Cryptocurrency wallets are often described as being hot or cold. The two serve different purposes related to your investment strategy and level of security desired. Hot wallets hold digital currency you want to use for purchases, cryptocurrency being sent to you, or sending to someone else. It is best to keep only small amounts of crypto in a hot wallet. Most people have both cold and hot wallets. A cold wallet is where you keep the bulk of your digital assets. Think of it like a safety deposit box vs. the physical wallet you carry around. Just as you would never walk around with your life savings in your purse or wallet, it is not a good idea to do the same with your crypto investment.
The security of a wallet is directly dependent on the type of the wallet. Hot wallets are strictly dependent on the security habits of others, whereas cold wallet security is dependent on the owner’s security habits.
It is easy to tell the difference between a hot wallet and a cold wallet. A hot wallet is connected to the Internet, cold wallets are not. Why is this important? Because hackers cannot steal digital assets without an Internet connection. When a wallet is connected to the Internet, it is vulnerable. However, hackers do not waste time, effort or resources trying to steal small amounts of cryptocurrency. This makes keeping small amounts in a hot wallet acceptable, and almost all cryptocurrency investors use a hot wallet for convenience.
In order to buy digital assets, you need an account on an exchange, such as Bittrex or Coinbase. Your account is also considered a wallet – and it is a hot wallet. Should the exchange get hacked, you could lose your assets. Best practice is to buy or sell, then move your assets off the exchange after closing the trade. Keeping large amounts of funds on any exchange breaks the most security important rule in crypto. Because these exchanges make it very easy to buy, sell, or trade and moving funds incurs a fee – it is tempting to leave funds in your hot wallet account.
A wallet like Exodus that use software downloaded to your computer are also considered to be hot wallets. But this type of wallet doesn’t store your private keys on its servers, so your funds are under your control, not theirs. That said, if your computer is connected to the Internet, your funds are vulnerable. Exodus is integrated with Shapeshift which allows you to make trades right from the main interface, and it is easy for beginners to understand. Their support is top-notch, as are their video tutorials.
There are many mobile wallets from which to choose and all are considered to be hot wallets. They are the least secure hot wallet and care should be taken when selecting and using mobile wallets. Research the options and make an informed decision when choosing any type of wallet.
Hardware wallets are physical devices that can be connected to an Internet-accessible device when needed. The rest of the time, they are completely offline. Hardware wallets are considered to be hacker-proof and are the safest security option, but not all are equal. The top brands are Trezor, Ledger, and Keepkey. These devices use a relatively complex hardened microcontroller similar to the processor in a computer or smartphone – only smaller with very few external interfaces.
Hardware wallets use both public and private keys to manage crypto assets, and have been designed to make it impossible to access the private keys because they never leave the device. They are not controlled or accessible by the manufacturer. This principle of isolation is known as cold storage, meaning the private keys are never “hot”, never exposed to the Internet or the device to which it is connected. As you can imagine, this makes these devices more complicated to setup and use compared to other types of wallets that put convenience ahead of security.
When setting up or initializing a hardware wallet, care should be taken to watch manufacturer provided video tutorials and follow every step of the process. This is not an area where you want to “wing it” and rush ahead without following explicit directions. You also want to ensure the firmware for the device is kept updated.
The most important thing when using a hardware wallet is to securely store your recovery seed phrase. Should your hardware device become lost, stolen, damaged, or destroyed – you can recover the private keys that it protects by using your confidential recovery seed phrase. Keeping your seed phrase hidden and in a secure location is highly recommended. If you secure that seed phrase, you can easily export the private keys to a new device or another type of wallet. If you lose that backup phrase, chances are you will never recover the funds.