Using safes and banks is common practice to keep your cash secure. But how are you storing your cryptocurrency? Just like a physical wallet can organize cash and credit cards by keeping them tucked in one place, crypto wallets do the same for your precious digital assets. Most crypto investors buy their coins (or tokens) through exchanges. While storing coins on these exchanges is convenient, they can, for various reasons, stop you from withdrawing your funds. Your crypto can also be vulnerable to hacks and cyberattacks. Why are exchanges so easy to hack? Simply because crypto exchanges are centralized single points of failure. Similar to centralized websites, they are vulnerable to the same cyber threats by design. So, if you want to have full control of your investment, you have two options: hot wallets and cold wallets.
What is the difference between them?
Hot wallets – also known as soft wallets – are wallets that are always connected to the internet. These include web-based wallets, mobile wallets, and desktop wallets. Since they are always online, hot wallets are the easiest to use and transact with. To access your hot wallet, you may only need a simple password. This leaves them vulnerable to cyber-attacks. Holding large amounts of crypto in hot wallets is considered bad practice by many crypto natives.
Cold wallets — also known as hardware wallets — live on devices similar to USB drives, giving crypto holders direct access and control of their holdings through unique sets of private ‘keys’. Since cold wallets are not connected to the internet, your funds are not vulnerable to online attacks. Cold wallets are immune to hacks even when they are connected to your computer because each transaction requires an in-device signature, meaning theft from a cold wallet requires owning the physical wallet and the associated pins or passwords. While hot wallets are usually free, a cold wallet can cost you anywhere from 50 to 200 dollars.
So which type of wallet is better?
The answer is neither or both. The best practice is to have a combination of different storage types for your crypto. Hot wallets give you the ease of use and accessibility. This is ideal for smaller amounts of crypto you are constantly trading or transacting with. While cold wallets give you unparalleled security and peace of mind. But no matter which wallet you choose - keep your passwords safe and secure - if you don’t, you could be locked.
This happened to Stefan Thomas, a San Francisco-based programmer, who lost the password to his cold wallet and only has 2 out of 10 attempts left. Failing the final 2 attempts will cause his wallet, which contains 7,002 Bitcoin, to encrypt itself forever. The debate is more than just hot vs cold storage though. It is also about finding the right balance for your portfolio. So, what does all this mean for the average investor?
Well, the funds you are holding for the long term are best kept in a cold wallet. This is the safest place for them. As for crypto you are actively trading, it’s fine to keep small amounts in hot wallets, as long as you are aware of the risks.
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