Hot or cold, which wallet is the one for you?
You’ve decided to join the world of cryptocurrencies. Whether as an investor, a trader or simply to receive and facilitate payments, the first thing that you will need to set up and configure is your wallet. You have to have a wallet in order to facilitate transactions when and if you decide to purchase or charge for goods or services using cryptocurrency or in order to buy or sell cryptocurrencies.
There are different wallet options available to you and it is important that you fully understand the difference between them before deciding which one to set up. You will need to decide whether you are going to use a cold or hot wallet or a combination of the two and in this article, we will explain the difference between them and outline some points to bear in mind when using either, or both.
To start, regardless of the wallet that you set up, you will be provided with private and public keys, although in some cases your private keys may be held by the third party or exchange you used to set up your wallet. These keys are critical for your security and fundamental to your being able to transact. Without them, you cannot buy, sell, receive or make payments using your wallet and cryptocurrency.
Your public key enables cryptocurrency to be transferred to your wallet and you can think of it in a similar way to your bank account and routing numbers. If someone needs to deposit money into your account, they would need your bank account number and routing number in order to do so. The same applies to cryptocurrency except that it is known as your public key. Anyone could know your public key but simply knowing it would not enable them to withdraw or transact on your account.
Your private key is required in order to verify transactions and to prove the ownership of a specific blockchain address. Without your private key, a transaction cannot be verified and validated by the network. Your private key also enables you to access your wallet, view your balances and transact.
You may never see your private key, as some wallet providers, have created a user-friendly system that encodes your private key in such a way that is easy for you to record and remember, and in some cases, they hold it on your behalf. For example, MetaMask assigns you a string of random words that you use to unlock your funds or recover your account. Your private key is hidden inside the software behind this string of words. Another reason you may never see your private key is if you use an exchange wallet such as Binance or Coinbase. In that case, the company holds your private keys on your behalf, and in theory, they, therefore, control your funds.
What is a hot wallet?
Essentially a hot wallet is a cryptocurrency wallet that is always connected to the internet or cryptocurrency network and its infrastructure. For you, your hot wallet is the interface used for accessing and storing your cryptocurrency. Hot wallets are great for ease of use as well as for transactions using cryptocurrency online. For any transactions, the cryptocurrency network is responsible for facilitating changes to the transaction record. Should you receive, pay, sell or buy cryptocurrency it is responsible for ensuring that the decentralized blockchain ledger is updated.
Hot wallets are always online and there is no need to transition between offline and online in order to make a transaction. While some may question the security of a hot wallet due to the fact that it is always online, the technology and software used are very difficult to hack but not impenetrable as the devices through which you access your wallet might be accessible. Device security is critical to ensure your overall wallet security. Some examples of hot wallets include exchange wallets, web wallets, mobile wallets, and desktop wallets.
Pros:
- You can instantly access your funds and make a transaction 24/7.
- Most hot wallets are user-friendly, easy to install, and relatively simple to operate. The interface is designed to make it easy to use and many hot wallets are connected to exchanges to make it easier to transact.
- Most hot wallets are either available for free or have a low maintenance cost and so do not require any capital outlay on your part.
- Reduced risk of losing your assets and private keys as your private keys and security thereof is the responsibility of a third party. Most web-based wallets are custodial wallets and so your private keys are held by a third party.
- Exchanges such as Coinbase provide hot wallets that insure users get their deposits should something happen.
Cons:
- Should the exchange or resource that provides your hot wallet close, their infrastructure be destroyed, or your funds not be insured, then you’ll lose all your assets.
- Most of the hot wallets that are provided do not give you access to your private keys. You are therefore unable to conduct transactions without an intermediary and so you never have full control over your funds.
- Hot wallets are less secure and more vulnerable to theft as public and private keys are stored on the internet. There have been numerous attacks on exchanges and in many cases losses of the assets resulted.
What is a cold wallet?
A cold wallet is a hardware device or application that is not on the internet and is used to store your private keys and cryptocurrency offline. Cold wallets are probably the most secure way to store your cryptocurrency as a person wanting to gain access to your holdings would need to obtain the physical device that they are stored on and have access to the associated PINS, keys, and passwords.
Another device, typically a computer would be required in order to connect to your cold wallet and move any cryptocurrency to a hot wallet. In order to use your cryptocurrency for a transaction, you would have to transfer the cryptocurrency to your hot wallet.
Pros:
- Cold wallets are secure as they are not connected to the internet.
- Cold wallets are easy to use and your digital assets are located on a physical asset that you control and secure.
Cons:
- Unlike hot wallets which are mostly free or have low fees, most cold wallets require some hardware. These are estimated to cost $100 on average to acquire.
- If you lose or damage the device your cryptocurrency wallet is stored on, you lose your wallet and all your assets.
- You do not have instant access to your funds should you wish to make a transaction and it would require you to connect, access, and transfer your cryptocurrency stored on your cold wallet to your hot wallet in order to transact.
- You are unable to stake your crypto or earn any interest. Your cryptocurrency cannot be used and its only change in value is based on the price or value of the cryptocurrency in the market.
Summary
Your cryptocurrency is an asset and like with any asset, you need to ensure that you make the best decision as to how you want to use, protect, secure, and manage it. As you can see from the above, both types of wallets have their pros and cons. Depending on what you want to do with your cryptocurrency, you may need to strike a balance between security and functionality.
For people who hold large amounts of cryptocurrency, it is advisable to store the bulk of it offline in a cold wallet and only keep what is required for transactions in your hot wallet. If you are someone who wants to maintain personal custody of your cryptocurrency and keys, then a cold wallet that you hold and control is the best option. This will better secure your holdings, however should you require cryptocurrency to transact you will need to transfer this to your hot wallet.
If you decide to use a hot wallet or exchange wallet and hold all your cryptocurrency there, make sure to select a provider that has a strong security reputation and better yet insures your holdings in the case of theft or closure. Make sure that if you select a hot wallet that you follow their security guidelines or you may be liable for the cause of your asset loss.
For many, a combination of the two is the best solution. It provides them with the best of both worlds. A cold wallet for the security of the bulk of their holdings and the ease of access with a hot wallet to transact on a day-to-day basis.
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