What Is a Cold Wallet?

By Lipsa Das

The world of cryptocurrencies can feel like the wild west sometimes. Markets can react to the slightest good or bad news and new and innovative tech comes by every month. Transactions are instant, stakes are high and security threats are very real.

In all of this, one thing is constant: the responsibility of storing your digital assets safely, away from hackers. It may seem a daunting task, given the volatility and unpredictability of the crypto world. However, a solution exists exactly for this — a specific type of crypto wallet called a cold wallet.

Cold wallets provide the ultimate level of wallet security for your digital assets, keeping it safe from malicious actors (and sometimes even your own mistakes!).

In this article, Ledger Academy will unpack what is a cold wallet and how they differ from other types of crypto wallets.

Let’s dig in.

What Is a Cold Wallet?

A cold wallet is a crypto wallet that does not interact with any internet network and PC or grant any permissions to smart contracts. If this sounds confusing, make sure you check out our article on what a crypto wallet is first. But essentially, Cold wallets are a form of offline storage where you store your private keys on something physical. Physical devices can range from specialized hardware wallets, to even a piece of paper with your private key.

The key role of these cold wallets is to act as a “vault” for your cryptocurrencies — which means they do not interact with anything except themselves. 

When you need to make a transaction, you can transfer the necessary funds from your cold wallet to a “hot wallet”. Your hot wallet is responsible for processing your transactions and connecting to different Web3 applications on the internet.

If you realize you don’t need some funds, you can always transfer them back to the cold wallet for long-term storage. So, to sum up, cold wallets act as “long-term” savings accounts while hot wallets handle day-to-day funds.

What Is a Cold Wallet For?

Due to its isolated design, a cold wallet is the preferred option for protecting high-value crypto assets long-term. 

Storing your crypto assets in a cold wallet keeps you safe while you navigate the dynamic, high-stakes world of cryptocurrencies. Here are the two main ways that a cold wallet can protect your assets:

Keeping Your Private Key Offline

Both cold wallets and hardware wallets keep your private key — the element that helps you sign transactions — completely offline and away from internet-connected devices. 

Ledger adds another layer of security through our proprietary Secure Element Chip. Secure Element is the highest level of security on a chip, which you can find in passports and security cards to keep highly sensitive information safe.  That’s why Ledger uses this industry-grade chip to generate and store your private key. Secure Element protects your crypto assets from various physical and software attacks by adding hacker-resistant countermeasures directly into the chip.

Protecting Your Assets From On-Chain Threats

Every crypto transaction requires you to allow a third-party application or contract to access your wallet. Just like smartphone applications require certain permissions to function correctly, smart contracts require similar access to carry out interactions.

Now, the issue here is that not all of these smart contracts have your best interests in mind. Some smart contracts could drain more funds from your wallet than you agreed to, or even share your information with untrustworthy parties. For instance, in 2022, $2.7 billion was lost to smart contract hacks.  So, in short, you need to be very careful about what you approve.

Using a Ledger device protects you from most of these physical and software hacks — but it’s important to remember that self-custody is your responsibility. No matter how hack-resistant your hardware wallet is, it cannot protect you from social engineering and other related scams.

Segregating your assets is a proactive measure that you can take in these scenarios. To explain, this means holding different amounts of cryptocurrencies in separate wallets, with the most valuable ones in a cold wallet. The best way to segregate your crypto assets is by different risk levels of transactions or asset types. 

This type of segregation helps because each wallet permission and transaction approval are completely separate. So, even if you approve a bad transaction on an account that is connected to the internet, your main holdings are still intact.

Types of Cold Wallet

Not all cold wallets are created equal. Each type of cold wallet fulfills the primary purpose of keeping your private keys offline. However, there are key differences in security, user-friendliness, and accessibility. In this section, Ledger Academy will unpack the three different types of wallets — paper, sound, and hardware wallets.

Paper Wallets

Paper wallets are where you record your private key and corresponding address as QR codes and print them on a piece of paper. Users can then transact with the wallet by sending cryptocurrency to and from the paper wallet address. Paper wallets were one of the first hardware wallets to exist, and were popular around 2013 and 2014. 

While this method keeps your keys offline, paper wallets are susceptible to physical damage or loss. Plus there is no way to recover your keys like recovery phrases, backups etc.

Transferring cryptocurrency from a paper wallet can also be challenging. Essentially, you will need to import your paper wallet into a software wallet using your internet connection. This invalidates its whole purpose–and puts your assets at risk. Plus, if this paper falls into the wrong hands, it leaves your assets vulnerable. 

So, while paper wallets can be a basic cost-effective way to store your assets, they are not the ideal option in the current crypto wallets. Paper wallets just do not provide the level of security, convenience and user-friendliness that crypto enthusiasts need.

Sound Wallets

Sound wallets are a unique cold wallets where you store private keys or seed phrases on a CD, flash drive or vinyl via audio files. While sound wallets are innovative, they are prone to physical damage. This can be scratches on a CD, temperature fluctuations or just long-term degradation. Such damage could corrupt your audio files, making you lose access to your wallet if you don’t back it up.

Sound wallets can also be expensive to maintain. They require special software like a spectroscope application or device to decode the private keys if they need it later. This adds a layer of complexity, but usually, transacting to and from the wallet only requires the wallet address.

Hardware Wallets

Hardware wallets generate and store your private keys offline in a secure physical device. This physical device usually has a screen and buttons to help you perform basic operations intuitively. If you want to know more about hardware wallets, check out our article on what is a hardware wallet. 

Hardware wallets are the preferred option for cold crypto storage because of their user-friendliness, security, and ease of use. In contrast to paper and sound wallets, hardware wallets protect your private keys from physical damage yet are accessible.

For example, Ledger devices are sturdy enough to withstand most physical threats and compact enough to put in your back pocket. Plus, they allow you to generate an almost infinite number of private keys, which control countless blockchain accounts–and all of these keys are kept safe in an environment isolated from your internet connection since your blockchain transactions are signed offline. That even includes private keys from multiple different blockchain networks. For example, you can protect your Ethereum, Tezos and Bitcoin accounts with a single hardware wallet, making managing your wallets much easier.

Importantly, if you want to transfer assets from cold storage, these wallets offer a user-friendly experience. Only you decide how to use your accounts, meaning you can keep one account for vaulting assets and another for interacting with smart contracts.

Specifically, Ledger devices are great cold wallet options. Firstly, they seamlessly connect to your PC via USB or Bluetooth. And you can easily check your balance, conduct transactions or manage your portfolio through Ledger Live. Ledger also adds another layer of security to its hardware wallets through its proprietary Secure Element Chip. The Secure Element is one of the most secure chips in existence. You can find in passports and security cards to keep highly sensitive information safe. That’s why Ledger uses this industry-grade chip to generate and store your private key. 

Cold Wallet vs Hardware Wallet: What’s the Difference?

Although often used interchangeably, cold wallets and hardware wallets mainly differ in how they connect to the internet and the Web3 ecosystem. A hardware wallet has the capability to interact with dApps or smart contracts. However, if you want to use your hardware wallet as a cold wallet, then it must not interact with any smart contracts.

So, to sum up, all hardware wallets are cold wallets when fresh out of the box, but they don’t all stay that way. As soon as you connect an account to a blockchain app, that specific account is no longer cold. To understand the distinction, make sure to read the full article on cold wallets vs hardware wallets.

Cold vs Hot Crypto Wallets: What’s the Difference?

But it’s not just cold and hardware. What’s the difference between cold and hot crypto wallets? For the full details, check out our article on hot vs cold wallets. But put simply, Hot wallets and cold wallets differ completely in how they store, access and protect your private keys. 

Firstly, hot wallets are designed to help you access and interact with the cryptocurrency world easily by connecting to the internet. However, in doing so, they sacrifice some security measures. While hot wallets are handy for quick transactions, they are also vulnerable to theft. This is because hot wallets store private keys on the host device, the same device connected to the internet. Unfortunately, anything connected to the internet is always more prone to attack.

In contrast, cold wallets have a completely different purpose. A cold wallet stores your private key completely disconnected from the internet. Plus, they do not interact with smart contracts – precisely the opposite use-case of a hot wallet. 

Segregate Your Assets: Keep One Account Cold

The concept of segregating your assets is a proactive measure that you can take to mitigate risks involved with interacting with smart contracts. To explain, this means holding different amounts of cryptocurrencies in separate wallets, with the most valuable ones in a cold wallet. The best way to segregate your crypto assets is by different risk levels of transactions or asset types. 

Every account on a Ledger device is shielded from the other accounts on the device. So, even if you approve a bad transaction on an account that is connected to the internet, your main holdings are still intact. You can explore the Web3 ecosystem safely with your hardware wallet, using the same device to manage your cold wallet account and your minting account.

So, if you want to use a segregated Ledger as a “cold wallet”, here’s what you need to do.

1. Connect your Ledger device to your computer and navigate to the Ledger Live app.
2. Install the app of the coin you want to use, in this case, you want to open an Ethereum account. If you already have an account for that coin, don’t worry, you can install a new and completely separate account with no issues.
3. Now your account is ready to use, and you can even name it in Ledger Live to avoid confusion with your other Ethereum accounts
4. Send Ether or other valuable ETH-compatible digital assets to this account
5. Don’t ever connect this specific account to any apps or services, and don’t set up any approvals!

Now, your cold wallet is set-up! Remember, this account is completely separate from the account you use to interact with smart contracts. 

Creating a Cold Wallet Device

If you want an extra layer of security, you can even separate your assets into multiple hardware wallets, leaving one device completely cold. This means that you don’t sign any approvals with any account on that entire device. While separate accounts on your Ledger are completely safe from each other, separating your assets across multiple devices can be a great way to give you peace of mind. That way, you can leave your cold wallet at home, and take your less valuable minting wallet out with you. 

All you need to do to have a completely cold wallet is to buy a Ledger and make sure not to sign any approvals with it! 

Why You Should Use a Ledger as a Cold Wallet

Using your Ledger device for cold storage allows you to take advantage of Ledger’s multi-level security system. Ledger stores your private keys offline through an industry-grade secure element chip, trusted display, and a hack-resistant custom operating system called BOLOS. 

The Donjon, Ledger’s world-class team of white hat hackers, thoroughly tests each of these security elements. This means you’re safe from advanced physical hacks at all times.

Apart from hacks, Ledger also protects you from any unauthorized access, even if you lose your device! Ledger’s devices come with a personalized PIN and a 24-word recovery phrase, ensuring only the owner can unlock the device if lost or stolen.

With Ledger, you can manage our assets via one easy-to-use interface, Ledger Live. Plus, Ledger allows you to set up multiple accounts on the same device, with each account operating independently. This means the choice is really yours—as is the responsibility of how you manage your assets. Because that’s what true self-custody is all about.