Cryptocurrency Hot and Cold Wallets

With extensive experience as an electrical/software/coding engineer along with having a diverse financial background, Thomas Wettermann’s areas of interest include Machine Learning (ML), artificial intelligence (AI), and Financial Technology (FinTech). For the past few years, Thomas Wettermann has focused on the underlying technologies that support and promote all phases of cryptocurrency, Web 3.0, and metaverse ecosystems.

Cryptocurrency Wallets (source:zipmex.com)

Introduction

Cryptocurrencies (crypto) are a relatively new type of currency evolving rapidly in an increasingly tech-driven economy. They do not have an actual physical form, but rather exist in a blockchain on a server. They are not backed by banks or other traditional lending institutions, and transactions are highly encrypted to keep personal information private. Crypto can be purchased, sold, or swapped on different types of cryptocurrency exchanges or on peer-to-peer marketplaces, like LocalCryptos. Once crypto is purchased, it is important to understand how this digital asset should be properly stored and how it can be securely transported or moved.

What is a Cryptocurrency Wallet?

When Bitcoin, Ethereum, or other crypto is purchased from a CEX or a DEX, these coins can be left sitting in the exchange where they were purchased. If purchased on a CEX, these coins will be kept secured in a storage mechanism referred to as custodial storage where the CEX maintains custody or control over the coins.

Alternatively, this crypto can be moved outside of the exchange and into non-custodial storage. These storage mechanisms are collectively referred to as crypto wallets.

A crypto wallet is a storage mechanism that allows for the secure storage of cryptocurrencies. You do not store your crypto but rather the public and private keys that provide access to your purchased crypto on the blockchain.

There are many different types of crypto wallets but generally, these wallets can be categorized into two main wallet types: a “hot” wallet (“software”) or a “cold” wallet (“hardware”). They vary in levels of security, accessibility, and usability.

Hot and Cold Wallets (source:coinmarketcap.com)

What is a Hot Wallet?

First, "hot" wallet options come in two forms: software wallets and online wallets. These two versions are termed “hot” wallets because they rely on an internet connection to properly gain access to the stored currencies.

Software wallets may be downloaded to a computer or mobile device, often in the form of an app. Online wallets act like websites and are usually controlled by major crypto centralized exchanges such as Coinbase or Binance. 

Both the software wallet and the online wallet possess similar benefits. For example, keeping crypto assets available online makes it easier for these to be transferred. This makes the hot wallets more convenient for users who intend to frequently trade their crypto.

However, a potential downside is connecting a hot wallet to the internet exposes the stored crypto to certain risks of potential attacks and hacking.

What is a Cold Wallet?

At the most secure end is what is called a "cold" wallet. A “cold” wallet is a digital wallet that stores the crypto private keys offline on a physical medium, such as a USB drive. These physical mediums are called cold storage wallets because they are not linked to the internet.

With a “cold” wallet, a user retains full control over when and where the wallet is accessed. Since all of the digital assets are stored offline, this makes it more difficult for hackers to access this crypto. But if you need to access the wallet quickly or while traveling, it is not the most convenient option of the two types of wallets. Let’s first take a look at soft wallets.

There are essentially two types of soft wallets: custodial crypto wallets (also referred to as hosted wallets) and non-custodial crypto wallets.

All the views expressed on this site are those of Thomas Wettermann and do not represent the opinions of any entity with which Thomas Wettermann has been, is currently, or will be affiliated.

Trading digital financial assets such as cryptocurrencies can carry a high level of risk, and may not be suitable for all investors. Before deciding to invest, purchase, and/or trade cryptocurrency you should carefully consider your investment objectives, level of experience, adversity to risk, and volatilities. The possibility exists that you may sustain a loss of some or all of your initial investment; therefore, you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with cryptocurrency trading, and seek advice from a qualified and independent financial advisor.

Thomas Wettermann is not an independent financial advisor. Any opinions, news, research, analyses, prices, or other information contained on this website is provided as a general market commentary of Thomas Wettermann and does not constitute investment advice. Thomas Wettermann will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information. All opinions expressed on this site are owned by Thomas Wettermann and should never be considered as advice in any form.