Hot wallet vs Cold wallet
Updated: May 11
Holding your own cryptocurrencies on an exchange (where you can directly buy them) is the easiest way to hold your assets without worries, but probably, not the best one.
As pointed out in a previous article, exchanges can sometimes operate as black boxes and temporarily block funds and transactions because we must remember that the exchanges -that provide users with digital asset custodial services- are the same that hold the key pair. This can be dangerous, and safer solutions can be chosen.
Keep in mind that it is important to secure your funds when operating with cryptos, and even more in the DeFi world.
This article will cover different aspects such as the best choice to secure your funds, what is a crypto wallet, the differences between the two types, and their features and examples.
What is a cryptocurrency wallet?
Like a regular wallet for fiat currencies, a cryptocurrency wallet is a “place” (usually a program, software or a system) to store and secure your digital assets. Usually, it includes an address, a public key, and a private key that allow users to send, receive and manage their assets.
The public key is taken from the corresponding private key using the function of elliptic curve multiplication. It can be shareable with others, so they can send money to you or take money from your account when you authorise it.
The private key is similar to a bank account password or PIN; for this reason, you must not share it with anyone and keep it secure. It is used to prove the ownership of an account by signing each transaction. You can no longer access your funds if you lose or forget your private key. Due to its complexity (random 256-bit numbers), it is complicated to remember and note. To minimise this problem, a sort of backup mechanism in the wallets, known as the secret phase, has been created. This seed phrase is a collection of 12 or 24 English words -written in a particular order- that store all the information required to recover that funds.
The address is a hashed public key version. It is a shorter representation of the public key’s final part and is around 160bits in length. The address is the unique identifier of a crypto wallet, and its format depends on the related blockchain. Usually, it consists of 25-40 alphanumeric characters.
Two types of crypto wallets
When you buy cryptocurrencies on a centralized exchange, you have two options:
leave them using the offered storage service,
or you can decide to move them off the platform to a personal crypto wallet, which may be software connected to the Internet (hot wallet) or an utterly offline device known as a cold wallet or hardware wallet.
Different crypto storage options can serve different purposes, depending on what you want to do with your assets.
Hardware wallet or Cold wallet
A cold or hardware wallet is a physical storage device similar to a thumb drive that keeps your cryptocurrencies completely offline, protecting them from hacking and online attacks, using a smart card to secure private keys. Hack a hardware device is difficult but not impossible; when you buy one, you make sure it comes directly from a manufacturer instead of a secondhand or third party because they could be tempered. It’s a good choice to invest a few hundred dollars/euros to buy a cold wallet if you plan to invest in cryptocurrencies in the long term. The most known hardware wallets are Tresor and Ledger.
In this category are also collected paper wallets that, as the word suggests, are pieces of paper with QRcode, address and keys. Although they are part of cold wallets, they are made of paper and are less safe because they are subjected to deterioration.
Software wallet or Hot wallet
A hot wallet -desktop, web or mobile software- is a form of digital storage internet-connected. Because of the internet connection that can facilitate malicious attacks, they are less secure than a hardware one. On the other hand, they are entirely free to download and highly user-friendly thanks to their arranged and handy user interfaces. Furthermore, this type is preferred by traders operating in DeFi, who decide to have direct and immediate access to their funds with a few clicks.
Examples of hot wallets
There are so many downloadable hot wallets with different designs and intents. Before downloading and using their services, users must research the correct URL address to avoid scams.
Several software wallets are available on the market, among the best known: Metamask, Coinbase wallet, Binance wallet, Blockchain wallets and Robinhood.
Read about the best ten crypto hot wallets for beginners according to Coinmarketcap.
Is Metamask a hot wallet?
A prominent positioning concerning hot wallets is occupied by Metamask, which has become a giant for all DeFi users in recent years. As a digital wallet, it allows you to manage, send and receive a lot of ERC-20 tokens and -add the network Binance Smart Chain manually- exchange BEP-20 tokens. It is a browser extension for Google Chrome or Firefox that allows you to connect with Ethereum blockchain and others, operating with several dApps without having to host a complete node on your laptop. In September 2020, the smartphone app with the same features as the browser was launched.
To learn more, read this about different types of wallets.
What are the differences between hot wallets and cold wallets?
Hot and cold wallets are different regarding internet connections and other features such as
Cost: hot wallets are generally free to download instead, while cold wallets can vary from hundreds of dollars or euros.
User experience: hot wallets are more user-friendly, and the entire process of token transfer is facilitated.
Security: Hot wallets are highly secure thanks to various cryptography protections, but they cannot reach the security range of hardware wallets.
Most exchanges allow you to purchase cryptocurrency and hold them in the “company” wallet that provides you to offer a custodian service. But moving it to a hot wallet or more-secure cold storage can provide more security.
Thus storing cryptocurrency requires making a personal decision about how best to keep it safe while striking the right balance between functionality and security.
In order to solve the dilemma of choosing hot or cold wallets as a storage method, many crypto investors use both. It is common to hold a small portion of tokens in a hot wallet to facilitate transactions and to keep the more significant amount in a more-secure hardware wallet.