Cryptocurrencies are digital or virtual currencies that use cryptography for security. They operate on decentralized technology called blockchain, which is a distributed ledger that records all transactions across a network of computers.
To own cryptocurrencies or use them for transactions, you need to have a wallet, which is essentially a combination of a private key and a public key. We discussed these keys in our previous post.
Many people believe that when they do transactions, they share their public key, allowing others to send crypto to that address. Then, with the private key, they approve transactions to move crypto from their address to another.
However, it’s a misconception to think that these coins physically exist in your wallet or address. In reality, all these cryptocurrencies are recorded on the blockchain ledger. Your wallet grants you the ability to use and spend those currencies that are on the blockchain.
So, the coins aren’t in your wallet; they’re on the blockchain, and your wallet provides access to them.
The main role of a crypto wallet is pretty simple: it generates a public and private key for you and helps you perform actions on the blockchain, such as receiving or sending cryptocurrency to other addresses on the blockchain.
Now, how can we make those private and public keys? And how can we keep them safe to ensure that no one can access your private key? There are various methods to create private and public keys or wallets, and we categorize them into two groups: cold storage and hot storage.
Difference Between Cold Storage & Hot Storage
The main difference between them is whether your private and public keys or your wallet are linked to the internet. If they’re connected to the internet, it’s hot storage; if they’re not connected, it’s cold storage.
Cold Storages
Cold storage refers to the practice of keeping your private key entirely offline, minimizing the exposure of your private keys to potential online threats.
Here are some common methods of cold storage:
What are Hardware Wallets?
These are physical devices designed solely for the purpose of storing cryptocurrency. They are not connected to the internet and provide the highest level of security. To access your funds, you typically need to connect the hardware wallet to a computer or mobile device
Pros:
High Security: Hardware wallets offer top-tier security by storing private keys offline, making them immune to online threats such as hacking and malware.
User-Friendly: Many hardware wallets feature user-friendly interfaces displayed on screens, allowing for easy balance checks, sending/receiving crypto, and transaction verification directly on the device.
Private Key Protection: Your private keys are securely stored within the hardware wallet and are never exposed to the device you connect it to, ensuring robust protection.
PIN and Recovery Seed: Hardware wallets use a PIN code for access, and they provide a recovery seed (a list of words) during setup. This seed serves as a backup in case the hardware wallet is lost or damaged.
Support for Multiple Cryptocurrencies: Most hardware wallets support a wide range of cryptocurrencies, making them versatile for managing various digital assets.
Ideal for Long-Term Storage: Hardware wallets are a popular choice for long-term cryptocurrency storage, particularly for investors who don’t require frequent access for trading or transactions.
Independence from Third Parties: Using a hardware wallet provides full control over your cryptocurrency holdings without relying on third-party services.
Cons:
Upfront Cost: Hardware wallets come with an initial purchase cost, which can be a deterrent for some users, especially those with a modest amount of cryptocurrency.
Risk of Physical Loss or Damage: Because they are physical devices, there is a risk of losing or damaging them. Without access to your recovery seed, you could potentially lose your funds.
Less Convenient for Frequent Transactions: Hardware wallets, while secure, are less convenient for users who require frequent access to their funds for daily transactions.
Setup Complexity: The setup of hardware wallets might be more involved compared to using software wallets, which could be intimidating for beginners.
Firmware and Software Updates: Users need to regularly update the firmware and software of their hardware wallet to maintain security and compatibility with the latest features and cryptocurrencies.
Examples of Hardware Wallets:
Ledger Nano S & Ledger Nano X: These hardware wallets are popular choices known for their security features and wide cryptocurrency support.
Trezor Model T & Trezor One: Trezor hardware wallets are user-friendly and offer robust security for storing cryptocurrencies.
Coldcard: Coldcard offers advanced security features and is particularly well-regarded for its security-conscious design.
When choosing a hardware wallet, it’s important to consider your specific needs, the cryptocurrencies you intend to store, and your comfort level with the device’s setup and operation. Hardware wallets remain a highly recommended choice for long-term cryptocurrency storage.
What are Paper Wallets?
A paper wallet is a physical document that contains your public and private keys. It’s usually printed or written down and should be stored in a safe and secure location, like a physical safe.
Pros:
High Security: Paper wallets are highly secure because they are entirely offline. They are immune to online threats, such as hacking and malware, making them one of the safest options for storing cryptocurrencies.
No Digital Footprint: Since paper wallets are not connected to the internet, there is no digital footprint or exposure to online vulnerabilities, which is particularly appealing to security-conscious users.
No Upfront Cost: Creating a paper wallet is often free, apart from the cost of printing the document. This can be an attractive option for those looking to securely store their cryptocurrency without purchasing a hardware wallet.
User-Controlled: You have complete control over your private keys with a paper wallet, and you do not need to rely on third-party services to access your funds.
Cons:
Physical Vulnerability: Being a physical document, paper wallets are susceptible to physical loss, damage, or deterioration over time. Protecting them from these risks is crucial.
Setup Complexity: The process of creating a paper wallet can be intimidating and challenging for beginners. It involves generating keys offline, which may require technical know-how.
Not Suitable for Frequent Transactions: Paper wallets are primarily intended for long-term storage and are not practical for users who need frequent access to their funds for trading or daily transactions.
Single Use: Paper wallets are generally considered single-use. If you decide to access your cryptocurrency stored on a paper wallet, it’s recommended to transfer the entire balance to a digital wallet. Once you do this, the paper wallet’s security is compromised.
Examples of Paper Wallets:
Bitaddress.org: Bitaddress.org is a popular online tool for generating paper wallets. It allows users to create a paper wallet for Bitcoin. Users can generate keys securely offline and print the wallet on paper.
Offline Wallet Generator Software: Some users prefer to generate paper wallets offline using open-source software, such as “bitcoinpaperwallet” or “Liteaddress” for Litecoin.
When using a paper wallet, it’s important to take steps to safeguard the physical document. Store it in a secure, dry, and fire-resistant location, and consider making multiple copies to prevent the risk of loss.
Additionally, only use paper wallets if you are comfortable with the technical aspects of generating and using them securely. They are an attractive option for those who prioritize security and long-term storage of their cryptocurrencies.
Offline Computer or Air-Gapped Device
This involves creating a separate computer or device that has never been connected to the internet to generate and store cryptocurrency keys. This method is less common but highly secure.
Pros:
Maximum Security: An air-gapped device is one of the most secure options for storing cryptocurrencies. It is completely isolated from the internet, making it impervious to online hacking attempts and malware.
Private Key Protection: Your private keys are stored offline on the air-gapped device, ensuring that they are never exposed to online threats, providing robust protection.
Full Control: You have complete control over your cryptocurrency holdings, as you do not rely on third-party services. This is particularly appealing to users who value independence.
Versatility: An air-gapped device can be used to manage various cryptocurrencies and tokens, offering versatility for users with diverse digital assets.
Cons:
Complex Setup: Creating and maintaining an air-gapped device can be technically challenging, requiring a strong understanding of security practices and procedures. This complexity can be a barrier for beginners.
Limited Convenience: Air-gapped devices are less convenient for users who need frequent access to their cryptocurrency for trading or daily transactions. Moving funds to and from the device may require extra steps.
Risk of Physical Damage or Loss: Just like hardware wallets, air-gapped devices can be at risk of physical damage or loss. Keeping them secure and well-preserved is essential.
Updates and Maintenance: Regularly updating the device’s firmware, software, and security protocols is crucial to maintain its security and compatibility with the latest features and cryptocurrencies.
Examples of Air-Gapped Devices:
Raspberry Pi: Raspberry Pi is a small, affordable, and versatile computer that can be set up as an air-gapped device for secure cryptocurrency storage. Various software and tutorials are available for creating a secure setup.
Dedicated Air-Gapped Computers: Some users opt to purchase or build dedicated air-gapped computers specifically designed for cryptocurrency storage. These systems are carefully configured to ensure maximum security.
DIY Air-Gapped Setup: Experienced users may choose to create their own air-gapped setup using an older computer, ensuring it is never connected to the internet. They can install the necessary software for generating and managing cryptocurrency wallets securely.
Air-gapped devices are an advanced method of securing cryptocurrencies and are typically chosen by users who require the highest level of security and are comfortable with the complexities of setup and maintenance. They are suitable for long-term storage and protection of digital assets.
Hot Storages
Hot storage, in contrast, refers to methods where your cryptocurrency private keys are stored on devices that are connected to the internet. This setup is typically used for the cryptocurrency you need for everyday transactions and trading.
What are Software Wallets?
Software wallets, also known as digital wallets, are applications or software programs that enable users to store, manage, and access their cryptocurrencies on computers, smartphones, or other devices.
Pros:
Convenience: Software wallets are easy to download and install, offering convenient access to your cryptocurrency holdings. They are user-friendly and suitable for daily transactions.
Versatility: Many software wallets support a wide range of cryptocurrencies and tokens, making them suitable for users with diverse digital assets.
No Upfront Cost: Most software wallets are free to use and do not require an initial purchase, making them accessible to a broad user base.
Accessibility: You can access your funds from any device with the installed wallet, as long as you have your recovery phrase (a backup phrase or seed) available.
Security Features: Some software wallets offer advanced security features, such as two-factor authentication (2FA), password protection, and encryption, to enhance the protection
Cons:
Online Vulnerability: Software wallets are connected to the internet, making them vulnerable to online threats such as hacking, phishing, and malware attacks. Security is highly dependent on the user’s device and practices.
Backup Responsibility: Users must securely store their recovery phrase (backup seed). If the device is lost, damaged, or compromised, access to the wallet and funds can be lost without the recovery phrase.
Dependence on Third Parties: Many software wallets rely on third-party service providers, which can pose risks if those providers experience technical issues, outages, or security breaches.
Limited Security for Large Holdings: While software wallets can be secure for smaller amounts of cryptocurrency, they may not provide the same level of security as hardware wallets or air-gapped devices for substantial holdings.
Examples of Software Wallets:
Electrum: Electrum is a popular and widely used open-source software wallet for Bitcoin. It offers advanced security features and is known for its fast and efficient operation.
Exodus: Exodus is a user-friendly software wallet that supports multiple cryptocurrencies and offers a built-in exchange feature. It has a visually appealing interface.
Coinomi: Coinomi is a mobile wallet available for Android and iOS, supporting a wide range of cryptocurrencies. It emphasizes privacy and security.
Trust Wallet: Trust Wallet is a mobile wallet, particularly well-regarded for its integration with decentralized applications (DApps) and DeFi platforms.
When selecting a software wallet, consider the level of security, the range of supported cryptocurrencies, ease of use, and the reputation of the wallet provider.
Software wallets are best suited for users who require convenient access for everyday transactions while taking precautions to enhance security.
For significant cryptocurrency holdings, additional security measures like hardware wallets or air-gapped devices may be recommended.
What are Crypto Online Wallets?
These are web-based wallets provided by cryptocurrency exchanges or online wallet services. Your private keys are stored on the service’s servers, and you access your funds through a web interface.
Pros:
Convenience: Online wallets are easily accessible from any device with an internet connection, making them convenient for users who need to access their cryptocurrency holdings on the go.
User-Friendly: Most online wallets offer user-friendly interfaces that are easy to navigate, making them suitable for both beginners and experienced users.
No Upfront Cost: The majority of online wallet services are free to use and do not require an initial purchase or setup fee, making them accessible to a broad user base.
Backup and Recovery: Some online wallets provide backup and recovery options, which can help users regain access to their funds in case of lost passwords or device changes.
Multi-Currency Support: Many online wallets support a variety of cryptocurrencies and tokens, offering versatility for users with diverse digital assets.
Cons:
Security Risks: Online wallets are connected to the internet, which makes them vulnerable to online threats, including hacking, phishing, and malware attacks. Security is highly dependent on the practices and measures taken by the wallet provider.
Dependence on Third Parties: Users entrust their private keys to the online wallet service provider, which can pose risks if the provider experiences technical issues, outages, or security breaches.
Control and Privacy: Using an online wallet means relinquishing some control and privacy. Users must trust the wallet provider with their private keys and personal information.
Limited Security for Large Holdings: While online wallets can be secure for smaller amounts of cryptocurrency, they may not provide the same level of security as hardware wallets or air-gapped devices for significant holdings.
Examples of Online Wallets:
MetaMask: MetaMask is a browser extension wallet primarily designed for managing Ethereum and Ethereum-based tokens. It allows users to interact with decentralized applications (DApps) directly from their browsers.
Coinbase Wallet: Coinbase Wallet is the standalone mobile wallet provided by Coinbase, a popular cryptocurrency exchange. It supports multiple cryptocurrencies and offers features like biometric authentication.
When using an online wallet, it’s crucial to choose a reputable provider, enable additional security features (like two-factor authentication), and exercise caution to protect your funds.
Online wallets are best suited for users who need convenient access for everyday transactions while taking measures to enhance security.
What are Exchange Wallets?
When you hold your cryptocurrency on a cryptocurrency exchange, it is stored in wallets managed by the exchange. These wallets are typically considered hot wallets because they are connected to the exchange’s servers.
Pros:
Convenience: Exchange wallets are incredibly convenient for users who frequently trade or engage in buying and selling cryptocurrencies on the exchange platform.
Instant Trading: Having assets in an exchange wallet allows for quick and seamless trading, as you can execute orders without the need to transfer funds between wallets.
Liquidity: Exchange wallets ensure that your assets are readily available for trading, which is advantageous if you need immediate access to your holdings.
User-Friendly: Exchange wallets are typically integrated into the exchange’s user interface, making them user-friendly and accessible for both beginners and experienced traders.
Advanced Features: Some exchange wallets offer advanced trading features, such as margin trading and lending, which can be appealing to traders looking for additional options.
Cons:
Security Risks: Keeping assets in an exchange wallet exposes them to online security risks, including hacking, phishing attacks, and the potential vulnerabilities of the exchange itself.
Third-Party Control: When you use an exchange wallet, you relinquish control of your private keys to the exchange. If the exchange experiences issues, you might have limited control over your funds.
Regulatory Risks: Exchanges are subject to government regulations, and changes in these regulations can impact the accessibility and security of your assets.
Risk of Loss: In the event of a security breach or a closure of the exchange, there’s a risk of losing your assets. Some exchanges have insurance to cover losses, but it might not fully protect your holdings.
Examples of Exchange Wallets:
Binance: Binance is a popular cryptocurrency exchange that provides an integrated exchange wallet. It offers a user-friendly interface, a wide range of supported cryptocurrencies, and additional features like staking and lending.
Coinbase: Coinbase is a well-known cryptocurrency exchange with an associated wallet. Coinbase Wallet offers a convenient way to store and manage your digital assets, with access to a mobile app for on-the-go trading.
Kraken: Kraken is another major exchange that provides an integrated wallet for its users. The wallet is accessible through the exchange platform and supports various cryptocurrencies.
Exchange wallets are best suited for active traders who frequently buy and sell cryptocurrencies on exchange platforms. However, it’s essential to exercise caution, employ security measures (like two-factor authentication), and consider transferring your assets to a more secure wallet, such as a hardware wallet, for long-term storage to mitigate security risks associated with exchange wallets.
There’s one more important thing I’d like to discuss before wrapping up this post, and it’s all about recovery codes or seeds.
Wallet Seeds (Recovery Codes)
Wallet seeds, often referred to as recovery codes, are a foundational aspect of cryptocurrency security and management. These are sequences of words, typically 12, 24, or 25 words long, arranged in a specific order. The purpose of wallet seeds is to provide a secure and standardized way to recover access to your cryptocurrency holdings in case of unforeseen circumstances.
Wallet seeds are generated deterministically from your wallet’s private keys. This means that if you use the same private keys, the same wallet seed will be produced every time. This deterministic nature is a crucial element, as it ensures consistent and predictable recovery.
These words are carefully chosen from standardized word lists. The most commonly used word list is the BIP-39 word list, which includes 2048 words. This standardization ensures compatibility and consistency across different wallets, making it easier for users to recover their assets regardless of the wallet used.
The security of wallet seeds is paramount. They are generated with a high degree of cryptographic entropy, which ensures that they are highly random and unpredictable. This level of entropy makes it exceptionally challenging for any malicious actor to guess or derive the private keys from the seed.
To recover a wallet, users need to enter the wallet seed in the exact order it was originally generated. The wallet software then derives the private keys from the seed, granting access to the cryptocurrency holdings. This process is straightforward and is a critical safety net in the world of cryptocurrency.
The secrecy and security of wallet seeds are of utmost importance. Sharing your seed or storing it electronically increases the risk of theft. Storing the seed on paper or other physical media is a secure approach. Many wallet providers supply a recovery sheet for you to write down your seed, which should be stored in a safe and secure location.
In some cases, wallets allow users to add an extra layer of security through a passphrase used in conjunction with the seed. This passphrase must also be kept secret, as it adds an additional layer of protection for your wallet.
Wallet seeds are an essential element in the security and recovery of your cryptocurrency holdings. Understanding their purpose, keeping them secure, and being aware of the recovery process are key steps in ensuring the safety of your digital assets, and providing peace of mind for cryptocurrency users.
Conclusion
In practice, many cryptocurrency users employ a combination of both cold and hot storage. They use cold storage for secure, long-term holding of their cryptocurrency investments and use hot wallets for quick access to funds needed for everyday activities. This balance helps mitigate the risks associated with hot storage while maintaining convenience.