A cold wallet is a way to securely store your cryptocurrency so that it can’t be stolen. It’s the digital equivalent of storing gold in a safe except that unlike a safe, so long as proper security procedures are followed cold storage is virtually impenetrable.
These can be physical or software-based, I.e. a wallet created on an air-gapped computer. Physical cold storage wallets (hardware wallets) come in different shapes and sizes although a majority are small and resemble a USB thumb drive.
When proper security procedures are followed a cold wallet is virtually unhackable, it is the safest way to store cryptocurrency.
Most cryptocurrency wallets are “hot wallets” which mean that they’re connected to the internet and are susceptible to hacking.
Cryptocurrency presents a double-edged sword. On one hand, investors can custody their own funds, similar to keeping gold in a safe. This can be beneficial as it can protect a person or business against asset seizure.
While in many instances that seizure was justified by crime, in an alarming number of cases there is little to no justification for the seizure and innocent people have had their lives ruined by government overreach. With crypto, you can self-custody your funds and asset seizure becomes much more difficult.
On the other hand, if you fail to store your funds correctly you may lose everything. The downside of a blockchain currency is that if something goes wrong there is no recourse or refund.
Unlike the traditional banking system which has safeguards built-in (bank transfers can be reversed), once a crypto transaction is confirmed the money is gone. That means that if a hacker drains your account the funds are lost.
Even if you can trace the path of your funds on a public blockchain there is no way to stop him from spending the money he’s stolen from you.
All of these facts are leading us to the topic at hand: securing your crypto with a cold wallet. A cold wallet is one that’s disconnected from the internet in order to prevent it from being hacked. As mentioned there are two types of cold storage wallets: software and hardware.
There are dozens of guides that will teach you how to set up a cold wallet (here is one for Bitcoin). You’ll need a computer that’s disconnected from the internet (air-gapped) and a USB thumb drive to transfer files between the air-gapped computer and one that is connected to the internet.
While a software cold wallet is very secure it’s also very inconvenient. Sending transactions from a cold wallet on an air-gapped machine is a multi-minute, multi-step process. Thus this type of cold wallet is really only suited for long term storage where withdrawals will only be made infrequently. Deposits, on the other hand, are easy.
*Sometimes you’ll see a software cold wallet referred to as a “paper wallet.”
This is a reference to the piece of paper that you record the seed phrase on when you create the wallet. More on seed phrases in the following section.
A better option for most crypto investors and traders will be a hardware cold wallet. Most hardware wallets cost less than $100 although more expensive models are available. Security is the same for all models, the higher end versions cost more as they come with additional features like Bluetooth or a touchscreen interface. A hardware wallet has several key advantages over a software cold wallet.
It’s significantly easier to send transactions.
A hardware wallet can host multiple crypto wallets (Ethereum, Bitcoin, XRP, Cardano, NEO, etc.) and installing a new wallet on a hardware device only takes a few seconds. If you use a software cold wallet for storage you’ll need to create a new wallet for each coin.
Backup is easier. When you create multiple software cold wallets you’ll need to store backup seed phrases for each wallet. With a hardware wallet, you only need to back up a single seed phrase.
A hardware wallet protects your cryptocurrency slightly differently than a paper wallet. Once cryptocurrency is sent to a hardware wallet it can only be withdrawn if a button is pressed on the device. Because of that, an investor can confidently connect their hardware wallet to the world’s most virus infected computer and so long as they don’t press a button on the device no funds can be sent from the device.
This level of security, however, requires that certain best practices be followed. When you first set up a hardware wallet the device will give you a seed phrase to write down. It’s imperative that you never store this phrase digitally on your computer or phone.
If a hacker were to gain access to your files he could use this phrase to steal all of your cryptocurrency. Don’t even take a picture of the seed phrase. Instead, write the phrase down by hand and make copies by hand to ensure that no digital copy of your seed phrase ever exists.
Store a copy of your seed phrase in separate locations. If you store hardware wallet and seed phrase backup in your home and there is a fire you will lose all of your cryptocurrency. There are no backups and no safeguards, that’s why it’s crucial that you keep backups of your seed phrase in multiple, safe locations.
So long as you follow these safety procedures a hardware wallet can be a very safe way to store your cryptocurrency. As a general rule of thumb, if your cryptocurrency investment exceeds the cost of a hardware wallet, $100 or more, it’s worth buying a hardware wallet. The two most popular manufacturers are Ledger and Trezor and more information on these devices is available online.
In summary, no matter how you choose to secure your crypto the important thing is that you do so! It’s fine to keep a small amount of Bitcoin in a hot wallet for easy spending but if you have long term investments a cold wallet is the only way to go.