With its continous market growth, keeping your cryptocurrencies safe has never been more important. Twelve years after the launch of the world’s biggest digital asset, high-profile hacks remain an issue — with malicious actors managing to run into the night with millions of dollars in ill-gotten gains. Thankfully, many centralized exchanges now have insurance policies to protect against such events, and set aside a part of their profits in the event that they need to reimburse their customers.
But here’s the problem: many crypto investors are unaware of how to safely store cryptocurrencies, and how to reduce the chance of their wallets being hacked. A good place to start is by learning about hot storage and cold storage. Both methods have pros and cons — and understanding which to use and when can boost the chance that your crypto will stay out of the hands of a hoodie-wearing hacker… like in the movies.
What Is Hot Storage?
Hot storage is used to describe crypto wallets that are connected to the internet. These wallets might run on devices such as phones, tablets and computers — and they’re ideal for keeping small amounts of digital assets secure.
Although they’re exceedingly mobile, and give you the ability to access your digital assets anywhere, funds held in hot storage can be vulnerable if malicious actors manage to hack into the device where a wallet is stored.
Notable mentions among the software wallets available are Exodus, Atomic and Electrum.
What Is Cold Storage?
In contrast to hot storage, cold storage is not connected to the internet.
Cold wallets tend to manifest themselves in the form of a physical device, such as a small but compact piece of hardware.
Prefer to (carefully) scribble down your public and private key on a piece of paper? Congratulations! This is a form of cold storage, too. (Although this does eliminate the risk that a hacker will be able to access a private key, it creates a whole new danger of you losing the piece of paper, meaning access to your crypto is gone forever). Because of this, it’s common to see people store such types of paper very, very carefully in safes and vaults — anywhere that’s nice and secure.
Cold storage are cryptocurrency wallets that are not connected to the internet or any other unsecure networks when not in use. This is done to provide an additional layer of security over that offered by the more widespread hot wallets, which are software wallets stored on a user’s local computer or accessed from a service provider’s servers via a website interface.
Cold wallets are employed by individual cryptocurrency users as an affordable and relatively simple way of insulating one’s crypto funds against the threat hacks, phishing and other vectors of attack that may lead to permanent loss of coins.
They are even more in demand with businesses that hold custody over their customers’ funds, such as cryptocurrency exchanges. By storing the coins that belong to tens or even hundreds of thousands of users in a centralized manner, these businesses become highly enticing targets for hackers and physically separating most of the reserves from the Internet is the only reliable way to protect from attacks.
Cold Storage Comes In Many Different Forms, The Two Most Popular Ones Being Paper And Hardware Wallets.
A paper wallet is a piece of paper with the public address and the private key of the wallet printed on it. The public address is used to receive cryptocurrency and the private key to access the funds stored and send them. Paper wallets often come with QR codes that can be scanned with a smartphone for ease of use.
A hardware wallet is an electronic device that must be physically plugged into a computer to be accessed. These can range from amateur homemade inventions to commercially available consumer devices (often in the form-factor of a USB stick or drive) to proprietary solutions designed by professional engineers to order. Most widespead examples of this being the Ledger Nano and the Trezor.
Other, less popular cold wallet types include smart cards and even sound wallets, which store private keys in the form of audio on CDs or vinyl records.
Hot Storage vs Cold Storage: The Pros and Cons
As with everything, hot wallets and cold wallets come with their own distinctive set of advantages and disadvantages.
If we’re getting competitive about it, hot wallets have the upper hand because they are very easy to use. They’re already connected to the internet, meaning it’s a convenient way of accessing crypto. Usually, they’re also free to use — and it’s easy to find a wallet that’s compatible with any cryptocurrency. While Cold wallets can be carried in your pocket wherever you go — and they can connect to computers via USB for things like firmware updates. (Then again, some argue that this means these devices will be connected to be the internet every now and again.)
But the main factor driving the popularity of cold wallets is far greater levels of security.
Hot wallets are extremely vulnerable to cyber attacks. While most providers have robust measures in place to provide added security, hackers have been turning to increasingly sophisticated measures in order to target victims. In some cases, criminals have created seemingly legitimate companies to win someone’s confidence and gain access to their computer.
The main challenge surrounding cold wallets is twofold. First, you’ll have to cough up money to buy one — often between $60 and $170 — and you might need a little technical knowhow in order to get it set up.
Crypto exchange accounts can be considered hot wallets — although security measures vary from platform to platform. More respected and established exchanges usually enforce stricter security measures and store the vast majority of assets under management in cold wallets, keeping a small percentage in hot storage for ease of access.
Famous Hacks Involving Hot Wallets
As hot wallets are more dangerous to use compared with cold wallets, it’s unsurprising that they’ve become the subject of several notable hacks.
KuCoin fell victim to a major hacking attack in September 2020 — with criminals stealing funds from Bitcoin, Ether and ERC-20 hot wallets. It was initially thought that $150 million had been stolen, but it later emerged that this figure was closer to $280 million. Thankfully, “on-chain tracing, contract upgrades and judicial recovery” meant that at least 84% of these funds were later recovered.
In July 2019, cryptocurrency exchange Bitpoint — which is owned by the Japanese firm Remixpoint — also saw its hot wallet ransacked. The damage was estimated at $32 million, which is roughly a fifth of the assets that the platform had under management. Assets including Litecoin, Ether, Bitcoin and Ripple were taken. Tellingly, the company’s cold wallets were not affected by this incident. However, it is still possible that cold wallets can also be compromised — but not in the exact same way as hot wallets. Cold wallet provider Ledger suffered a hack in December 2020, but customer funds weren’t stolen — customer information was. Over 272,000 Ledger customers had their names, mailing addresses and phone numbers leaked online by hackers, making them vulnerable to phishing attacks and other nefarious tactics to get at their cold storage crypto.
While this type of “hack” of a cold wallet is relatively rare, the Ledger incident showed that crypto holders should always be on their guard and follow best practices for safe crypto storage.
A Quick Recap
If you’re going to be dealing in larger volumes of crypto, investing in cold storage might prove advantageous. It’s crucial that you do your own research and assess the pros and cons of different products on the market first.
Another top tip is to perform plenty of due diligence into the security measures that are enforced by crypto exchanges. You should fully expect these platforms to keep the lion’s share of the assets they have under management tucked away in cold storage.