The difference between hot and cold wallets in the digital currency world
Digital currency exchanges are notorious for their vulnerability to cybercrimes. Although cryptocurrencies were created to offer an added layer of security and privacy, the exchanges where altcoins are bought, sold and stored have been mired with doubt due to hacks. Since 2011 there have been at least three dozen heists of such exchanges. Altogether more than 980,000 Bitcoins have been stolen, which today would amount to $13.5 billion, and very few Bitcoins have been reclaimed.
COTI’s main consumer offering is a wallet that provides instant, easy access to the COTI payments network and supports a variety of consumer payments use cases. COTI wallets can be used in peer to peer (P2P) transactions, as payments to merchants and as a way of storing and exchanging digital and fiat currencies.
COTI-powered merchants will have access to a dashboard with wallet-like functionality that enables them to make payments to COTI wallet-holders and other COTI-powered merchants, as well as to use COTI’s currency exchange facility. You can read more about COTI wallets for consumers and merchants in the Overview Document online.
Many cryptocurrencies are held in digital wallets through exchanges and are considered hot wallets as they’re online and connected to the Internet. To overcome the downfalls of such wallets, cold wallets were created and act as offline backups in the form of hardware and paper wallets that are not connected to the Internet. These days most people who own digital currencies have both hot and cold wallets.
Best practice tips:
- Don’t keep your money on exchanges longer than you need to. If you day trade, understand the risks involved in doing so.
- Set up your hot and cold wallets by planning the amount of digital currencies you’ll be storing, whether you’ll use them over the short or long term and what security risks you’re willing to take.
- Use cold wallets for large amounts of money that you don’t plan on using for a while.
- Always use hardware wallets that are PIN or password-protected.
- Set up multi-signature, multi-party, or multi-factor wallets for weekly transactions.
- Reserve your hot wallet for micropayments.
Hot Wallet: Pros & Cons
- Efficient access to your digital currencies.
- User-friendly applications streamline the payment interface.
- Digital currencies are prone to cybercrime and fraud.
- Your funds may be permanently lost.
Cold Storage: Pros & Cons
- A robust method for storing large amounts of cryptocurrencies for a long period of time.
- Greater security as the funds are stored offline.
- Vulnerable to external damage, human error and theft.
- Not efficient for micropayments and daily transactions.
Types of cold wallets:
- Hardware wallets
Physical devices like Trezor, Ledger Nano S and KeepKey support a range of digital currencies like Bitcoin, Ethereum, Dash and ZCash. They employ two-factor authentication using FIDO/U2F industry standards, logins with single or multiple sessions and encryption with GPG. If you happen to lose your hardware wallets, you can regain access to your keys, funds and account history as long as you remember your password.
- Paper wallets
Receiving and sending digital currencies requires access to public and private keys. Your private key should never exposed because it would provide outside parties with access to your funds. Instead of storing your private key online, printing out a paper wallet with all your account information is a better way to keep your money safe. Paper wallets can be created offline using a software program that randomly generates public and private keys. The program can be deleted after to erase any trace of the keys.
Types of hot wallets:
- Cloud wallets
These types of wallets store cryptocurrencies using any device that can connect to the Internet, such as a mobile phone or computer. Desktop wallets like Exodus encrypt all your blockchain assets and stores them directly on your computer.
- Multi-signature wallets
Transactions that are processed through a multi-signature wallet need two to three keys in order to access funds. This makes it especially difficult for hackers to access the information and be able to guess multiple private keys.
A multi-signature wallet like BitGo issues three private keys: one is held by the company itself, one is stored by the user and the third one is a backup that can be given to a trusted party for safekeeping.
To ensure that your digital currencies stay secure, follow our best practice tips and evaluate the benefits and disadvantages of hot and cold wallets, as well as the different options that are available to you.
Read more about COTI wallets for consumers and merchants in the Overview Document online.