Many people are confused over a hardware wallet and cold storage as a way to store your bitcoins and other cryptocurrencies. The difference between Hardware Cryptocurrency Wallet and Cold Storage is mostly in wording though. It basically means that Bitcoins and other crypto are stored offline, i.e. that your private key is nowhere stored on a computer that itself is connected to a network such as the internet. Let’s evaluate these main differences between hardware wallet and cold storage in the crypto industry and explain in more detail what they mean.
A hardware wallet is a small computer device that is used to store cryptocurrency. It is a form of cold storage because the wallet itself is not connected with the internet and the private key is not stored on a server, phone or any other computer. Another form of cold storage is by writing out your private key on a piece of paper, this is called a paper wallet. Most people use a paper wallet as a backup in addition to using a hardware wallet.
Cold storage is just the name for any method where your private key is not stored on a networked computer where it could be stolen from: it can be as simple as a piece of paper with your private key written on it.
In the past decade, cryptocurrencies became the biggest invention in the world. At their peak, all cryptocurrencies were worth almost a trillion dollars. Today, Bitcoin alone is valued at more than $185 billion. If it was a publicly traded company, Bitcoin would be the 30th biggest company in the United States. At the same time, fraud has continued to remain rampant in the crypto industry.
What is a Crypto Wallet?
A crypto wallet is a secure place where you store your currencies. In the fiat currencies world (the plain money like US dollars), a wallet can be a leather product where you store your money. A wallet can also be an online platform where you keep your funds.
Some of the most popular online wallets for fiat money are Google Pay, Apple Pay, Chase Pay, PayPal, and Venmo. Products by Transferwise and Revolut can be said to be wallets also. You can deposit, withdraw, and send money from a wallet.
A crypto wallet operates in a similar method. In the simplest way, a crypto wallet is a place where you store your cryptocurrencies. You can send crypto from the wallet, withdraw it, and also invest. Crypto wallets are usually software programs that store your public key on the blockchain. There are four main types of crypto wallets. These are:
- Desktop wallets. These are downloaded and installed in a computer.
- Online wallets. These are the popular wallets that are offered by companies like Coinbase and Kraken.
- Mobile wallets. These are wallets that operate as a mobile app on your smartphone. An example is the Samurai Wallet).
- Hardware wallets. These are wallets that operate as a hardware that look like a USB stick.
- Paper wallet. The paper can mean a real piece of paper. It can also mean a hardware that stores the keys, which are then printed.
Hardware Wallet and Cold Storage
A hardware wallet is a small device that is used to store cryptocurrency. People who use these wallets do so because of safety reasons. This is because many online wallets are usually not secure. In fact, online wallets are usually very susceptible to hacks. Hardware wallets have four main benefits.
- Computer viruses. Many scammers and criminals use viruses to get access to your online wallets. A hardware wallet is not susceptible to these hacks.
- Safety. Hardware wallets are safer than online wallets. This is because the private key is stored in a protected area of a micro-controllers. As such, they cannot be transferred out of the wallet in plaintext.
- Security and interactively. Hardware wallets can be used in an interactive way.
- Open source software. This is an important feature because it allows a user to validate operations on the device.
Hardware wallets are usually safer compared to other online wallets. However, they can also be compromised in five ways. Some of these ways are:
- A malware can be put into the wallet. The malware can in return monitor crypto transactions.
- The random number generator (RNG). The RNG may not be secure. This can lead to security issues. For example, an attacker can recreate the key’s RNG.
- Implementation. The security of the device depends partly on how it is implemented. Implementation lapses can lead to vulnerabilities.
- Shipping. A device can be destroyed when it is being shipped.
- Production. The device can be compromised during its production process.
What is a Cold Storage?
A cold storage is the process of storing Bitcoins and other crypto offline. Special pieces of hardware that cannot connect to the internet are used to store the cryptocurrency. Cold storage is commonly used by cryptocurrencies exchanges. The idea is that storing this crypto in online wallets is very risky. As such, these companies transfer some of the crypto in cold storage, which cannot be accessed by anyone who is online.
The process of sending crypto to a cold storage is relatively easy. First, you need to set up two computers. One of the computer should have an internet connection. The other computer should have a bitcoin software installed. You should use a special software to generate a wallet.
Second, you need to get the master public key of the wallet and take it to the computer that is online. You should use this to create a watch-only wallet. You should then transfer the unsigned transactions to the offline computer to sign the transaction. Finally, you should send the fully-signed transaction to the online computer and send it to your network.
A cold storage is relatively safe. This is the main reason why many major exchanges have not been susceptible to hacks.
The biggest risk for cold storage is forgetting the master key. A good example of this is what happened when the CEO of a Canadian crypto exchange died. He was the only one who knew the master key. As a result, holders of the crypto lost currencies worth hundreds of millions of dollars.
As mentioned above, cold storage and hardware wallets are usually a lot safer than online storages. We have not heard cases of these wallets being cracked.
Also, while online wallets are usually free, hardware storage as a form of cold storage is not free. Trezor sells its wallets starting at EUR 50. At the same time, a hardware is a hardware. This means that it is not fire or water resistance. It can also be lost. The same is true with a paper backup.
If you hold Bitcoin, it is strongly advised to think of a good strategy to store it and to have a secure backup on a different location than the hardware wallet.
Summary of Cold and Hardware Wallets
Cryptocurrencies have changed how people transact. They are, without a doubt, the future of finance. However, the biggest challenge for crypto is the high number of hacks. In 2019, criminals stole crypto worth more than $4.4 billion.
If you own bitcoin or other crypto, we recommend that you store whatever you want to hold for the long term in a hardware wallet, using a paper trail backup in a safe place. In addition to this, you can create a mobile wallet to use your bitcoin on the go so that you can actually use crypto to spend on stuff or services.
Crispus is a finance professional with more than a decade experience in the industry. Over the years, Crispus has written in-depth articles on leading platforms like CCN, Marketwatch, and Seeking Alpha. He also runs a Forex education and managed account company called WestEndFx.