Hot and cold: Crypto wallets fundamentals

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Hot And Cold Crypto Wallets (Blog post image)

“Being your own bank” is one of cryptocurrency’s best advantages. However, that means that only you are responsible for your money. There are many types of wallets, each one for different uses. That said, it’s crucial that every coiner feels comfortable with the one they’re using to hold and protect their crypto. If you’re undecided which kind of wallet suits you best, this articles is for you.

Crypto Wallets Basic Concepts

Before taking a deep dive into hot and cold wallets, let’s point out some fundamentals about how these work. 

Crypto newbies tend to make a common mistake, which is to think that their wallet stores their crypto. It doesn’t. All funds, with no exception, are stored in the blockchain. What the wallet actually stores is the private keys that grant the owner access to those funds. Private keys are the proof you have to show the blockchain for it to let you move, spend or exchange your coins. You have to keep them safe (we can’t stress that enough). Losing these means losing your money for good. 

We’ll return to private keys later. Now, let’s mention another common mistake: mixing up private and public keys. While we’ve covered the former, the latter is the code that allows users to receive information, in this case, in the form of cryptocurrency. A wallet address, then, is a hashed (encrypted) version of its public keys. While you can safely share your public keys to receive funds, for example, your private keys must always stay secret.

All in all, wallets are the interface that enables users to interact with the blockchain. They work by providing public keys that encrypt data and private keys that decrypt it. However, the way they manage these keys varies. Hence, we have different types of wallets.

The Crypto App has a built-in wallet in which you can store your funds. You can also link it to your portfolio to keep track of your profits and losses. Download the app here.

Hot wallets: Immediate access, less security

Hot wallets have that name because they are connected to the internet, providing instant access to the funds. They can connect to any blockchain application and platform with a few clicks or taps. Usually, you can install hot wallets on your phone, your computer or even on your web browser as an extension, which is why they tend to be more user-friendly and agile.

Imagine you hold Dai on a hardware wallet. You wake up in the morning and open The Crypto App on your phone to find that Bitcoin price has dipped 20%, giving you a unique opportunity to buy. You’d have to fetch your hardware wallet, plug it into your PC, send your Dai to Metamask (which means an extra cost for the fee), wait for the transaction to go through, then open a DeFi exchange and swap your Dai for BTC. 

Sounds like a lot of trouble, doesn’t it? Even more, you could lose your window of opportunity if BTC recovered while you were in the middle of the process. That’s why hot wallets are the common choice among traders and regular investors, as they have their funds at their disposal immediately.

Every time you initiate a transaction, the device signs (approves) it with the private key and broadcasts it to the blockchain. Everything happens within the hot wallet. There’s no need for any other device or interface.

The ease of use comes with a downside, however. Remember private keys? A wallet connected to the internet poses a high risk of vulnerability to your private keys. A hacker could get through to them, giving them access to your assets. Malware from a malicious website or downloaded file could also pick them up and compromise your wallet.

Some examples of hot wallets are Metamask, Binance and Coinbase.

Cold wallets: A holder’s dream

If hot wallets get their name for being connected to the internet, you must have already guessed it: Cold wallets are offline storage devices. They store your keys in a physical means to keep them protected against any malicious intent to hack or steal them. There are, in turn, many different kinds of these wallets: Paper, hardware and some software wallets are all considered cold storage methods.

You must be wondering how can that happen. Even more so: If cold wallets never connect to the internet, how can they possibly interact with the blockchain? 

Cold wallets usually split into two platforms. One safely stores your keys offline; the other is an interface to access the blockchain. Through the latter, you can initiate a transaction, which is then sent to the former to get signed with the private keys. The cold wallet performs the signing offline, so the wallet never exposes the private keys to the internet. After the transaction is signed, it goes back to the online platform, which broadcasts it to the blockchain.

Here’s an example to better explain it: Trezor T is a cold hardware wallet that works just like a USB. The physical device that holds the keys connects to a computer through a cable. Once the setup is complete, you have to operate using a program called Trezor Suite, which in this case is the online interface connected to the blockchain. Trezor Suite generates unsigned transactions and sends them to the physical device (the offline storage) through the cable, so no internet involved. The device signs the transaction and returns it to Trezor Suite, which broadcasts it to the network. The hardware device never goes online, so if you unplug it from your PC, the transaction will be interrupted.

As you can see, cold wallets are far more secure than hot wallets, but all this process can be cumbersome, and it certainly takes more time. In the extremely volatile crypto market, just a few seconds is enough to miss a one-of-a-kind opportunity. That is the main reason why cold wallets are the preferred choice of long-term holders and traders that want to cash out profits.

The most common cold wallets are the already mentioned Trezor, Ledger (which are both hardware wallets), and some software cold wallets like Exodus, Electrum and Coinomi.

The best of both worlds

Who’s to say you can get the best out of each kind of wallet? That’s what most people do anyway. Proficient crypto investors know how much to keep in a hot wallet ready to buy the dips; and how much to safely store in their cold wallets to secure their profits. Just make sure you understand what you’re getting into and how the wallet of your choice works. That way, you’ll know how your keys are stored, the risks you’re exposed to, and the time you’ll need to operate.

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