What Is Cold Wallet? What Are the Differences Between Cold Wallet and Hot Wallet?

Today, cryptocurrency markets are highly developed and continue to grow. Many people, from individuals to institutions, own cryptocurrencies. After purchasing cryptocurrencies, it is an important step for cryptocurrency owners to decide how and where to store their assets. Unlike fiat or physical currencies, cryptocurrencies operate on a blockchain. Therefore, cryptocurrency owners need digital cryptocurrency wallets to store their cryptocurrencies. A cryptocurrency wallet allows for the holding and transfer of assets and consists of public and private keys, which are strings of characters that allow holders to receive and transfer cryptocurrencies.

There are optionally two types of storage systems for cryptocurrency wallets:

Hot Storage
Cold Storage

Hot Storage

Hot storage refers to an online application or platform that is connected to the internet.

Cold Storage

Cold storage refers to a storage application that is used offline through a physical device, usually similar to a flash drive.

While both hot storage and cold storage systems offer individuals access to their digital funds, they differ in terms of user experience and levels of security.

The choice of hot or cold storage systems depends on user's preference.

Wallets used for storing cryptocurrencies are divided into two:

Hot wallets
Cold wallet

Hot wallets use hot storage systems, while cold wallets use cold storage systems.

A hot wallet refers to a cryptocurrency wallet where cryptocurrencies are stored and accessible online. Hot wallets usually run on computers, mobile devices, or online platforms that are connected to the internet.

A cold wallet refers to a cryptocurrency wallet that is used to store cryptocurrencies and is not connected to any internet network. A Cold Wallet is an offline wallet that is not connected to the internet.

A cold wallet protects from security incidents such as theft, corruption, or hacking. A cold wallet works offline to host cryptocurrencies. Therefore, the wallet is protected against unauthorized access, cyberattacks, and other vulnerabilities that an internet-connected system may be exposed to. In other words, cryptocurrencies are stored in an environment that is not connected to the internet through cold storage systems and can be protected from unauthorized access, cyberattacks, and other security vulnerabilities. In addition to security, cold storage is also used for videos, photos, and backup data.

How Does Cold Wallet Work?

When a cryptocurrency is bought, the transaction is recorded on the blockchain, which is called the transaction ledger. When the blockchain is public, anyone can access it as long as they have an internet connection. Blockchains are usually hosted by a decentralized network of computers, meaning they are not tied to a single authority. In order to access cryptocurrencies, a public and private key is needed for security and asset protection.

Cold wallets securely store private keys. These wallets store your private key, usually on a device similar to a smart memory stick. To access a cold wallet, the wallet needs to be connected to a computer or mobile device using a connection method such as USB or Bluetooth. Then, using the cold wallet's mobile or desktop application, helps the owner gain access to their assets. Cold wallets are usually password protected and take additional security measures to increase safety.

For instance, Ledger, one of the popular cold wallet manufacturers, requires a PIN code of 4 to 8 digits. Using this PIN, the wallet can be accessed and cryptocurrencies can be managed.

Cold wallets are also considered the best way to protect cryptocurrencies against cybercrime. This is because the wallets are offline, not connected to the internet.

What Are the Types of Cold Wallet?

Cold wallet is divided into two basic types:

Paper wallet
Hardware wallet

Paper Wallet

A paper wallet is a document with the public key and cryptocurrencies written on it. It usually also contains a QR code representing the keys. Although a paper wallet does not carry the risk of being transported over the internet, it should be stored carefully. This is because if the wallet is lost, stolen, or damaged, the account cannot be accessed. However, since paper wallets have some flaws, their use is now considered risky.

One of the biggest flaws of paper wallets is the ability to send the entire cryptocurrency inside. That is, only the entire cryptocurrency can be transferred using the wallet. It is not possible to make partial transfers. This can be limiting in the transfer of all assets.

Hardware Wallet

A hardware wallet is a private key-based wallet designed for the secure storage of cryptocurrencies. They protect private keys by storing them in offline, encrypted chips.

To access the hardware wallet, a PIN code must be entered using a special field on the device. If the PIN code is forgotten, the device may need to be reset. For this, it is possible to reset the device by entering the set of keywords specified during the setup phase of the device. The hardware wallet is used offline to ensure that the private keys do not leave the device and need to interact with another device.

The hardware wallet has high levels of security, minimizing the risk of viruses or leakage of private keys compared to other devices such as computers and phones. It allows cryptocurrencies to be stored more securely.

Why Do You Need a Cold Wallet?

When a checking, savings, or credit card account at a bank is compromised, the bank can return the lost or stolen money to the account holder. However, if a cryptocurrency account or wallet is compromised and assets are stolen, it may not be possible to recover those assets. It is because most cryptocurrencies do not rely on a central authority or central bank. Crypto investors should be aware of the security measures necessary to protect their assets. Therefore, it is necessary to provide a secure storage environment for cryptocurrencies.

The cryptocurrency wallet is associated with the public and private keys of the asset owner. All cryptocurrency storage methods provide access to the wallet as it involves the protection of these keys. A cryptocurrency owner's private key is a unique string of alphanumeric characters to access their cryptocurrencies and is required for spending transactions.

The public key functions similarly to an account number or email address, helping to identify a destination for assets sent to the wallet.

Two people transacting in cryptocurrencies have to share their public key to complete a transaction. The selling party sends the required amount of relevant cryptocurrencies to the address specified for the receiving party to make a payment, and the blockchain verifies the validity of the transaction and confirms that the sender has the necessary assets to make the payment. Once the payment is delivered to their address, the recipient can only access their assets using their private key. Therefore, private keys must be stored securely, because if they are stolen, the user's cryptocurrencies could become vulnerable to unauthorized access.

What Are the Differences Between Cold Wallet and Hot Wallet?

Cold wallets work offline, without being connected to the internet, while hot wallets work online, connected to the internet. Hot wallets are often used for free and are therefore less costly than cold wallets. Cold wallets are offline and therefore protect against cyber-attacks. Hot wallets, on the other hand, operate online and are therefore vulnerable to cyber attacks.