You may not be able to see cryptocurrency, but you still have to store it somewhere – in a wallet that’s either ‘cold’ or ‘hot.’ Which one is best for holding your bitcoin and other digital assets depends on your goal.
Since cryptocurrencies are decentralized, or aren’t held or governed by an entity, it’s up to individuals to safeguard their digital coins. If your crypto is lost or stolen, there’s usually no one to call for help.
That’s why it’s crucial to understand your crypto storage options. A cold wallet offers stronger protection because it’s literally off the grid and maybe, locked in a vault, making it less convenient than a hot one, which is always online, if you plan to spend your cryptocurrency.
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Crypto transactions work like cash
Crypto transactions are a lot like those from a regular bank account, except you’re transferring money to wallets held by individuals, not federally-protected bank accounts.
Transactions are recorded on a public ledger so anyone can see the transaction – but not the people involved in it. Crypto enthusiasts enjoy that anonymity, while the government says it attracts criminals.
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To use crypto, individuals have a public key and a private key for their wallets. The public key is akin to your bank account number so people know where to send or receive their crypto payments. The private key is like your bank account’s PIN, used to verify your identity forthe transaction. Like a PIN, you should never share your private key.
Hot wallets versus cold wallets
Hot wallets are always connected to the internet and cryptocurrency network, which makes them easy to access. People can quickly send and receive crypto, anytime and anywhere. That makes a hot wallet ideal for everyday use.
That connectivity also is a hot wallet’s major drawback, making it susceptible to hackers and thieves since public and private keys are stored online. Like with all online accounts, some of that risk can be mitigated with strong passwords and two-factor authentication.
In contrast, cold wallets are stored offline, like on a thumb drive. By keeping your private keys off the internet, cold wallets are protected against hacking attempts. To access crypto in a cold wallet, you must connect your device to the internet which makes it safer, but more cumbersome to use for everyday purchases.
“Think of them as checking and savings accounts, with the hot wallet being like the checking account and the cold wallet like your savings account,” said Ric Edelman, founder of Digital Assets Council of Financial Professionals and author of a new book The Truth About Crypto.
Cold wallet, hot wallet, or both?
Anyone who owns or has ever owned cryptocurrency has a hot wallet because a hot wallet is needed to accept digital assets.
From there, whether you need or want a cold wallet depends on how much cryptocurrency you have and what you want to do with those assets. If you’re dealing only with small amounts that you spend or trade regularly, maybe a hot wallet is all you need for those quick transactions.
If you get hacked and are a victim of cybertheft, you may not lose much more than what you might lose if you lost a wallet with cash in it.
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However, if you plan to buy digital assets as investments or plan to hold large amounts, you probably want to get cold wallet storage to keep them safe. You can use a third party to put your assets in a cold wallet or you can download your coins onto a drive of your own and keep it safe.
Just remember, DIY’ing it will require you to remember your private key, lest you end up like Stefan Thomas, a programmer in San Francisco who forgot his private key and forever lost about a quarter of a million dollars.
Using a third party, such as Coinbase, to lock up your cold wallet transfers the responsibility for your private key to the company, Edelman said. But beware of the saying “not your keys, not your coins.” If a third-party takes care of your storage, they own your keys, which could leave you hanging dry if the company, for example, goes bankrupt.
Medora Lee is a money, markets, and personal finance reporter at USA Today TODAY. You can reach her at email@example.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.