What is a cold wallet? How does it work? The most complete guide to cold wallets

A cold wallet is a storage method for storing cryptocurrency, which helps prevent digital assets from being stolen. We will introduce you to the basic differences between cold wallets and hot wallets, provide you with a comprehensive understanding of cold wallets, and introduce the types of hardware wallets, recommended usage scenarios, operational principles, and advantages and disadvantages.

What is a Cold Wallet?

A cold wallet (Cold wallets) is a way to store cryptocurrencies, with the main feature being that it is not connected to the internet while in use, which helps to avoid common online security vulnerabilities such as hacking attacks.

A cold wallet does not necessarily have to be a hardware device; it can also exist in non-hardware forms like paper wallets. Paper wallets, as the name suggests, are a piece of paper with the user's private key for transferring cryptocurrencies printed, handwritten, or displayed as a QR code.

In simple terms, a cold wallet is a hardware cryptocurrency wallet designed solely for asset storage. It allows users to check their holdings of cryptocurrencies and execute transfer tasks from other wallets without interacting with any smart contracts or external resources.

Most threats of cryptocurrency theft come from the internet, and the disconnected nature of cold wallets helps keep assets safe from digital threats, preventing asset theft. Typically, cold wallets are protected with a password, such as the popular cold wallet brand Ledger, which requires a 4 to 8-digit PIN to access the wallet.

When Is It Recommended to Use a Cold Wallet?

Cryptocurrencies recorded on the blockchain are secure by nature as a decentralized distributed ledger, but the wallets used to manage these assets are vulnerable to online attacks. Therefore, using a cold wallet can provide an additional layer of protection to ensure that cryptocurrencies are safe from online threats.

Compared to hot wallets, cold wallets do not connect to the internet, which means they can prevent unauthorized access, cyber attacks, and other system vulnerabilities associated with being online.

So, when is it recommended to use a cold wallet? The general principle for using a cold wallet is: when you have a significant amount of cryptocurrency holdings or cannot afford to lose the cryptocurrencies you own, you should use a cold wallet.

If you only hold a small amount of cryptocurrencies, using a cold wallet may not be necessary. However, storing a large amount of cryptocurrencies in a hot wallet connected to the internet is as unsafe as carrying a large amount of cash in a crowd.

In terms of cost, cold wallets are more expensive than hot wallets (prices for cold wallets on the market range from $79 to $255), whereas most hot wallets are free. Additionally, in terms of convenience, cold wallets require specific passwords or methods for access every time, making transactions more cumbersome compared to hot wallets.

Nevertheless, many people are willing to choose cold wallets for security reasons.

Cold Wallet vs. Hot Wallet: Which Is a Better Cryptocurrency Wallet?

Hot wallets and cold wallets are the main methods used to store and exchange cryptocurrencies. Hot wallets are software wallets that allow users to store public and private keys in an online environment, enabling direct operations through computers or mobile devices. On the other hand, cold wallets store assets in offline hardware devices not connected to the internet, providing higher security.

How do you choose the right wallet? The answer varies from person to person. You should find a balance between the convenience of hot wallets and the security of cold wallets, considering factors like ease of use in hot wallets and security in cold wallets.

Therefore, we compare the characteristics and advantages and disadvantages of cold wallets and hot wallets in the table below:

Why Is a Cold Wallet More Secure?

The private key is essential for accessing encrypted assets in a wallet. When the private key is connected to the internet, it is vulnerable to online theft. Cold wallets maintain asset security by keeping the private key offline and signing transactions.

In other words, storing cryptocurrencies in a cold wallet away from the internet helps prevent assets from being compromised by hacking attacks, malicious software, and other online security threats. Therefore, cold wallets are often considered the best way to protect cryptocurrency assets and prevent asset theft.

It is important to note that while cold wallets provide high security, they can also be lost or damaged. Therefore, protecting the cold wallet is crucial.

Types of Cold Wallets

Cold wallets come in various forms and sizes, all designed to protect digital assets from being stolen online due to their offline usage environment.

However, cold wallets can be categorized into the following types based on their storage forms:

1. Paper Wallets: Private and public keys of cryptocurrencies are printed on paper and securely stored. However, paper wallets come with risks such as potential loss or physical damage (e.g., moisture, fire). Additionally, manually entering the private key for every transaction increases user burden.
2. Hardware Wallets: Physical devices designed specifically for storing cryptocurrencies, usually in the form of USB or cards. They store private keys in an offline portable hardware device and often have a PIN code for additional protection, considered the best security option. If the device is lost or damaged, users can recover using backup seed keys. These wallets are usually not cheap.
3. Sound Wallets: An innovative storage method that uses sound to transmit cryptocurrencies. Private and public keys are converted into audio signals and stored in products like CDs or vinyl records. The hidden codes in these audio files can be decrypted using spectrum analyzer applications or devices.
4. Deep Cold Storage: Cryptocurrencies are stored in devices completely disconnected from the internet, such as burying private keys underground or storing them in different safe deposit box services for the highest level of security. This method is typically adopted by financial institutions or users with high security demands.
5. Offline Software Wallets: Similar to hardware wallets but more complex. Offline software wallets split a wallet into an offline wallet containing private keys and an online wallet storing public keys. Each transaction generates a new unsigned transaction from the online wallet, sends the user's address to the recipient or payer on the other end of the transaction, and then moves the unsigned transaction to the offline wallet for private key access and signing.

Finally, the signed transaction is moved back to the online wallet. Since the offline wallet has never been connected to the internet, the private key remains secure. Examples of this type of offline software wallets are Electrum and Armory.

We have summarized the different types of cold wallets in the table below, where you can find the most suitable type of cold wallet for you based on a comparison of their pros and cons:

In conclusion, a cold wallet provides a robust protective barrier for our digital assets. Although it may not be as convenient as hot wallets, for those who prioritize security, it is undoubtedly the best choice for protecting cryptocurrency assets.

So, are you ready to store your cryptocurrencies in a cold wallet?

Common Questions About Cold Wallets

Is a Cold Wallet the Best Way to Store Cryptocurrencies?

According to a report by Forbes Adviser, Samira Tollo, Chief Technology Officer and Co-founder of the Australian cryptocurrency exchange Elbaite, stated that with the continuous turmoil in the virtual trading market, such as the bankruptcy of FTX, investors are increasingly aware of the importance of self-custody. She recommends using a cold wallet if you have a significant amount of cryptocurrencies or do not need to access your assets frequently.

On the other hand, if you engage in frequent short-term trading, speed may be more important than security, so a hot wallet may be more suitable. (Forbes Adviser suggests that while cold wallets are more secure, they may not be as convenient for general transactions compared to hot wallets. It is essential to take adequate precautions when setting up and using cold wallets to avoid losing private keys and to have a way to recover cryptocurrencies in case of unfortunate events such as hardware loss or damage.

Is a cold wallet completely secure? In fact, it still requires cautious use to achieve optimal security. For example, protecting the device correctly, using strong passwords, keeping the device updated, avoiding sharing private keys with others, or storing private keys online, and choosing reputable hardware wallet manufacturers are crucial.

How Do You Deposit Cryptocurrencies into a Cold Wallet?

Assuming you have a hardware wallet, the first step is to connect it to a computer with internet access, then choose the option to receive cryptocurrencies. This will generate an address where you can send the cryptocurrencies, storing them in your cold wallet; and vice versa.

Cold wallets sign transactions offline using private keys to ensure security. Therefore, any transaction initiated will temporarily be transferred to an offline wallet stored on USB, CD, hard drive, paper, or offline computer, and then signed before being transferred back online.

Since the private key does not touch any online-connected servers during the signing process, even if a hacker discovers the transaction, they cannot access the private key used for that transaction.

When Is It Necessary to Use a Cold Wallet?

We need cold wallets for two main reasons: high security and long-term storage.

Firstly, hot wallets are vulnerable to hacking attacks due to their internet connectivity, while cold wallets are completely offline, accessed via hardware devices, reducing the risk of digital asset