Crypto Wallet Safety: Cold Wallet vs Hot Wallet

Crypto Wallet Safety: Cold Wallet vs Hot Wallet

After the unprecedented collapse of FTX in 2021, many investors have lost their hard-earned portfolios. Some experienced crypto investors suggested that we should keep our crypto investment in our own wallet instead of a centralized exchange.

As the crypto golden rules say “Not your key, not your coin,” let’s get to know the knowledge of crypto wallets: cold wallet vs hot wallet. You might consider using them when you want to level up your token storage securities. 

Why you should use a non-custodial crypto wallet

If you’ve been in the crypto space for a while, you may have seen “Not your key, not your coins.” That is, your coins are only safe with you if you have the secret keys to your crypto wallet. This phrase addresses the problem of using a centralized exchange (CEX). You don’t have full control over your wallet, as the CEXs can suspend your withdrawals at their convenience, just like what FTX did.

To prevent that “lost-it-all” risk on centralized exchanges, where could you safely store your crypto? A self-custody crypto wallet is an alternative. “But how?” “Where can I get one?” “What about a cold wallet? I’ve heard that before, but how do I use it?”

What is a self-custody crypto wallet?

A self-custody wallet, also referred to as a non-custodial wallet, is a cryptocurrency storage solution where you can securely hold your crypto assets without relying on a third party, such as centralized exchanges (CEXs).

Upon setting up your wallet, you will be provided with a set of key phrases. These key phrases serve as the sole means of accessing your wallet. It is important to maintain the confidentiality of these keys and take utmost care to ensure their security.

What can a non-custody wallet do?

A non-custody wallet functions like any other wallet in CEXs. It can interact with blockchain-based apps for different transaction activities on a decentralized basis (except for the activities on CEXs). For example, they can:

  • Swapping your coins (Uniswap, Sushiswap, etc.)
  • Lending or borrowing (compounding)
  • Trading on the decentralized exchange (dYdX)

Hot Wallet v.s. Cold Wallet: What’s the difference?

You may have heard of a hot wallet and a cold wallet, but what is the difference? Hot wallets are software programs connected to the internet on your computer or phone, while cold wallets are hardware gadgets that can store your data offline.

Hot Wallet: Software Wallet (Metamasks, Trust Wallet and Coinbase wallet)

One of the most popular hot wallets in the crypto space is “Metamask.”

Remember this fox? The fox icon belongs to “Metamask,” which is a widely used software wallet that can be accessed through a browser, computer system, or mobile app. The best part is that it is both free and user-friendly for on-chain transactions (never pay for any software for a crypto wallet!).

However, your key is kept in the software, and it might become a security weak point for hackers to break through. Trust wallet, Meta mask, and Coinbase wallet are some of the most popular hot wallets in the crypto world.

Cold Wallet: Hardware Wallet (Ledger, Trezor)

What does a physical USB do? These hardware wallets store your keys offline and enable you to connect to the network for transactions when you plug them into the hardware. This way, you don’t have to worry about any issues on the internet when the wallet is offline. While using a hardware wallet may require an extra step, it can provide a secure way to safeguard your cryptocurrency.

Ledger and Trezor are two well-known brands for hardware wallets.

Created by Anson Chiu with Canva.

Types of cold wallets

Not all cold wallets are the same. Each type fulfills the main purpose of keeping private keys offline. However, there are differences in security, user-friendliness, and accessibility. Ledger Academy will explain the three types of wallets in this section: paper, sound, and hardware wallets.

Paper wallets

Paper wallets are a method of storing cryptocurrency by recording the private key and address as QR codes on paper. They were popular in 2013 and 2014.

However, paper wallets have limitations. They can be easily damaged or lost, and there is no way to recover the keys. Transferring cryptocurrency from a paper wallet can be challenging, requiring the use of an internet-connected software wallet. This exposes your assets to risk and can compromise security if the paper falls into the wrong hands.

While paper wallets can be a cost-effective storage option, they lack the security, convenience, and user-friendliness of current crypto wallets.

Hardware wallets

Hardware wallets store your private keys offline in a secure physical device. They are user-friendly, secure, and easy to use. They protect your keys from physical damage and allow you to generate multiple private keys for different blockchain accounts. Ledger devices, for example, are compact, sturdy, and can be used for Ethereum, Tezos, and Bitcoin accounts. They offer a user-friendly experience for transferring assets from cold storage and allow you to manage your accounts and interact with smart contracts. Ledger devices also have an additional layer of security with their proprietary Secure Element Chip, which is used to generate and store your private key.

Which types of wallets are suitable for you?

In order to determine the most suitable wallet for you, consider the following:

  • If you are a frequent trader who needs to move funds frequently, a hot wallet may be the best choice. It offers greater functionality and user-friendliness, allowing you to conduct transactions without having to connect your device each time.
  • If you are a “HODLer” who purchases bitcoin and holds it for a long time, a cold wallet can provide the best security for your crypto assets.

Of course, you can always opt to have multiple wallets for different purposes.

How to use a cold wallet

To use a segregated Ledger as a “cold wallet”, follow these steps:

  1. Connect your Ledger device to your computer and open the Ledger Live app.
  2. Install the app for the coin you want to use, such as Ethereum. If you already have an account for that coin, it’s okay. You can create a new and separate account.
  3. Your account is now ready to use. You can even give it a name in Ledger Live to avoid confusion with your other Ethereum accounts.
  4. Transfer Ether or other valuable ETH-compatible digital assets to this account.
  5. Never connect this account to any apps or services, and don’t set up any approvals!

That’s it! Your cold wallet is now set up. Remember, this account is completely separate from the one you use for smart contract interactions.

How to keep your crypto safe when using DeFi

Using a non-custodial wallet does not guarantee 100% safety for your coins. Here are some important points to remember when using DeFi.

Beware of Phishing Sites or Viruses

Remember the basics of internet security: never click on unknown links as they could be phishing sites. Even if you have a complex password or a secure cold wallet, your funds can still be lost if your computer gets hacked. Therefore, be cautious about internet security and continuously improve it whenever possible.

Cold Storage is Not Completely Safe Either

Nothing in real life can be 100% safe. There is always some level of risk, and the same goes for cold storage. The biggest risk with cold wallets is physical access. If hackers gain access to your wallet, they may be able to break your passphrases and take control of your funds.

Be Aware of DeFi Rug Pulls

Even with the highest level of wallet security, you can still lose money by investing in scam projects. Rug pulls occur when crypto developers or scammers abandon a project and steal investor funds, which unfortunately happens quite often. Here are a few tips to spot and avoid potential rug pull situations:

  • Check if a project has a small number of wallets holding the majority of the coins or low liquidity in the market.
  • Be cautious if the developer team remains anonymous and the project seems to appear out of nowhere.

Stay Away from Too-Good-to-Be-True Traps

Crypto is still new to many people, and achieving a 10X return may seem easy. You may see individuals bragging about their 10X gains on Twitter frequently. It’s common for most of us to experience “FOMO” (fear of missing out) and look for more opportunities to make money.

Hackers may exploit this psychological vulnerability and create enticing traps, promising high yields in a short period of time. However, “FOMO” is not the ideal mindset for investing, as it lacks careful consideration. It’s better to take a step back and evaluate the situation from a different perspective.

Learn More About Crypto and Take Responsibility for Your Actions

Using a non-custodial wallet means venturing into the real crypto world alone, as this is what cryptocurrency was initially designed for. However, it also means that you are solely responsible for your actions.

You need to understand how to make transactions with the wallet, sign smart contracts, and most importantly, be aware of the blockchain you are using. Anything you do on the blockchain is irreversible, and once a transaction is completed, it cannot be reversed. Therefore, you are accountable for every action you take.

Final Words: The Key To Keep Your Crypto Safe

It’s back to the very basics of internet security: level up your computer security, like updating your antivirus software constantly and never interacting with unknown links. You should leave no loopholes for hackers to steal a cent from you!

Investment involves risks. The information on this website is for educational purposes only and should not be construed as investment advice or recommendations. Therefore, it should not be considered as the basis for making any investment decisions or taking any investment actions.

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