The Difference Between Hot Wallet and Cold Wallet

Newcomers to cryptocurrencies will probably put all of their cryptocurrencies on exchanges. Actually, cryptocurrencies can be stored in many ways which can be classified according to centralization, decentralization and whether they are stored in centralized exchanges.

The centralized exchanges we usually use can be considerd as bank accounts, on which assets are managed in centralized ways. It means that your cryptocurrencies are actually stored in the wallets of these exchanges, not in your own wallets. The amount displayed is the balance we can use or withdraw, similar to our usual bank account. We don’t actually own the cryptocurrencies shown in the exchange balance.

In addition to storing our purchased assets on the exchange, we can also open a cryptocurrency wallet to store them. For a crypto wallet, it is important to keep your private key well because owning your private key means owning the ownership of your crypto assets on the address. There are two types of wallets:

Cold wallet: Most of the time a cold wallet is offline.. It is only connected to the Internet through the hardware wallet when operations are required. Only you know the private key or the seed phrase.

Hot wallet: There are centralized hot wallets (that is, exchange wallets) and decentralized hot wallets. For decentralized hot wallets, the private key or helper note is also in your own hands, which means that the ownership of the asset is in your possession, but most of the time it is connected to the internet.

Decentralized hot wallet

Examples: Trust Wallet, Metamask, and MyEtherWallet

Simply put, a decentralized hot wallet is a wallet that is connected to the Internet in a certain way most of the time. It is usually in the form of software. Subdivided into web wallets (Metamask, MyEtherWallet), web plug-in wallets (Metamask), mobile applications (Metamask, Trust Wallet), and independent applications, each wallet stores assets in different modes.

The advantages of a decentralized hot wallet include: You can keep the private key and the seed phrase in your own hands, so that you can fully control your assets without centralized exchange. So when the exchange encounters emergency situations and you may fail to operate for a time, you can turn to your hot wallet. In addition, these hot wallets are a tool for users in the crypto space to enter DeFi (Decentralized Finance). The transaction records of all applications on DeFi are recorded on the blockchain. People interact with these decentralized applications by using their own hot wallets to borrow, invest, and purchase different financial commodities (ETF, futures, options) and execute other economic tasks.

Though with these benefits of hot wallets, it is necessary for users to have a very strong awareness of information security to avoid the case that one day their private key, seed phrase and other data are stolen or leaked, and these assets cannot be recovered. After all, users are identified through the so-called public key. Users do not know each other’s identities, and no KYC or other information can be checked. Therefore, it is advisable that users in the community be vigilant about websites they entered or assets to be stored because they could be phishing websites. Otherwise, if they enter their password or private key and other information on the wrong website, they may suffer asset loss. In addition, they may encounter suspicious users in the community asking for their personal information. So they must be very careful.

Cold wallet

Examples: SafePal, Ledger, and Trezor

Cold wallet, as the name implies, is a wallet that is mostly offline, mainly in the form of hardware devices, such as SafePal, Ledger, Trezor, and Coolwallet. Cold wallets are more suitable for long-term crypto holders. It is the safest way to store assets because, in addition to holding a physical hardware wallet, you also need to use a computer to connect to the Internet to perform operations and transfer your own assets.

Certainly, it also has risks. Users must ensure that the hardware wallet is brand new and unused when purchasing, otherwise it is possible that the private key is leaked. Meanwhile, it is also necessary to keep the hardware wallet well, or you will also lost your assets when the device is lost.

Nowadays, many kinds of cold wallets are offered on the market for users to choose from according to their needs. In the past, we may only be able to store assets through cold wallets. Many cold wallets allow us to directly perform DeFi operations. For example, the ledger nano wallet is compatible with Metamask and can be directly connected. Taiwan’s CoolWallet allows users to stake and mine tokens via cold wallets. Thus, users can not only purely deposit cryptocurrencies in a safe manner but also be able to use the currency held in hand to carry out operations such as lending to earn interest.

Notes when using cold wallet

Purchase from an official website

Many websites on the Internet offer cold wallet purchases, such as Shopee, open-air auctions, etc., but to be on the safe side, it is recommended to order from the official website or buy from the official sales team. By doing so, we’re able to figure out the source of the seller’s goods, and whether the wallet has been used. Don’t buy an unsafe cold wallet just because you are greedy for petty gains.

Write down the private key/seed phrase and keep it safe

The private key generated by the wallet is used to sign transactions to prove that you are the owner of this address. That is to say, when the private key/seed phrase is lost, the assets will never be found again. However, assuming that the cold wallet is missing or damaged, the assets can be recovered by importing the private key to different devices (hot wallet, cold wallet) as long as the private key/seed phrase is still there.

Whether the wallet is open-sourced

When choosing a wallet, we need to pay attention to whether the wallet is open-sourced. For example, TreZor is fully open-sourced, and Ledger is semi-open-sourced (some parts are not open-sourced). Open source is a double-edged sword compared to non-open source. For open-sourced cold wallets, the chances of doing evil will be relatively low. If there is no open source, it is actually difficult to find out that the company team tampered with the code behind the scenes. However, there is also a chance that hackers will attack a certain vulnerability and cause huge losses because the code is all public.

Here we sort out the advantages and disadvantages of hot wallets, cold wallets, and hand-written private keys in the following table to provide you with more reference information.

The most suitable asset storage mode

No matter what form you choose to store your digital assets, you should remember that it is very risky to put all your assets in the same place. Therefore, it is advisable that you put your assets in at least 3 or more different places, which is a relatively safe practice. By doing so, you can sail in the crypto world with peace of mind.