As retail and institutional investors increasingly consider crypto as part of their portfolios, the issue of securely storing the invested funds comes to the fore. While traders on centralized exchanges often store their funds in on-platform, custodial wallets, decentralized and offline wallets are the preferred method of storing crypto over the long term. In this article, we will cover the two main forms of non-custodial crypto wallets – hot wallets and cold wallets. We will discuss their pros and cons, and consider situations where you might choose one wallet type over the other.
What Is a Hot Wallet?
A hot crypto wallet is software that stores your private keys, i.e., the credentials to access your blockchain-based crypto funds, in digital format online. Being always online, hot wallets allow you to conveniently transact whenever you need to.
Hot wallets come in the form of mobile apps, desktop applications, web-based apps, and browser extensions. Many hot wallets are free to use. Some of the most popular among the decentralized, i.e., not based on a crypto exchange account, hot wallets are MetaMask, Math Wallet, Trust Wallet, and the privacy-oriented Brave Wallet.
What Is a Cold Wallet?
Unlike hot wallets, cold crypto wallets store your private keys offline on a hardware device or on paper. Hardware wallets are the most commonly used type of cold wallet. Typical devices for cold wallet storage are specialized cold wallet dongles, USB dongles, PCs, and even smartphones not connected to the internet.
A cold wallet could be described as an environment where you simply sign crypto transactions with your private key while staying offline. This helps minimize the probability of having your private key data hacked.
Cold wallets typically cost anything from $50-$60 USD and up to a few hundreds of USD for more advanced models. Some of the most popular hardware wallets on the market are wallets from Ledger, Trezor, and Electrum.
Paper wallets are another type of cold wallet. Paper wallets allow you to print out your private and public key information along with a QR code on a good old piece of paper. When you need to sign a transaction, you simply swap your private key into software that reads your key and lets you process the transaction.
You can set up a paper wallet for free. Paper wallets also sound more secure than even hardware wallets. However, there are issues with possible physical paper degradation. You could also risk losing access to your crypto funds if the paper is lost, stolen, or damaged.
Such a loss is usually not a critical issue with hardware wallets. If your hardware wallet breaks or gets stolen, you can easily replace it with a new hardware wallet and recover your private key using the seed phrases, a set of secret phrases designed for key recovery.
The improved security of hardware wallets over recent years has largely made paper wallets obsolete. Paper wallets are still a valid form of wallet and could possibly be useful for storing large amounts of crypto funds. Investors with large crypto holdings destined for long-term storage may use paper wallets locked in a secure safe.
Hot Wallet vs Cold Wallet – Advantages and Disadvantages
Hot wallets have the advantage of convenience and ease-of-use compared to cold wallets. When you use hot wallets, there is no need to access a piece of hardware to sign/confirm your transactions. All the operations involving your crypto funds are carried out conveniently online.
Another advantage of hot wallets is the price, or, to be precise, the absence thereof. The vast majority of hot wallets on the market will not cost you anything, while hardware wallets, the most commonly used cold wallet variety, are never free. Paper wallets are usually free, of course, but they come with the limitations outlined above.
However, the biggest disadvantage of cold wallets is security. While most hot wallets have reasonable security features, the fact that your funds, or rather the keys to your funds stored on the blockchain, are held online always carries the risk of having your data hacked.
Compared to hot wallets, cold wallets, either in hardware or paper form, are much more secure thanks to storing your keys offline. In fact, the entire thriving industry of hardware wallets has emerged largely due to the security of storage factor.
Hot Wallet vs Cold Wallet – Which One to Use?
You do not necessarily need to choose one wallet type. Nobody, to the best of our knowledge, has issued an international arrest warrant against people using multiple crypto wallet types.
The best way is to use both wallet types and choose the one most suitable for each specific situation. If you need to securely store large amounts on a longer-term basis, use a cold wallet. We would advise using hardware wallets over paper-based ones.
These days, leading hardware wallets come with impressive security features. Unlike paper wallets, hardware wallets make private key recovery easy via the use of seed phrases.
However, if you frequently transact using your crypto funds, hot wallets are the recommended wallet type. If you accumulate larger amounts while trading crypto, you may always move them to the more secure cold storage.