One important notion to understand before we jump into this comparison is that the term cryptocurrency wallet is somewhat misleading, as the wallet does not actually hold any cryptocurrency. Instead, the wallet is where your keys are stored, and these keys give you access to your cryptocurrencies that are on the blockchain. For more information on the difference between a public and private key take a look at our other blog post here.
In its most basic form, the public key can be shared to receive funds and the private key allows access and control over your cryptocurrency assets.
Now, if that all sounds a bit confusing to you then don't worry, the most important idea to grasp is that different wallet types store your keys in different ways. This is why cold storage is the safest method for storing your keys - we will delve into this further on in the article.
- Hot wallets
- Cold wallets
Hot wallets are digital wallets that are usually accessible from mobile devices, laptops and desktops. When you first purchased a digital currency on an exchange your purchase would likely have been stored in a hot wallet on the same exchange. Alternatively, there are now many different web and mobile wallets that allow beginners to easily store their tokens - however, there is an inevitable trade-off when it comes to security.
These wallets are exposed to the internet, increasing the risk of private keys being stolen by malicious actors. It's also worth considering that many of these options do not truly represent self-custody as your private keys are generated and held by a third party. This of course involves a high level of trust, as the third-party organisation technically has ownership over your assets as they possess these private keys.
Here are a few examples of popular hot wallets:
Now, at the top end of the security spectrum are cold wallets. Also referred to as hardware wallets, these are physical devices that store your private keys in an encrypted, offline environment. This means your private keys (your proof of ownership) are never exposed outside of the device - thus, keeping your crypto assets safe.
Now, you may be wondering how these devices work without an internet connection? Let's explain how.
When you use your hardware wallet you need to plug the device into a computer or connect to a mobile device, this is where you can manage and trade your cryptocurrency. However, your private keys are generated offline in the hardware wallet microprocessor - this is securely isolated so that even if your hardware wallet becomes infected with malware from your computer, there will be no risk of your private keys being compromised.
Hopefully, you now have a better idea of the differences between hot and cold wallets.
We'll leave you with this closing thought, something which we as investors and crypto enthusiasts follow religiously:
Treat your hot wallets as you would treat a physical wallet, where you keep small sums of cash at a time for convenience sake. In all other cases, use a secure hardware wallet for more substantial, long-term storage of your assets.