technically, it’s impossible to hack a cold wallet. However, this doesn’t mean hardware wallets are “theft-proof.” Indeed, a few studies suggest hackers could decode a hardware device’s PIN when it’s plugged into a computer.
While someone could steal funds from a cold wallet, it’s less likely versus a hot wallet. If you keep your cold wallet’s PIN and private key in a fireproof safe, the chances you’ll lose your crypto are low.
Final Thoughts on Hot Wallets vs. Cold Wallets
Please don’t feel you need to choose between hot or cold storage. Indeed, many crypto investors use software and hardware wallets to secure their assets. While you should put the bulk of your crypto in cold storage, it’s helpful to have a few mobile or desktop wallets for ease of use.
If you’re a long-term investor, you should purchase a hardware wallet for the bulk of your crypto holdings. However, since most software wallets are free to download, adding a few to your phone or desktop doesn’t hurt.
As a final warning: Always write down the seed phrase for each of your wallets and keep them locked away.
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Eric Esposito is a freelance writer, editor, and cryptocurrency enthusiast. Although it took him a few years to grasp the Bitcoin revolution, Eric has become a crypto convert and long-term “hodler.” Besides crypto investing, Eric is interested in helping others understand how to safely stack sats with passive income opportunities.