Hot Wallet: Definition, Types, Examples, and Safety Tips
What Is a Hot Wallet?
A hot wallet is a cryptocurrency wallet that is always connected to the internet and cryptocurrency network. Hot wallets are used to send and receive cryptocurrency, and they allow you to view how many tokens you have available to use.
KEY TAKEAWAYS
How a Hot Wallet Works
When you buy or mine a cryptocurrency, you have to set up a wallet to facilitate transactions if you decide to use it for purchasing goods or services. Yourcryptocurrencies, or rather the private keys you use to access the currency, are stored in these wallets when ownership is transferred to you by the ecosystem.
When you own a cryptocurrency, you're given private keys that identify it as yours. Public keys are similar to account usernames; they identify the wallet so that the user can receive tokens without revealing their identity. Private keys are similar to personal identification numbers; they allow you to access the wallet and check balances, initiate transactions, and more. Without either of these keys, the wallet is effectively useless.
Hot wallets are applications connected to the internet and the cryptocurrency infrastructure, which allows you to use them. For a user, the hot wallet is the interface for accessing and storing your cryptocurrency. For the cryptocurrency network, their role is to facilitate any changes to the transaction record kept on the decentralized blockchain ledger for whichever cryptocurrency you're using.
Cold wallets are also called cold storage, and they are considered one of the safest methods for securing your digital currency.
They are different fromcold wallets, which are devices or applications that store your private keys offline—these can be an application on your device that doesn't connect to the internet or a device that looks like a USB thumb drive that stores your keys. To use the cryptocurrency you have in cold storage, you need to transfer them to your hot wallet.
Types of Hot Wallets
There are a variety of hot wallets available, and many of them are free to download. Some wallets are specifically designed to be used in partnership with particular mobile web applications; you might find one that only works with a particular cryptocurrency or ecosystem. In addition, some cryptocurrency exchanges will only accept transfers to and from specific wallets.
Examples of hot walletsare MetaMask, Coinbase Wallet, and Edge Wallet. MetaMask is designed for transactions using the Ethereum ecosystem. Coinbase Wallet is the wallet for the cryptocurrency exchange Coinbase and Edge Wallet is designed to accept transactions using all of your digital assets.
Because there are so many wallets with different designs and intents, it's important for you to research hot wallets before downloading and using their services. Wallet developers have varying degrees of expertise, various commitments to security and privacy, and different priorities in mind when creating their wallets. Some might have fees; others might not. You might need to use one wallet that integrates with your internet browser for one currency and use another wallet that is a dedicated application.
Special Considerations
There are several aspects you should consider before deciding on your hot wallet. Most important are its security features and how you use them. Because your cryptocurrency is only as safe as the way you use it, its safety and security depend upon how you're storing your tokens. Any items stored in a hot wallet are vulnerable to attack because the public and private keys are stored on the internet. To keep your cryptocurrency safe, consider some of these tips.
The old saying "don't keep all of your eggs in one basket" applies to many financial assets, including cryptocurrency. If you use more than one storage type or strategy, you're minimizing the risks of theft and loss.
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Use Your Hot Wallet Only for Transactions
It's a good idea to only keep a small portion of your cryptoassets in your hot wallet; you might only put the amount of cryptocurrency you need for spending in it when you need it. This strategy would mean storing most of your assets in a cold wallet, then transferring what you need to the hot wallet for immediate or near future use.
Store Your Assets in an Exchange
You could also choose to keep your cryptocurrency tokens in accounts linked to the exchange you use. Someexchangeswill store your cryptocurrency within their infrastructure, essentially making them a hot wallet provider. However, if you keep your tokens in an exchange account and an attackergains access to the exchange's network, you could lose your cryptocurrency in the attack.
Exchange Your Cryptocurrencies
If you maintain a substantial balance of cryptocurrency, you're accepting the risk of drawing the attention of hackers or losing a significant portion of your holdings in an attack. Because many of the top digital currency exchanges allow users to transfer between various fiat currencies and cryptocurrencies, you could only hold small amounts in your wallet. You can convert the rest to your country's currency and place it in your bank account.
There might be fees for exchanging cryptocurrency for fiat currency and transferring the funds out of the exchange or removing it to store it, but it's worth considering if you're not holding your cryptocurrency as an investment.
Hot Wallets and Investing
Cryptocurrency investing is similar to stock market investing—you own a cryptocurrency and wait for its fair market value to increase. You could continue holding it, or try to sell it to another investor at a profit. However, a hot wallet is a very risky place to store your cryptocurrency investments. Cold storage,paper storage, or other non-connectedstorage methodsmight serve you better as you wait for your cryptocurrency's value to increase.
How Do I Secure My Hot Wallet?
Only keep small amounts in your hot wallet, ensure you back it up, keep the software up to date, encrypt it, and keep your password secure to make sure your wallet is safe.
Can Hot Wallets be Hacked?
Current technology and software make it difficult to hack hot wallets, but that doesn't mean that they can't be. The devices (phone, computer, or tablet) your wallet is on can be accessed through various methods, which is what makes hot wallets most vulnerable.
Are Hot Wallets Safe?
Hot wallets can be safe if you use them only to transfer digital currency. When the cryptocurrency you're not going to use is in cold storage, there is no risk of loss if the hot wallet is accessed.
Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.
