Hot Wallets vs. Cold Wallets

If you are new to crypto, you might have already come across the never-ending debate between proponents of hot wallets and those of cold wallets. The truth is that there is no clear winner in this debate. Both wallets offer their own sets of advantages and disadvantages and you might prefer one over the other depending on how you want to use them. 

In this guide, you will learn the key differences between these two wallet categories, review several use cases for each type of wallet and get a clear understanding of what wallets suit your needs.

Cryptocurrency Wallets: A Simplified Definition

First of all, what is a wallet in the world of crypto? Well, similar to normal wallets, you can think of crypto wallets as devices that help you store your wealth (in this case, cryptocurrencies and tokens). 

However, the term wallet might be a bit misleading as crypto wallets don’t store the tokens and cryptocurrencies the same way a regular wallet stores banknotes and coins. Instead, a crypto wallet only holds your private and public keys.

How does a crypto wallet work?

As a primer, the blockchain works as a record of transactions between peers. In Bitcoin’s case, for example, the blockchain keeps an immutable record of how many Bitcoins have been sent from one wallet to the other. Each wallet comes with unique identifiers in the form of a private key and a public key. As the names suggest, the private key remains private as it gives ultimate control to the wallet and the public key can be shared for receiving transactions.

Only those with the private keys to a wallet can change balances and move Bitcoin around. Therefore you can think of the private key as a unique identifier of a wallet’s owner and the public key or address as an account number you send to your peers when you want them to send Bitcoin to your account. This model secures your wallet such that even though it’s visible to the public through the public key, it remains secure thanks to the private key.

Therefore, a crypto wallet is more like a post office box with two keys. The public key enables other peers to know where to send Bitcoin if you transact with them and the private key acts as the ultimate password that allows you to access your Bitcoin on the blockchain. Anyone who has access to the private key of a wallet, ultimately has control of the Bitcoins addressed to that wallet on the blockchain network. 

This also means that if you lose your private keys or addresses, you lose your Bitcoin altogether. Even though the Bitcoin blockchain still has records of how much Bitcoin you own, without the private keys, you remain locked out of your account forever.

Wallet Categories 

Even though all crypto wallets operate under the principle highlighted above, they come in different forms. There are desktop wallets that store your private keys on your desktop, paper wallets that store the keys physical paper or hardware wallets that come with a device, custodial wallets on exchanges, and mobile wallets. All these can be categorized into the two major categories that we will be discussing, i.e., Hot and Cold wallets.

Hot wallets

A ‘hot’ wallet is a crypto wallet whose private and public keys are stored online. This could be on an exchange platform like Coinbase or Binance or a mobile or desktop software. The term ‘hot’ means the wallet is always ready to be used especially for everyday purchases. With a hot wallet, you can seamlessly make transactions on the go. Most exchanges will offer these types of wallets for free. 

Even though hot wallets are the most common wallets and feature ease-of-use and accessibility, they lack sufficient security especially for large amounts of crypto holdings. This is where cold wallets come in handy.

Cold wallets

Cold wallets, unlike hot wallets, are not connected to the internet. Therefore, the private keys of a cold wallet are stored either on an offline device or written down on physical paper. Therefore, the owner of a cold wallet will only connect to the internet when in need of making transactions. 

The most common types of cold wallets are hardware wallets such as Ledger Nano and Trezor. Compared to paper wallets, hardware wallets are easier to use as they feature intuitive user interfaces as well as customer support features from manufacturers. Both hardware and paper wallets are used for securing large sums of cryptocurrencies. To use any cold wallet, the private and public keys have to be imported temporarily via a scan to a hot wallet to connect to the blockchain. 

Why and how to use a cold wallet

Cold wallets are great for the long-term storage of cryptocurrencies. Since they are not always connected to the internet, the chances of a hack taking place on a cold wallet are close to minimal. Most users with large amounts of crypto prefer to store them in a cold wallet device or physical paper wallets. Paper wallets, for instance, have been around since 2011 and are known to be popular among crypto whales with large Bitcoin holdings. The device or paper wallet can be kept in a safe as losing the device or papers is as good as losing your entire crypto holdings.

Cold wallets are ideal for users looking to move large amounts of money in the most efficient way possible. With a simple hardware wallet the size of a USB drive, you can practically carry with you unlimited amounts of wealth in crypto. 

Also, since most cold wallets are programmed to be compatible with available operating systems, you can take your cold wallet with you anywhere and still have access to your cryptocurrencies on the blockchain.

For safety, you can make a written backup of the seed phrase generated when you configure your hardware device. This backup phrase will be useful in recovering your wallet’s contents in case you lose the hardware device. If you go for the paper wallet, the safest move is to keep them in a safe. Also, while generating a cold paper wallet, download the wallet generator and go offline before generating the paper wallet. This reduces the chance of hackers hijacking the entire process or copying your seed phrase with malware. 

While cold wallets are ideal for storing large amounts of crypto, they are not the most convenient for trading and making daily purchases as you have to connect to the internet with every transaction. 

Here is a recap of the pros and cons of a cold wallet.

Pros of Cold Wallets

• Provide guaranteed safekeeping and protection from hackers
• Cold wallets are portability
• Cold wallets such as paper wallets are simple and easy to use
• Ideal storage of value and savings
• Paper and hardware wallets can be encrypted for more security

Cons of Cold Wallets

• Without a backup, you can lose all your crypto
• They are inconvenient for daily transactions
• Require extra care and protection e.g. A safe
• They are not free

Hot wallet use cases

Hot wallets are useful for daily crypto transactions. If you are looking to trade cryptocurrencies or make daily purchases, hot wallets offer the most convenience as they are already connected to the internet. They are also easier to manage as all that is required for safekeeping is the password and two-factor authentication. 

Although the hot wallet’s connection to the internet increase convenience, it also increases the chances of hackers getting access to the wallet. You can however mitigate the problem by using a multi-signature wallet that requires confirmation of the transaction from several different people. 

Like any other software program, hot wallets can have errors in their code that create vulnerabilities that can be exploited by hackers. To offer protection to users, some exchanges offer insurance on coins stored in hot wallets. Others have backed up reserves stored in cold wallets for protection. Overall, using a hot wallet is risky. However, you can use third-party software such as the Google 2FA authenticator as well as antivirus software to add layers of protection to your hot wallet. Also, never give out the seed phrase of your hot wallet to anyone. Some hackers have used clever tactics of acquiring a wallet’s seed phrase; however, most victims end up giving up the seed phrase out of ignorance.

For best practices, you should only keep a small amount of your portfolio in a hot wallet.

Pros of Hot Wallets

• Easy to manage
• Ideal for micropayments and moving money around
• Can be accessed from anywhere with an internet connection
• They are free

Cons of Hot Wallets

• They are vulnerable to attacks
• There don’t offer full control of the private keys

Examples of Cold and Hot Wallets

As discussed above, hot wallets are the most common types of wallets as they are free. You can easily get one by opening up an account with an exchange or downloading a desktop or browser wallet such as MetaMask. 

To boost the security of hot wallets, some manufacturers create hybrid wallets that can be used either as hot or cold wallets. In no particular order, the following list will highlight some common examples of cold and hot wallets you will find out there.

Atomic wallet (desktop and mobile hot wallet)

This wallet is one of the most popular hot wallets as it features support for more than 300 cryptocurrencies. If you are looking for a hot wallet with an intuitive user interface and easy integration with popular exchanges, this desktop wallet has an easy answer. It features an intuitive UI and comes with customer support. Although it’s not as secure as a hardware wallet it is a better alternative than leaving large sums of your crypto on an exchange. 

Leger Nano (Hardware wallet)

This wallet is one of the most popular hardware wallets out there and Trezor’s main competitor. The wallet comes in a sleek device the size of a USB drive and features an intuitive user interface plus an app that can be downloaded on your phone.

Trezor

This was the pioneer of cold wallets with the release of their first product in 2013. Since then, the small and compact Trezor wallets have become the industry’s staple. The manufacturer is known for releasing constant updates to their cold wallets to further boost protection from hackers which is great for security.

Blockchain.com

This is a hot wallet that also operates as a cryptocurrency blockchain explorer. Since its first release in August 2011, Blockchain.com has served as a gateway hot wallet for many beginners in the crypto world. Their software comes with an easy-to-use interface that can be secured with two-factor authentication.

Should I get a cold wallet or a hot wallet?

Whether you are going for a hot or cold wallet, the number one priority for anyone looking to hold cryptocurrencies for any purpose is security. If you are just starting, you can get a hot wallet and download free desktop or mobile software as you learn more about crypto. Cold wallets have a steeper learning curve compared to hot wallets.

However, once you accumulate a substantial amount of crypto, the best idea is to purchase a hardware wallet. Keep in mind that even though you might have a hardware wallet, it is still important to be careful only to use it on verified platforms and check your devices for malware. 

Other considerations to have in mind while picking a cold wallet include the quality of the wallet, its size, and its capacity to withstand the elements. The best move is to pick a durable wallet that is easy to store, as losing your hardware wallet results in losing your cryptocurrencies. 

Best Practices

A wallet is an essential tool for any crypto enthusiast. A good wallet can help you store your coins for the long term and still have access to them years later. What you need to remember from this guide is that cold wallets offer the best security but have limited convenience and hot wallets are intuitive, easily accessible but lack security. However, no matter the wallet you go for, you should consider some best practices for keeping your wallet safe. 

These practices include;

• Enabling multiple-factor authentication to your wallet, 
• Backing up your wallet’s keys in several secure places
• Manually updating your hot wallet’s software and turning off automatic updates

Overall, the rule of thumb is to only have what you need for daily transactions on your hot wallet and leave the rest on your cold wallet, similar to a pocked and a bank account.