Hot and cold wallet: What are their differences
In the world of cryptocurrency, a wallet is a digital storage space for your digital assets, such as Bitcoin, Ethereum, and other cryptocurrencies. It is a place for you to manage your cryptocurrency at your finger without the coding knowledge needed.
However, do note that crypto wallets are just simple UX/UI software that gives users access to a coin on the blockchain. Thus, your crypto is always “on the blockchain, not wallet providers”. Not to mention the case that it’s centralized/custodial services like FTX or you got scammed by fake projects.
Therefore, in order for you to understand blockchain technology, today we will explore the term “crypto wallet” a little bit deeper. To begin with, there are two main types of wallets: hot and cold wallets.
"Hot wallet" refers to any wallet that is connected to the internet at all times. In the list, there are online wallets (browser extensions), mobile wallets (apps on mobile phones), and software wallets (apps that need to be downloaded onto a computer). If we compare these three sub-types, online wallets are considered the least secure because they are vulnerable to coin/private key theft if they are attacked, as transactions occur online through a browser. However, it is also the most convenient to use.
Note: Many well-known exchanges often store their clients' coins in the company's private cold wallet, and divide some coins into the hot wallet to prepare for customer usage. Therefore, if users choose to store their cryptocurrency on an exchange, they should at least study the information about the service to ensure their background and how they work. Otherwise, it may end up being like FTX (FTX collapsed due to poor backend management).
Easy to use, easy to understand, and always connected to the internet.
Convenient access, suitable for frequent traders.
Can store anywhere from one to tens of thousands of cryptocurrencies.
Can be accessed from multiple devices.
Potentially be vulnerable to hacking.
Not suitable to keep significant amounts of crypto or savings in hot wallets
Example of hot wallets
A cold wallet refers to any cryptocurrency wallet that is not connected to the internet. This can include both hardware wallets (devices that resemble a flash drive or come in other forms that are used to store coins offline) and paper wallets (where private keys or seed phrases are written on paper and stored by the user themselves).
Paper wallets, as the name suggests, are simply a piece of paper with your private keys (Seed phrase) written on them. Although it can be secure, this method alone is not very popular and has been replaced by purchasing high-quality hardware wallets that are trustworthy to use, or by using custodial services from reputable trading platforms.
In general, a cold wallet like a hardware wallet is much safer than a hot wallet, as it is not constantly connected to the internet. However, it can still connect via USB, Bluetooth, or WiFi but only when signing transactions, making it less susceptible to hacking. Yet, a disadvantage of hardware wallets is the inconvenience of carrying around the connecting cable and hardware device to use it whenever you want. Otherwise, users will not be able to access their cryptocurrency wallet (unless the user remembers the recovery seed and can use it to open the wallet on another hardware device).
Hardware wallets are designed to be secure from attack, and even though they need to be connected to a computer via USB or Bluetooth, the security is not compromised. It is almost impossible for money to be stolen because the process of accessing the wallet requires verification from the device itself (Which is in your custody).
Suited for long-term storage (wealth accumulation).
Excellence security as they can’t be accessed online, preventing being hacked.
Requires learning how to store and maintain it properly to prevent damage, loss, or theft.
Require the purchase of an external device, around $50 to $250.
Cold wallets require an extra step to connect online through USB, Wi-Fi, Air-gapped, or QR code to process a transaction.
It takes longer to complete transactions as it always needs to be connected to a PC before commands can be sent.
Example of Cold wallets
Which one should you choose?
The answer depends on each person's lifestyle. If the user is a frequent trader or farmer who moves money frequently, a hot wallet is a faster option. However, if they focus on long-term holding and rarely use the coins, a cold wallet (hardware wallet) is a more suitable and secure option.
Alternatively, both can be used together, such as keeping a small amount of money in a hot wallet for quick access, while the rest is stored in a cold wallet for security purposes.
In short, a hot wallet is convenient but less secure, while a cold wallet is more secure but harder to use. It depends on what the user prioritizes.
Next, let’s explore a new option that combines the advantages of both wallets!
Currently, most users tend to have multiple wallets to cover all usage scenarios, such as 1. Hot wallet for trading accounts, 2. Hot wallet for DeFi use, such as Metamask, 3. Mobile hot wallet for quick access, 4. Hardware cold wallet for long-term holding. Having multiple wallets like this also makes managing the seed phrase for each wallet more confusing.
Another popular trend is using a second phone that functions only as a mobile crypto cold wallet. When using a cell phone as a cold wallet, you would only turn it on when you want to make a transaction. The secondary phone acting as a cold wallet is then connected to your primary phone via bluetooth or WiFi and funds are transferred to your hot wallet for the transaction. After the transaction is made, the WiFi or bluetooth connectivity is turned off and the secondary phone is powered down.
Many find this more convenient than a hardware wallet, while also offering the peace of mind that comes with knowing your cryptocurrency is safe and secure. This method of using a secondary phone as a cold wallet would be more secure than a typical mobile hot wallet but still less secure than a hardware cold wallet. This approach would typically store an intermediate amount of cryptocurrency.