Hot Wallet vs. Cold Wallet: What's the difference?
March 20, 2020
Cryptocurrency is a booming market, with 3,000 projects spanning a broad range of use cases in 2020. Bitcoin development is especially hot, and your cryptocurrency advisor may recommend you get involved. The best way to do this is by developing a secure blockchain wallet. Of course, a hot wallet has flaws, but a cold wallet is used by the biggest cryptocurrency exchanges to protect their holdings.
In this guide, we’ll explain what a cryptocurrency wallet is, how it works, and how we can work with you to develop storage solutions to ensure your fintech security.
What is a blockchain wallet?
A blockchain wallet is a digital wallet to store your cryptocurrency balances. There is a specific project called Blockchain Wallet, which stores bitcoin (BTC) and ether (ETH). Beyond that, crypto wallets developed by companies like Ledger, Trezor, and Archos can handle dozens of cryptocurrencies.
These wallets use both hardware and software to store crypto keys. They’re able to send, receive, hold, and track your coin balances and even be used to store non-fungible crypto tokens. Users of blockchain wallets have exponentially increased from 10.98 million in the fourth quarter of 2016 to 44.69 million by the end of 2019.
Despite their market proliferation, their actual function can be confusing to the non-technical crowd. They don’t technically hold your physical currency like a leather wallet holds your cash and credit cards. Instead, they work more like credit cards, simply tracking your crypto balances according to each corresponding blockchain’s digital ledger.
Each cryptocurrency you own has a set of public and private keys. Your address is derived from your public key that other users can send currency to. Your private key is held only by you and is used to cryptographically sign transactions. Both keys are stored securely generated and stored in your cryptocurrency wallet. These electronic wallets can use either hot or cold storage, so let’s explain the difference.
What’s the difference between hot and cold storage?
Hot wallets are connected to the internet, allowing them to directly communicate in real time with their respective blockchains. This enables faster processing, while also potentially exposing our holdings to hackers. Several cryptocurrency exchanges have had their hot wallets hacked, including most recently Upbit, a South Korean exchange that lost approximately $50 million worth of ether.
Still, these exchanges do need a portion of their holdings stored in hot wallets for the liquidity and efficiency of the market. While cybersecurity is an issue, hot wallets are not inherently unsafe, just potentially vulnerable. There are several types of hot wallets:
- Web-based wallets run in remote cloud-based servers and can be accessed from any device with a web browser. The convenience and accessibility come at the price of security. Your keys are held by a third party that may be shut down or compromised without your knowledge. Blockcahin.info is a web-based wallet.
- Software wallets store your private keys on your local hard drive. From a developer standpoint, a software wallet must be created for each operating system (Windows, MacOS, Linux, Android, iOS, etc). This is more secure than web-based because you are in full control of your keys. Electrum is a software wallet.
- Hardware wallets run the entire wallet environment from a USB-powered device that acts as both hot and cold storage, depending on whether it’s plugged in at the time. Hardware wallets are standalone devices, so you won’t get them mixed up with your thumb drives. Trezor is a hardware wallet maker.
Cold storage is nothing new. Like a freezer, we store documents long-term in drives disconnected from the internet. Think of a thumb drive – when it’s plugged into your laptop, it’s hot, but when it’s unplugged, the data is no longer accessible remotely. In this manner, a cold wallet essentially acts as a safe or bank vault for your cryptocurrency assets not meant to be spent.
Just like your company’s private data, or even your own finances, a mix of hot and cold storage options are inevitably used. This balances both security and convenience to maintain the viability and value of your crypto assets. There are several types of cold wallets.
- Paper wallets print your private keys to keep them off the internet. The upside is you will never have your keys compromised. The downside is if you lose the paper, your keys can not be recovered.
- Metal wallets use steel and titanium to store seed phrases. These options are much more durable than paper, as they are fire- and heat-resistant and do not degrade as much over time.
There are also companies, which provide the cold storage of digital assets as a service. They keep your assets safe on cold wallets with private keys that are not revealed even to you, and you can withdraw them when you need them (although the process can take several hours). It seems like a reasonable option for anyone who’d prefer to rely on an established company’s reputation rather than try to set up appropriate security measures themselves. Before you go for it, make sure that you trust your company of choice, though. An example of such a digital custodian is Vo1t.
If you’re still confused, don’t worry. An experienced cryptocurrency advisor can help you create both hot and cold solutions, both for internal use and white-label sale to clients. Here’s how to get started.
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