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Crypto is a type of global digital money in which transfers are verified and recorded using a decentralized system. This is in contrast to fiat currencies that are issued by a centralized authority, such as a government. The first cryptocurrency ever developed was Bitcoin, which was created in 2009 by a person (or group) using the pseudonym Satoshi Nakamoto. To this day, no one knows the identity of Satoshi Nakamoto.
Intriguingly, the creation of Bitcoin was the first time in history that humans developed a global currency, free of governments and country borders, that could be effortlessly sent and received.
Given the meteoric rise of Bitcoin and other cryptocurrencies, the question becomes, how do you safely store your cryptocurrency assets?
If you’re ready to learn this important skill, this article will teach you what a cold wallet is and how to use one to securely hold your cryptocurrency assets.
Do you need a crypto wallet?
As earlier stated, cryptocurrencies are a new type of digital, borderless money. No matter what types of crypto assets you choose to buy, you can liquidate your funds for fiat (aka, government-issued currencies) at any time. All you have to do is to transfer your funds over to an exchange platform and sell them to an interested buyer.
With the crypto market worth billions, cashing out can be done in a matter of minutes.
However, if you want to HODL (“hold on for deal life”) your crypto assets, then you will need somewhere safe them. Despite the near infallibility of blockchain technology, security loopholes have been exploited in the past by malicious scammers.
Indeed, even on the big exchange platforms, watertight security is an illusion. The recent hacking of the cryptocurrency exchange, Binance, is proof that these platforms are not 100% safe for storing crypto holdings.
Although Coinbase holds the honor of being the only top-profile exchange platform to have never been hacked, it holds most of its digital assets in cold storage vaults worldwide. If you’re serious about keeping your assets safe, you should consider getting a cold wallet too.
What is a cold wallet?
To begin with, a crypto wallet is a device or software that securely holds your digital tokens. It’s the equivalent of a bank account for fiat currency.
There are two kinds of wallets: hot and cold wallets. While they both perform the same function, a cold wallet differs in that it allows users to store their digital assets safely offline.
For a hot wallet, you need an internet connection to access your tokens. Because of the cybersecurity risks involved with this connection, using a cold wallet is a significantly safer approach.
However, some investors choose to use hot wallets because of their ease of use. On the other hand, cold wallets are arguably more secure, even though they typically cost more.
How does a cold wallet work?
To understand the concept of cold wallets, it’s important to understand a few simple technical concepts. Cryptocurrencies are blockchain-based digital assets. Crypto wallets are similar to physical wallets in that they hold valuables. However, the difference between the two lies in their encryption keys.
There are two types of encryption keys: public and private. The latter is similar to your bank account number, serving as a way for the blockchain to identify your unique account for transactions.
On the other hand, your private keys serve as a password to your account, providing the final line of encryption. Both keys are made up of a string of random characters called a hash and are necessary to effect fund transfer to or from your wallet.
How can using a cold wallet protect you from cyber theft?
When you use an internet-based wallet, you’re vulnerable to brute force attacks from scammers. So, if you’re in the habit of using network-based crypto wallets to store your private keys, you’re at a huge risk.
When you use a hot wallet, the configuration for completing transactions is effected from one network device. The wallet stores and generates your private keys, signs each blockchain transaction digitally, and broadcasts the block to the rest of the network.
However, this same procedure also broadcasts your presence to online hackers who crawl the networks, looking to gain knowledge of the private keys used to timestamp the transaction block.
When you use a cold wallet, the transaction is signed offline. As a result, there is no chance of having your private keys compromised. After initiating a blockchain transaction, the details are temporarily relocated to offline storage such as a CD, hard drive, offline computer, or USB.
Cold storage can also be as simple as private keys written out on paper. The signing is digitally done on a cold wallet. Afterward, it is transferred to the blockchain. Because your private keys remain separate from any online server while the signing procedure is underway, thieves cannot access it.
However, there’s a hitch. While cold wallets are safe, they don’t work with an internet connection, so the transfer process can take longer than a hot wallet and prevent you from quickly selling or liquidating your assets in a crisis.
Types of cold wallets
Here are some of the most popular forms of cold wallets:
Paper wallet
This is one of the most basic cold storage forms. It’s a document containing both private and public keys, usually a sheet of paper. You can print it out from the corresponding online tool.
Usually, the document contains a scannable QR code to enable the digital signing of transactions. However, anyone using a paper wallet has to take extra care to safeguard it. If it falls into the wrong hands, you may lose your funds forever.
Hardware wallet
This type of wallet employs a smartcard or an offline-based device to generate private keys. Everything is done offline, securely, so you needn’t worry about malicious incursions. An example of this type of hardware wallet is the Ledger USB Wallet.
Resembling a USB device, it functions similar to one and works with a Chrome-based app and a computer to keep your private keys safely offline. Similar to a paper wallet, it’s a physical item and has to be handled with care and discretion. If you lose the device or have it suffer irrevocable damage, you can lose access to your hard-earned tokens forever.
Other examples of hardware wallets are KeepKey and TREZOR.
Offline-based software wallet
As a crypto investor looking for ways to secure your coins, you can also go for an offline software wallet. It’s like a regular hardware wallet, though it operates more technically and complicatedly.
First, it divides your wallet into two separate platforms, both fully accessible. The first compartment stores the private keys offline, while the second compartment stores the public keys online. As a result, it’s a sort of hybrid wallet that combines the best features of offline and online wallets.
The online wallet generates the transactions and then transferred to the offline wallet to be signed. After the digital signing, the transaction goes back online and is then broadcasted to the blockchain.
Some popular offline software wallets are Armory and Electrum.
DeFi wallets
Another interesting option to know about are DeFi wallets. Because DeFi wallets are non-custodial wallets, there is no centralized authority that can be hacked. Thus, only someone who knows your seed phrase or your private key can access your cryptocurrency assets.
For example, Coinstats offers a DeFi wallet that you can use to manage your crypto assets. Meaning, it lets you use a single wallet to buy, sell, track, and earn on your crypto. Crypto.com also offers a DeFi wallet, as does MetaMask, Trust Wallet, and a few others.
Conclusion
Now you know about cold wallets for cryptocurrency and how they can be used to securely hold digital assets. When choosing a wallet, make sure to check that your tokens compatible with it. This is because cold wallets do not universally support all types of tokens.