Understanding the differences between wallet types is crucial for anyone navigating the world of crypto.
Owning cryptocurrency doesn't mean physically possessing coins in a tangible wallet or safe. Instead, ownership means having a digital key to access, transfer or spend these assets. A cryptocurrency wallet stores cryptographic keys used to make and receive transactions.
Wallets fall into two broad categories, software and hardware.
Software wallets (also known as hot wallets)
Software wallets are connected to the internet, which makes them very accessible and user-friendly. They make transactions straightforward with very low barriers to entry. They can be mobile, desktop or web-based applications. Wallets are specific to a blockchain so a bitcoin wallet will only support bitcoin tokens.
They are ‘hot’ in nature, given they are always online and therefore open to attack from hacking, phishing scams and malware. Software wallets are considered the least secure wallet type - particularly web-based wallets. Accordingly, experts generally advise against storing large amounts of crypto assets in hot wallets. Instead, hot wallets tend to be more suitable for frequent trades or purchases
Hardware Wallets (also known as cold wallets)
Hardware wallets are offline storage solutions. They are ‘cold’ because they are disconnected from the internet and store private keys within the device. They are physical devices which connect to a computer to make a transaction. Most will require a PIN or password before signing a transaction. They range in price, function and supported assets.
Cold wallets are designed to be immune to hacking even when connected to a compromised device or computer. The wallet stores private keys, which only ever remain within the device. A signature is broadcast to the blockchain via the internet once the transaction has been signed using the private key.
The main disadvantage of cold wallets is convenience of use. Access or transferring assets isn’t instantaneous compared to hot wallets. Moreover, the loss or damage of a cold wallet can result in the irreversible loss of the stored cryptocurrencies, making safekeeping paramount.
Some wallets are in custody, meaning while you control sending funds, the private key is held by a third party. This means the third party has control of your funds. Self-custody solutions mean you are the sole owner of the private keys used to access funds but also means you are solely responsible for securing funds. The majority of web-wallets and exchange wallets are custody solutions.
Choosing between hot and cold wallets depends on one's needs and priorities. Those seeking higher security and long-term storage might prefer to use cold wallets. Frequent traders or those new to the cryptocurrency world might prefer the convenience of hot wallets. Given the tradeoff between the two solutions, combining hot and cold wallets can balance security and ease of access.
