In 2022, more than $1B+ were stolen because of hacks and phishing attacks to wallets. Cold storage wallets can make a difference in keeping your cryptocurrencies secure. Learning what is a cold storage crypto wallet, the different types and their benefits will drastically reduce your chances of getting hacked.
In this guide on what is what is a cold crypto wallet you will learn:
- What cold wallets are
- How cold storage wallets work
- The various types of cold wallets
- Cold wallets vs. hot wallets vs. hardware wallets
- Pros and cons of using a cold wallet
So, let’s get straight into it and understand what a cold storage crypto wallet is.
What is a Crypto Cold Storage Wallet
A cold storage crypto wallet is a type of crypto wallet that isn’t connected to the internet. Since cold wallets aren't connected to the internet, they're less likely to be exposed to online threats like malware or phishing attacks. Additionally, their separation from smart contracts prevents unwanted approvals that could cause losses. This makes cold wallets ideal for the long-term protection of high-value crypto assets.
Let's understand how cold storage wallets function and how they protect you from on-chain and off-chain threats.
How do cold wallets work?
To understand how cold storage wallets work, we need to understand what crypto wallets are in their most basic form. As we explained in this article about digital signature algorithms and key generation, wallets at their core aren’t much more than a couple of keys generated thanks to a quite complex algorithm called Elliptic Curve Digital Signature. Regardless of where these keys are generated and stored, the crypto assets will ultimately be stored on the blockchain.
When referring to hot and cold storage, we refer to how available those keys, specifically the private key, is to the internet.
Hot Storage Wallets: Wallets that are often considered “online.”
Cold Storage Wallets: Wallets that are considered “offline.”
Hot crypto wallets
For example, hot wallets, such as Metamask or Rainbow, are constantly connected to the internet because they private key itself is stored in your browser. So, any time you open up your browser, your wallet is right there, and you can easily connect to web apps. It’s important to note, that even most hot wallets still store the private key itself offline. For most browser extension wallets like Metamask, your browser app itself creates and stores the private key, and doesn’t need to be connected to the internet to create your private key.
If you’re using a website-based hot wallet where the wallet is 100% stored on someone else’s server, get out now. You should never use a hot wallet where the private key is not generated on your local device.
Cold storage crypto wallets
On the other hand, cold storage wallets always securely generate private keys offline, because the wallets themselves are disconnected from the internet. These keys are usually stored in physical forms such as paper wallets or, more commonly, hardware wallets, ensuring they stay out of reach from hackers or unauthorized users.
It’s important to note, that even most hardware wallets have some way to connect to the internet. How else would you transfer cryptocurrencies if you couldn’t connect to the blockchain? When a cold storage wallet or hardware wallet temporarily connects to the internet to make a transfer, you could consider it for a short duration to be “hot wallet.” But, we are getting a little to in the weeds with this explainer.
Simply put, cold storage wallets, if used properly, are very good at doing two things:
- Keeping your keys offline: Your keys are generated and stored in your device, on paper, or engraved on a metal sheet.
- Keeping your wallet disconnected from malicious apps: If your wallet is never connected online, the potential attack vectors a hacker has is minimized.
- Protect your assets: Avoid on-chain threats and unwanted approvals requiring signing transactions to be performed offline, especially in the case of hardware wallets
Types of Cold Wallet
Many use the terms ‘cold wallet’ and ‘hardware wallet’ interchangeably, but it’s important to note this is not entirely accurate. Cold wallets can come in different forms:
- Paper wallets (where you write down your private key on a secret slip of paper)
- Hardware wallets
- Brain wallets (where you just memorize your private key)
- etc
The potential for these types of wallets to be cold doesn't necessarily mean they're always cold.
For any wallet to be considered a cold wallet, it must fulfill the primary purpose of keeping your private keys offline. Still, there can be key differences in security, user-friendliness, and accessibility. Let’s take a look at the different types of cold wallets.
Paper Wallets
Paper wallets refer to wallets which private keys or mnemonics are written down on a physical space, it can be a steel sheet, a book or a piece of paper with private keys printed on them. Users can then receive cryptocurrencies from it, as they would with any wallet, as, again - the account is stored on the blockchain.
While this method keeps your keys offline, paper wallets are susceptible to physical damage or loss. Plus, you cannot recover your keys.
Not only that, but transferring cryptocurrency from a paper wallet can also be challenging. Importing your paper wallet into a software (hot) wallet using your internet connection would be best. This invalidates its purpose since software wallets risk revealing your keys to bad actors via an internet connection.
Worse, even if your paper wallet falls into the wrong hands, you can kiss your assets goodbye. The private keys are all they need to gain access to your account.
So, while paper wallets can be a cost-effective and secure way to protect your assets, the attention needed to manage them effectively is best left to the experts. Today, there are plenty of cold wallet options, such as hardware wallets with a better user experience.
Hardware Wallets
Hardware wallets generate and store your private keys offline in a secure physical device isolated from your internet connection. So, how do they send transactions to the blockchain?
Unlike paper wallets, hardware wallets also offer an interface, usually in the form of an app you install on your computer or smartphone. Hardware wallets can sign transactions offline using a companion app and transmit the signed transaction to an internet-connected device. You can interact with the blockchain without compromising the security of your private keys.
Another reason hardware wallets are so popular is that they protect your private keys from loss and physical damage. Plus, even if the physical device falls into the wrong hands, hardware wallets typically protect your assets from physical access, too, using a PIN, fingerprint, or sometimes even facial recognition.
Cold wallets vs hardware crypto wallets: what’s the difference?
While a crypto hardware wallet can function as a cold wallet, the terms are not interchangeable. Each new account you create on your hardware wallet technically becomes a cold wallet. However, once the hardware wallet connects to a blockchain app, that particular account ceases to be a cold wallet. Any approval signed with an account risks its security.
Put simply, a cold wallet keeps private keys offline, much like all hardware wallets – but its defining feature is that it never interacts with smart contracts, apps or unknown wallets. In other words, a cold wallet is purely for storing private keys and sending and receiving assets – not for engaging with Web3 applications. And to clarify again, an account on your hardware wallet only stays cold if you do not connect it to apps and services.
Now that we have explored the different types of cold wallets, let’s take a look at the pros and cons of using a cold storage crypto wallet.
Benefits of using a cold storage crypto wallet
- Offline Keys: Cold wallets keep private keys offline, which protects them from online hacking and cyber threats. This greatly reduces the chances of unauthorized access and theft.
- Physical Wallet Required for Transaction: For hardware wallets, transactions need manual confirmation since the private keys must come from offline storage. This safeguards them from unwanted access.
- Non-custodial: In cold wallets, users have complete control over their private keys and funds. This decreases reliance on third-party services, enhancing autonomy and security.
- Ideal for Long-Term Storage: Cold wallets are perfect for storing cryptocurrency for extended periods. They provide a safe and reliable way to hold substantial digital assets without constant supervision.
Disadvantages of cold wallets
- Less User-Friendly: For transactions, cold wallets require manual interaction to access the stored funds because the private keys must be retrieved from offline storage. This may be less convenient than hot wallets, especially for regular traders.
- Risk of Damage or Loss: Cold wallets, including hardware and paper options, can be physically damaged, lost, or stolen. If not properly backed up or stored securely, there's a chance of losing access to the funds permanently.
- Learning Curve: Setting up a cold wallet, specifically a hardware wallet, can be challenging. Users must adhere to particular instructions for initialization, seed phrase creation, and safe storage of the wallet device.
- Possible Expense: Hardware wallets, a common type of cold wallet, aren't free. Despite the enhanced security often outweighing the cost, it may discourage some users, especially those with smaller cryptocurrency portfolios.
- Single point of failure: If you don’t have a backup, or someone gets access to the single private key, they can move all your funds in one go! A popular way to mitigate this issue is to combine your hardware wallet with a multi-sig wallet or a social recovery wallet.
Cold crypto wallets vs. hot crypto wallets: What’s the difference?
Hot wallets store their keys online, while cold wallets store them offline. The debate between hot and cold wallets is widespread among crypto enthusiasts, each with their preference for different reasons.
There are four main aspects differentiating cold and hot crypto wallets:
- Security
- Custodial vs non-custodial
- User experience
- Compatibility
Security
Cold wallets are considered more secure than hot wallets because we reduce the attack vectors by keeping our wallets offline. Whenever we connect our wallets online, there is a chance we connect it to a malicious app, or we download some malicious software that can steal our funds.
Custodial Vs. Non-custodial
Some hot wallets — like exchange wallets — are defined as “custodial,” meaning the private keys are stored by third-party organizations, leaving users with little control over their assets. Most browser extension-based wallets are still non-custodial, but a lot of newer crypto enthusiasts sometimes may have a hard time knowing what custodial is vs. what is not.
User experience
Hot wallets are often more convenient than cold wallets for transferring assets, as they typically don't require additional steps to sign transactions.
Compatibility
Regarding capacity, hot wallets are often favoured due to their compatibility with a wide range of networks and tokens, including recently launched cryptocurrencies. Integrating a new network or token into a cold wallet can be time-consuming. As a result, most cold wallets only support a limited number of cryptocurrencies.
Conclusions: what is a cold wallet?
Hot or software wallets store private keys on an internet-connected device. However, this method comes with many risks. Malware or spyware on your device could reveal your private keys to a third party or manipulate your screen to trick you into signing a fraudulent transaction.
In contrast, cold wallets do not connect to the internet and avoid malicious smart contract approvals as they do not interact with blockchain apps or services.
Simply put, cold wallets can provide higher levels of security for long-term crypto asset protection. Hot wallets, on the other hand, are more suitable for short-term purchases and should not hold large amounts due to their security risks.
