Hot Wallet vs Cold Crypto Wallet: What’s The Difference?
|— To secure crypto keys, use either hot or cold wallets. Each has different methods and significant security implications. It’s crucial to understand the differences.|
— A hot wallet is a piece of software you install on your smartphone or laptop to store private keys.
— A cold wallet is a type of crypto wallet that never interacts with any smart contracts. Sending and receiving cryptocurrencies.
Hot Wallets vs Cold Wallets: What Are They?
Both hot and cold wallets secure your crypto private keys, but they do so in different ways. This has important implications for your security. And that’s not the only critical difference between these two wallets. Let’s take a closer look.
What Is a Hot Wallet?
A hot wallet, sometimes known as a software wallet, is a piece of software you install on your smartphone or laptop. It is normally protected by a password set by you, ensuring that nobody can physically access the wallet via your device.
So why exactly is a hot wallet known as “hot”? The defining feature of this type wallet is that it generates your seed phrase online, and subsequently stores your private keys online too.
Seed Phrase Generated Online
A hot wallet generates your seed phrase in an online environment and displays it to you on the screen of your computer or phone when you first launch the wallet. The problem with this system is that, once your seed phrase (or secret recovery phrase) has been online once, you have no way of knowing who has seen or accessed it remotely. This is the problem with data generated by a hot wallet.
Private Keys Live Online
Hot wallets also store your private keys digitally, within their application on your phone or computer. Since these devices are always connected to the internet, your private keys are also constantly online.
So to recap – what makes a hot wallet “hot” is the fact that both your seed phrase and your private keys are online. And once these pieces of data have been online once, you have no way of knowing they are still secret.
What Is a Hot Wallet For?
Having your private keys online makes transacting very straightforward. It’s simple — just log in and start interacting with online applications. If you’re new to the crypto world, the hot wallet can be an attractive starting point. It’s easy to download, gives you custody of your private key and makes it easy to interact with crypto platforms.
But all of these great benefits come with some significant security implications.
The Risks of Hot Wallets
Securing private keys online might be convenient for browsing Web3, but it also leaves you vulnerable to hacks deployed via your internet connection. For example, a sophisticated hacker can use your connected device as an attack vector, using it to penetrate your hot wallet and extract your private keys remotely. Securing private keys on a computer or phone means they are always exposed to this type of risk.
Thus, hot wallets are great for making quick and convenient transactions, but they aren’t suitable for securing assets of high value, since private keys connected to the internet are always at risk of being hacked.
So, now you know all about hot wallets, let’s look now at cold wallets.
What Is a Cold Wallet?
Let’s start with some clarity. A cold wallet is commonly misunderstood to be simply the opposite of a hot wallet – but this is inaccurate. While a cold wallet does generate and store your private keys in an offline environment, it also has another essential trait: it never interacts with smart contracts.
This defining feature means a true cold wallet goes beyond simply keeping your keys offline, it also air gaps you from potentially malicious smart contracts as well.
What Is a Cold Wallet For?
The purpose of a true cold wallet is to act as a vault for the bulk of your crypto, isolating it from all potential risks. You can think of it as a “savings” account, where you keep the majority of your funds but don’t actively transact.
Why Do You Need a Cold Wallet?
As you know, an offline private key is the only way to secure yourself against hacks and malware. But there are some risks even offline keys cannot protect you from.
Using dApps and Web3 usually means interacting with smart contracts. And whenever you interact with a smart contract, you expose your crypto wallet to the conditions of that contract. If you make a mistake – i.e., if you don’t read the conditions properly or sign something you don’t quite understand – you’re effectively opening the door to the contents of your wallet.
Mistakes happen, and since not all smart contract transactions can be displayed clearly, even an advanced crypto user can fall prey to this type of error.
So how can you remove the risk posed by smart contracts, while continuing to explore Web3 platforms? The answer is – you can’t.
Cold wallets exist simply to mitigate that risk. By having an account that doesn’t encounter these sorts of dangers, you can store your most valuable digital assets with confidence.
So how does that work exactly?
Well, there are several types of cold wallets, including paper wallets and sound wallets. However, typically people opt for the easiest cold storage solution; hardware wallets.
Why Is a Hardware Wallet a Good Cold Crypto Storage Solution?
While many people use the term “cold wallet” interchangeably with “hardware wallet”, these two concepts are not the same thing. To explain, a hardware wallet is a physical device. However, it tends to be a popular option as a cold wallet due to its key features: It never connects to the internet and secures your private keys in an offline environment.
This is an important detail, since it ensures your keys cannot be accessed remotely. Even the most sophisticated hacker cannot penetrate your hardware device – it is simply out of reach.
Another key reason hardware wallets make great cold wallets: They don’t require any special technology other than the hardware device you already have and some commitment on your part.
Using your Ledger device, you can set up multiple accounts—with each account having a specific use. That means you can set up an account on your Ledger device that you designate as a cold wallet—simply for sending and receiving assets.
As long as you don’t connect that account to apps and services, it will stay protected from malicious smart contracts. Be warned though, when you’re using a hardware wallet, whether your account connects to an app or not is completely down to you.
Hot Wallet vs Cold Wallet: Which is Better?
If you’re asking yourself this question, you shouldn’t be. There is no need to choose between a hot and cold wallet, because you can access the utility of both from the same Ledger device, while your private keys remain offline.
Ledger devices allow you to create unlimited accounts (individual wallets with private keys) for each blockchain asset. Each of these exists independently—protected from the approvals of the other. This enables you to segregate your crypto assets into different wallets, designating one as a secure vault, and another for interacting with Web3.
So now you know what’s possible, let’s explore how it works in practice.
Hot Wallet vs Cold Wallet: How To Set Them Up
Say you’re securing 10 ETH with your Ledger Nano S, Ledger Nano X, or Ledger Stax. To keep risks to your assets at an absolute minimum, you should secure the bulk of your ETH in a wallet that never interacts with smart contracts.
To do this, you’ll simply create two ETH accounts within your Ledger, designating one as a vault that never interacts with Web3. This is your cold wallet, and you’ll name it clearly to make sure it stays that way.
Meanwhile, you will designate the other ETH wallet as an active Web3 wallet (also clearly named), using it for smart contract transactions and exploring Web3. You will only transfer ETH into this wallet when you need it, and only the specific amount you require.
Although this is not a hot wallet – because its private keys are still secured offline, inside your Ledger device – you can still use it to connect to hot wallet interfaces to interact with blockchain apps outside of the Ledger ecosystem. For example, you can connect your Ledger to metamask to interact with countless dApps on the Ethereum network.
Ledger also supports several other third-party wallets across multiple chains, such as Electrum, MyEtherWallet, Yoroi Wallet, Phantom, Temple, and Kukai, so you’re free to explore with peace of mind.
Freedom Is Security
So now you know, hot and cold wallets are for completely different use-cases. While software (or hot) wallets are designed primarily as a gateway to blockchain apps and services, cold wallets exist for the complete opposite reason. In short, cold wallets offer a way to store valuable assets securely.
Freedom means not having to choose between exploring Web3 and staying secure. With a Ledger and some basic wallet organization, you can manage the risks your crypto faces, even as you embrace the growing ecosystem of dApps and services.
Stay informed and stay secure – YOU are in control of your crypto.