Managing crypto assets can be complicated and has proven to be a barrier of entry for many investors looking to enter the market. Even with advanced custody solutions and more user-friendly interfaces hitting the market, self custody in a digital world is no easy feat.
Crypto assets must be stored in a hot or cold wallet. Crypto wallets store a string of numbers and letters known as a private key. Private keys are used to unlock users' addresses (the unique IDs required to make and receive payments). For a crypto transaction to occur, two parties need to share their addresses, and the blockchain then needs to verify them to make sure each party has the necessary funds. Unlike private keys, addresses can be public and can’t be used to authorize movement of your funds. Similar to a bank account number, knowledge of your crypto wallet address can only equate to someone sending you value (authorized or not).
Understanding how to best store custody information, and the difference between crypto wallet types, is a crucial first step to entering the crypto market. Keep reading to learn more.
For comparison sake, think of a hot wallet as your checking account and a cold wallet as a safety deposit box. Crypto assets you hold in a hot wallet are connected to the internet and are instantly available for transacting. Hot wallets are usually best suited for small holdings, similar to the type of wallets people use to carry their everyday cash. On the other hand, cold wallets are kept completely offline and are therefore better suited to store large amounts of savings.
Breaking Down Hot Storage
Hot storage refers to any crypto wallet that is run through an internet connected system. Hot wallets can be run on the cloud, a mobile device, or a desktop. Depending on the system, the user may or may not be in control of their private keys. A hot wallet can provide users with a convenient way to access their crypto assets on the go and can make sending or receiving crypto simple.
While there is a benefit to having ready access to your funds, the fact that the crypto wallet is connected to the internet presents additional vectors of attack by malicious third parties. How the private keys are stored and generated, whether the user has full and sole access to the private keys, among other factors should be taken into consideration when using a hot wallet.
- Major retail exchanges utilize hot wallets (these are often called “hosted” hot wallets as the asset owners forego private keys to let exchanges more easily manage assets)
- Most wallets that you can download to your phone are hot wallets.
Breaking Down Cold Storage
Cold storage is offline storage. By not storing the private keys on an internet enabled device, you are mitigating many of the risks inherent to hot wallets. Cold wallets may enable users to receive, send, and sign transactions from a USB, hard drive, or offline computer, with the broadcasting of the transaction being completed through an internet enabled device. Since the private keys aren’t in contact with an online server, there are fewer vectors of attack from wannabe hackers.
Cold crypto wallets may require users to keep track of an additional physical object and are less convenient for accessing your funds quickly or on the go.
Example of cold storage would be:
- Paper wallet: Writing keys on a piece of physical paper
- USB device
Which is better?
Hot and cold crypto wallets offer different advantages, and most crypto users chose to utilize both, holding some of their assets in a hot wallet for everyday transactions, and the rest in cold storage for safekeeping.
If you choose to manage your assets on a crypto exchange, you're likely utilizing their version of a hot wallet. Though, many exchanges hold their customer's assets in a mix of hot and cold wallets to provide both liquidity and security to their users.
Choosing the right mix of hot and cold storage is a personal decision and should be thought through based on your individual crypto trading strategy.
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