Anyone learning about digital assets will inevitably come upon a familiar word that has taken on a new (and sometimes confusing) meaning: Wallets. In crypto, a wallet is quite different from the physical billfold you keep in your pocket. Instead of holding money, a crypto wallet holds the keys to your money, which resides on a computer network.
In this article, I’ll explain what a crypto wallet actually does, and why different types of wallets — in particular, “cold” and “hot” wallets — have different use cases. I’ll explain the unique features of each wallet type so that you can make informed decisions about how to store your crypto safely and responsibly.
Understanding Crypto Wallets
A crypto wallet is a piece of software that lets you store, manage and transact with digital assets. Remember, when we say “store,” we don’t mean that your crypto coins are actually inside the wallet software, but rather that the wallet stores a private key (also called a secret key), which is a unique, unguessable code that proves your ownership of specific coins on a cryptocurrency’s ledger.
A design challenge for wallet apps is that they must balance security and ease of use. If a wallet prioritizes security, it may be relatively difficult to use day-to-day, because it will require several steps to unlock and access your funds. On the other hand, a wallet that prioritizes ease of use may forego some security in order to enable fast, easy access to your crypto.
This is why different crypto wallets are optimized for various needs and preferences, with the two main categories being hot wallets and cold wallets. Hot wallets are apps that run on a phone or a computer. Types of hot wallets include mobile wallets, desktop wallets and web wallets. Cold wallets, on the other hand, always remain completely offline. Two common types of cold wallets include hardware wallets and metal wallets.
A note before getting started: When I provide examples of wallets, I will specify those that are bitcoin-only. Although most crypto wallets support bitcoin, if bitcoin is the only digital asset you need to deal with, we recommend that you use a wallet that only supports bitcoin and no other cryptocurrency. This is because, with fewer moving parts, bitcoin-only wallets are less likely to contain critical bugs that could compromise their security.
Hot Wallets Explained
Hot wallets are a popular choice for those who prioritize convenience and must frequently access their digital assets. In this section, we'll describe what hot wallets are and how they function, and provide some examples.
What Is A Hot Wallet?
A hot wallet is a crypto storage solution that is connected to the internet. Hot wallets are designed for quick and easy access to digital assets, making them ideal for frequent traders. They can be native applications installed on your computer or smartphone, or web-based apps accessed through a browser.
While internet connectivity offers convenience, it also exposes the wallet to potential online threats, making hot wallets generally suitable for storing smaller amounts of cryptocurrency that you intend to use regularly.
How Hot Wallets Work
Hot wallets operate by storing your private keys — the secret codes that prove ownership of your digital assets — on an internet-connected device or server. When you want to make a transaction, the wallet software uses these private keys to sign a transaction for you, verifying your ownership and authorizing the transfer of funds on the network. In other words, anyone with access to the computer or phone that holds the private key (which could include remote attackers on the internet) may be able to sign transactions on your behalf. To prevent this, some hot wallet apps include layers of security such as PINs or biometrics (for example, Apple’s Face ID).
Once a transaction is signed, a hot wallet broadcasts it to a cryptocurrency network. Hot wallets often include features like address book management, transaction history and integration with exchanges or decentralized applications (dApps), enhancing their utility for active crypto users.
Examples Of Hot Wallets
Several popular hot wallet options are available. Mobile wallets like Cake Wallet and AQUA (bitcoin-only) offer user-friendly interfaces for on-the-go access. Desktop wallets such as Exodus and Sparrow (bitcoin-only) provide robust features for computer users. Browser-based wallets like MetaMask and Alby (bitcoin-only) are popular for interacting with decentralized finance (DeFi) and social networks. Exchange wallets provided by platforms like Kraken and Coinbits (bitcoin-only) also fall under the hot wallet category, offering integrated trading features alongside storage capabilities.
Cold Wallets Explained
Cold wallets offer a different approach to private key storage, prioritizing security over convenience. In this section, we'll explain how cold wallets work and what kinds of assurances they offer. We’ll also provide some popular examples.
What Is A Cold Wallet?
A cold wallet, also called an offline wallet or simply “cold storage,” is a wallet that is not, has never been, and will never be connected to the internet. No matter how secure an internet-connected device may be, there could always be a bug or misconfiguration that allows an unauthorized person to access the memory of an internet connected device. To be absolutely certain that critical data cannot be leaked or hacked, it is safer to store that data completely offline. Cold wallets are designed to store your private keys in a secure, “air-gapped” environment, isolated from potential online threats.
How Cold Wallets Work
Cold wallets work very differently from each other, depending on the type.
Most hardware wallets have a touchscreen and/or buttons to interact with the device. Many provide extensive functionality and advanced features for managing digital assets
A metal wallet is just a metal object engraved with information. Before metal wallets, paper wallets were a common way to keep funds in cold storage. A paper wallet is simply a written list of characters or words that spells a secret code. To make paper wallets less vulnerable to accidents like floods and fires, people began using steel plates instead of paper, engraving information permanently into the surface. Now that metal wallets are commonplace and inexpensive, there is no reason to store significant amounts of digital assets using a paper wallet.
To spend the funds stored in a metal wallet, you must first choose a hot wallet or a hardware wallet. Then, read the private key off of the metal wallet and load it into the software. Once this is done, you will be able to sign and broadcast transactions.
Examples Of Cold Wallets
Popular hardware wallets that can store the keys to many different digital assets include Ledger and Trezor devices. Just like with hot wallets, if you only need to manage bitcoin, it is recommended to use a bitcoin-only device like a Passport or a Bitkey.
It is important to understand whether the hardware wallet you are evaluating has open source software. If it does not, then you can never be sure that your private keys are safe. Do some research and make your own decision about whether you are comfortable using a hardware wallet that is not open source.
As for metal wallets, many options exist. Here is a comprehensive list that includes results from rigorous testing.
Note — there are many web services that offer “free” paper wallets. These websites generate a private key on their servers and display it in your browser so you can write it down. This is extremely unsafe. Do not use free online paper wallet websites – your funds will probably disappear!
Understanding the differences between hot and cold wallets is important for making a good decision about which type of wallet to use for your circumstances.
Accessibility And Convenience
Hot wallets excel in accessibility and convenience. Most hot wallets feature user-friendly interfaces. They're typically available as mobile apps or web-based platforms, ensuring you can manage your crypto from anywhere with an internet connection.
Cold wallets, while less convenient for everyday use, provide better security for long-term storage. The setup process can be complex and, although detailed instructions are available, a sequence of steps must be precisely followed, which can be challenging for some. Additionally, spending funds from a cold wallet requires several steps. In the case of a hardware wallet, you may need to ensure the device has a power source, then unlock the device with a PIN, and use QR codes or NFC scanning to sign transactions.
Keep in mind that you do not need to access a cold wallet in order to send funds to it. You only need to access your cold wallet to send funds out of it. If you are primarily using crypto to accumulate wealth and save for the future, you won’t be signing transactions very often, so the inconvenience of spending from cold wallets won’t be a major factor for you.
Security Features
Hot wallets, by nature of their internet connectivity, are more vulnerable to security threats. They store private keys on internet-connected devices or servers, potentially exposing them to hacking attempts or malware. However, reputable hot wallet providers implement various security measures such as two-factor authentication, multi-signature support and encryption to minimize these risks.
Cold wallets offer superior security by keeping private keys completely offline. Hardware wallets, for instance, store keys on a secure chip that makes it impossible to extract the private key from the chip, even if sophisticated hackers gain physical access to it. They often include additional security features like PIN protection, passphrases, and tamper-evident packaging to further enhance their security profile.
Cost Considerations
Hot wallets are generally more cost-effective in the short term. Many mobile and web-based hot wallets are free, with the wallet provider generating revenue through transaction fees or affiliated services.
Cold wallets require an initial investment. Quality hardware wallets can range from $60 to $200 or more. Metal wallets can be essentially free to create but may require more technical knowledge. If you enjoy DIY projects, you can make a metal wallet from parts you can find at a hardware store. You can also spend anywhere from a few dollars to a few hundred dollars for purpose-built metal wallets.
Pros And Cons Of Hot And Cold Wallets
Let's examine the advantages and disadvantages of both hot and cold wallets. This comparison will highlight the strengths and weaknesses of each option, allowing you to weigh the trade-offs of each one.
Advantages Of Hot Wallets
Convenience: Hot wallets offer instant access to your funds, making them ideal for frequent transactions and day-to-day use.
User-friendly interface: Many hot wallets have a refined user experience, making them accessible to both beginners and experts.
Integration with exchanges: Many hot wallets can easily connect to cryptocurrency exchanges, facilitating quick trading.
Disadvantages Of Hot Wallets
Security risks: Being connected to the internet exposes hot wallets to potential hacking attempts and malware.
Counterparty risk: Web-based hot wallets often require trusting a third-party service with your private keys.
Potential for loss: If the device hosting your hot wallet is lost or damaged, you may lose access to your funds.
Advantages Of Cold Wallets
Enhanced security: Offline storage eliminates the risk of hacking and significantly reduces the risk of unauthorized access to your funds.
Protection for large holdings: Cold wallets are ideal for securely storing substantial amounts of cryptocurrency for long periods.
Full control: You have complete ownership and control over your private keys without relying on a third-party.
Disadvantages Of Cold Wallets
Less convenient for frequent use: Spending funds from a cold wallet requires multiple steps, making them less suitable for daily transactions.
Initial cost: Hardware wallets require an upfront investment, which can be significant depending on the model.
Learning curve: Setting up and using cold wallets may require some technical knowledge and time to learn.
How To Choose Between Hot And Cold Wallets
Selecting the right type of cryptocurrency wallet is crucial for managing your digital assets effectively. In this section, I'll explore the factors to consider when choosing between hot and cold wallets so that you’ll be equipped to decide which one suits your needs.
Factors To Consider
When deciding between hot and cold wallets, several important factors come into play. Security should be a top priority, especially if you're dealing with significant amounts of cryptocurrency. Ease of access is another crucial factor if you plan to frequently spend crypto from your wallet.
Matching The Wallet Type To Your Needs
Your choice between hot and cold wallets should align with your cryptocurrency usage patterns and risk tolerance. Hot wallets are generally better suited for active traders and those who frequently spend their crypto. If you're regularly selling or spending your digital assets, a hot wallet's convenience and quick access can be invaluable.
On the other hand, cold wallets are ideal for long-term investors or "hodlers" who prioritize security over frequent spending. If you're primarily receiving crypto, not spending or selling it, the security of a cold wallet can provide peace of mind with little downside. Many people use a combination of both wallet types, using a hot wallet for day-to-day transactions and a cold wallet for long-term storage.
Bottom Line
Choosing between hot and cold wallets ultimately depends on your individual needs, risk tolerance and cryptocurrency usage patterns. Hot wallets offer convenience and accessibility for frequent transactions, making them ideal for active traders and day-to-day crypto use.
