One of the most important things for every cryptocurrency holder to consider is where they will keep their cryptocurrency holdings. Since cryptocurrencies are built on decentralized blockchains, there is no third-party intermediary or institution, like a bank, that a cryptocurrency holder can call if they lose any or all of their funds. Every cryptocurrency holder is their own “bank”, and is therefore completely responsible for the safety and security of their cryptocurrency funds. This is why it is so important for every cryptocurrency holder to make the right choice when it comes to the storage of their funds. The ideal storage location is really dependent on the individual cryptocurrency holder. In today’s article, we will take a look at the two categories of cryptocurrency wallets, namely hot and cold wallets, the main differences between the two, the pros and cons of each category, as well as some of the best hot and cold wallets.
Before we proceed, let’s quickly take a look at what a cryptocurrency wallet is.
Disclaimer: We want to emphasize that this is not financial advice. Cryptocurrencies operate in a volatile market, where values can drastically fluctuate in a blink of an eye. It is imperative to conduct thorough research and seek guidance from a qualified financial advisor before investing.
What Is a Cryptocurrency Wallet?
A cryptocurrency wallet is an application or a physical device that keeps your private keys safe and secure. Your private keys are the passwords that give you access to your cryptocurrency holdings. The main purpose of a cryptocurrency wallet is to make it easier for you to send and receive cryptocurrencies like Bitcoin and Ethereum. As mentioned, these wallets can either be an application or a physical device that looks like a smart USB.
The Importance of Cryptocurrency Wallets
Dissimilar to a conventional wallet that securely holds tangible cash, a cryptocurrency wallet doesn't physically store the cryptocurrency itself. Instead, the records of your cryptocurrency holdings are stored on the blockchain, an immutable digital ledger. Accessing your cryptocurrency assets on the blockchain necessitates possession of the private keys associated with those assets. These private keys serve as authentication credentials to demonstrate ownership and enable transactions using your cryptocurrency funds. However, it's crucial to recognize that losing your private keys equates to forfeiting access to your blockchain-based funds. This underscores the significance of safeguarding your wallet, whether it's a hardware wallet, or entrusting your assets to a reputable wallet service such as Coinbase.
Now, let's delve into the two principal categories that encompass cryptocurrency wallets. As you may recall, these categories consist of hot wallets and cold wallets. However, what distinguishes these two types of wallets from each other?
A hot wallet can also be called a software wallet and is a form of digital storage that you can access either on your phone or computer. Hot wallets are cryptocurrency wallets that are always connected to the internet. Due to their constant internet connection, hot wallets are considered less secure and more vulnerable to hackers than cold wallets. Hot wallets are often connected to an exchange platform and make it easier to transfer cryptocurrency to and from an exchange to do more trades or to cash out your holdings. These wallets are a lot more secure than storing your funds on the exchange platform itself. The majority of hot wallets are free.
So if a hot wallet is connected to the internet, then a cold wallet is a cryptocurrency wallet that is not connected to the internet. Cold wallets are also known as hardware wallets or cold storage and are generally physical device that keeps your cryptocurrency completely offline. By storing your funds offline, you are relatively protected from hackers and online attacks. Cold wallets are also generally more expensive than hot wallets and can cost you up to $200. However, there are still cheaper options available.
Even though a cold wallet does offer more protection from hackers, the possibility of your wallet getting hacked is still there. This is why it is important to only purchase cold storage devices directly from manufacturers and never secondhand, since secondhand devices may have been tampered with in a way that leaves them vulnerable.
Cold wallets are good for if you just want to buy a cryptocurrency and hold it for a long period of time. However, if you’re looking to buy and trade cryptocurrency on an ongoing basis, then a hot wallet may be best. You can also leave your cryptocurrency funds on an exchange platform so that you don’t have to constantly send cryptocurrency to the exchange every time you want to trade. Although it’s not the safest option, you can look at storing your funds on exchange platforms that offer insurance for your funds in case of a cyber attack on the platform. This way your funds are safe if the exchange is hacked.
Pros and Cons
Some of the pros of cold wallets are their security and recovery.
Since you don’t have to trust a third party with your private keys, and your wallet is not connected to the internet, a cold wallet does offer more security than a hot wallet. You can also store your cold wallet in a safe or a vault making it even more secure. Most hardware wallets also come with encrypted pin protection and may even add an extra layer of security by including biometric authentication.
Restoring a cold wallet is relatively easy if you lose the device with your cryptocurrency on it. On the initial setup, you will be presented with 12 to 24 words. These words are the recovery words that you can enter into a new hardware device if you lose your old one. You will then be able to easily restore your cryptocurrency wallet and gain access to your cryptocurrency funds again.
Some of the cons of cold wallets are the delays, high prices of the hardware devices, and limits as to how many cryptocurrencies you can choose from. Even if the transaction itself takes the same amount of time, you will still have to access the cold wallet device. You also won’t be able to use it in a public place or on the go, which makes it not ideal for day traders. Cold wallets are also relatively more expensive than hot wallets which are normally free to use.
The pros of hot wallets are that you can access the funds in them almost instantly, they’re easy to use, they offer a lot of flexibility, they’re low cost, and they are custodian wallets.
If you transact frequently with your cryptocurrency, then you may not always want to have to battle with a USB. Mobile wallet applications give you control over your cryptocurrency assets 24/7 no matter the circumstance. Hot wallets are also easy to install and operate, with some of them even being connected to some kind of exchange or having in-built exchange capabilities.
Most hot wallets give you the option to store a wide array of cryptocurrency tokens or coins and are either available for free or have very low maintenance costs.
Lastly, some cryptocurrency holders might not want to bear the full responsibility of safekeeping their digital assets. Therefore, they use the services of third party custodians instead. With a custodial wallet, another party stores and protects your private keys. This decreases your chances of completely losing all of your cryptocurrency assets.
Some of the cons of hot wallets are that they are prone to theft, make you dependent on a third party, and you do risk losing your assets. Any assets stored in a hot wallet are vulnerable to attack since the public and private keys to your wallet are stored on the internet. Some third-party hot wallet providers don’t give you access to your private keys and only ask you to enter your username and password to access your account. So, you can’t really send funds from your wallet without logging on to the third party’s platform first. Lastly, if the exchange is hacked or the company closes down, you lose all of your funds.
Some of the best hot wallets are Exodus, Electrum, and Mycelium. All three of these hot wallets are free. Exodus is the best wallet for beginners, Electrum for advanced cryptocurrency users, and Mycelium for users that prefer mobile devices.
Some of the best cold wallets are Ledger Nano X, Trezor Model T, and Ledger Nano S. The Ledger Nano S is the cheapest of the three at $59. Next is the Ledger Nano X at $119, and then the Trezor Model T at $195. Ledger Nano S is the best value for money, Trezor Model T is the most secure of the three, and Ledger Nano X is considered the best hardware wallet.
There are two main categories of cryptocurrency wallets: cold and hot wallets. The main difference between the two is that hot wallets are connected to the internet and cold wallets are not. Each wallet comes with its set of pros and cons. Cold wallets are more secure than hot wallets but are not ideal for cryptocurrency holders who want to frequently transact with their cryptocurrency or who want to day trade with their cryptocurrency holdings, and if you're undecided which cold wallet to buy, then you should probably check out a comparison between Ledger and Trezor, the two largest hardware wallet manufacturers.