Cryptocurrency Wallets: The Difference Between Hot and Cold Storage

So you’ve finally gotten around to purchasing your first cryptocurrency. Now what?

It’s not enough to keep your cryptocurrencies on an exchange, gradually increasing or decreasing in value. Best practice suggests that cryptocurrency investors should immediately move their coins into a hot or cold storage wallet.

But what exactly is a cryptocurrency wallet, and what is the difference between hot and cold storage?

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Why move cryptocurrencies off of exchanges?

While it’s super convenient to leave cryptocurrencies on the exchanges from where you bought them (like Coinbase or Binance), this comes with two problems.

One problem is that you don’t own your coins when they’re sitting on an exchange. Similar to how central banks handle money, centralized cryptocurrency exchanges are still technically holding your coins in reserve. They can use their reserve holdings as they see fit.

And this leads to the second problem: if something happens to the exchange, such as a major hack, they may lose all of their reserve coins and not pay back the traders. Scenarios like this have happened many times before.

Essentially, leaving your cryptocurrencies on an exchange leaves them open to a single point of failure. Additionally, as the saying goes, “not your keys, not your crypto.” In other words, the only way to truly own your cryptocurrencies is to own the storage method.

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What are cryptocurrency storage wallets?

Cryptocurrency wallets can be software or hardware-based. Software wallets are apps or programs that you can download to your PC or smartphone. Hardware wallets can be USB drives or paper wallets.

When you transfer funds from an exchange to a cryptocurrency wallet, the wallet will usually require you to set up a passphrase, or “seed phrase,” to access your funds. Seed phrases are the keys referred to in the saying mentioned above, “not your keys, not your crypto.”

The seed phrase often comes in the form of 24 words that you’ll need to memorize or write down. Seed phrases are your private keys, and no one else should ever know them.

Once you transfer your funds to a cryptocurrency wallet, you officially own your coins. Before this, however, you must decide whether to use a hot or cold storage method.

The difference between hot and cold storage

Cryptocurrency wallets can either be software or hardware-based. Wallets are considered “hot” when connected to the internet or “cold” when wholly isolated from the internet.

Software wallets are usually hot. Those seeking the convenience of quickly moving funds from an exchange to a wallet will often opt for hot storage in the form of an app. Smartphones have made it even more convenient to manage cryptocurrencies in hot storage apps.

While using any wallet is better than keeping funds on an exchange, the only problem with hot storage is that they are still open to internet-based hacks. If a hacker can take over your device, they can likely access the programs on said device, including your cryptocurrency wallets.

On the other hand, investors champion cold storage as the absolute safest way to store cryptocurrencies because the internet is no longer an attack vector. Cold storage is typically hardware-based, coming in the form of flash drives or even paper wallets. With flash drives, for example, all you need to do is connect it to a computer, quickly transfer funds, and disconnect the flash drive and store it somewhere physically safe.

Cryptocurrency Wallets The Difference Between Hot and Cold Storage
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Furthermore, paper wallets are pieces of paper that look like dollar bills and have QR codes or wallet addresses printed on them. Transferring funds to a paper wallet is just a matter of scanning the QR code or manually entering the wallet address.

And although software wallets are usually considered hot storage, it’s possible to convert them into cold storage. For instance, you can download a wallet program onto your device and then disconnect that device from the internet—a good idea for people with spare devices they won’t need to use any time soon.

Finally, finding somewhere secure to store your wallet physically is the most important thing when using cold storage methods. People often go with safes, security deposit boxes, or storage spaces.

The bottom line

After buying cryptocurrencies from exchanges, the first thing to do is transfer the funds to a personal wallet, whether that be hot or cold storage. Both options are safer than leaving the coins on an exchange. However, while highly convenient to use, hot storage methods are generally more at risk than cold storage methods.

The difference between hot and cold storage wallets is whether or not they connect to the internet. The internet is just another attack vector hackers can use to steal your funds. Ultimately, the most secure way to store your cryptocurrencies for the long-term is to use a cold storage wallet and keep it locked away.

Always remember, “not your keys, not your crypto.” Never lose or forget the private seed phrase that comes with your hot or cold cryptocurrency wallet.

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