When speaking about the Bitcoin’s wallet, the key point to consider is its access to the Internet. This feature divides wallets into two categories: hot and cold wallets. It’s like the bank keeping some funds at the bank teller desk so customers could access it any time they want, while the rest of it kept in a vault. In other words, hot and cold wallets are security measures used by the exchange platforms to protect their customers’ funds.
The advantages of a hot wallet
Hot wallets are always in some way connected to the Internet, thus they’re more likely to be exposed to the funds’ theft. But there are also important advantages of hot wallets impossible to overlook. They allow software developers adoption to their own applications. It enables withdrawing cryptocurrencies easily with no need for third-party users like exchange support to access the private key. Crypto Agent application, developed by Match-Trade Technologies is an integrated crypto exchange wallet for Coinmatch platform. It prevents hackers’ attacks using its custom protection methods like different confirmation procedures for higher withdrawals and two-step login. But that’s not the only thing that makes hot wallets get closer to the security level of cold storage. Whole blockchain technology was created around the idea of decentralization and what fits better than multisig? When the whole point of it is to dissipate trust by requiring two or even three keys to access the funds to make it nearly impossible for hackers to steal them.
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What kind of wallet is an exchange itself?
An exchange is a specific type of hot wallet where clients do not possess the private key. Meaning that they completely entrust the funds to the exchange operator and have no influence on whatever happens to their cryptocurrency funds. However, each customer can create a so-called warm wallet on his mobile phone or desktop if they want to use the benefits the private key gives like receiving after-fork coins or managing ICO tokens. The handiest wallets we recommend are Exodus (for desktop) and Jaxx for desktop and mobile devices or Coinomi (also for mobile) that supports even 64 cryptocurrencies. Though warm wallets are not advised for beginners because they are more vulnerable to cybercrime. The protection of exchange wallets is much more advanced due to the cooperation with a trustee (eg a law firm to make sure the keys do not fall into the wrong hands).
Is cold wallet a better option to store crypto?
A paper wallet (a type of cold wallet) is a printed version of public address and private key. As they are both generated offline, it’s the best way to secure your cryptocurrencies from hackers. Just remember to check if your computer is virus free before generating the keys. Simply download the Bitaddress generator from GitHub website and run bitaddress.org.html.
As the public address is used for sending funds to the wallet — there is no need for the wallet to be connected to the Internet. Private keys, however, allow withdrawing the crypto from the wallet and to do so it needs to stay connected. Cold wallets are never connected to the Internet – once you use a private key from your paper wallet while online, you can’t consider it a cold storage anymore. So in reality, it’s extremely hard to only maintain the paper wallet.
Trying to eliminate the hassle, some companies have created ‘hardware wallets’. The most important feature that makes them the “Bitcoin safe storage” is that they return the signed message without private key ever leaving the device. Stored cryptocurrencies are secured by the microchip which is additionally secured by a numeric password. The most used hardware wallets by the crypto community are Ledger and Trezor, secured with BIP-44 seed backup in case of the device failure.
How to manage hot/ cold wallets?
Keeping all funds on a hot wallet is very high risk due to its uncertain safety and using cold wallet only can be really inconvenient. Good practice for a cryptocurrency exchange is to never store too many funds on a hot wallet – it protects the customers and exchange itself. The Pareto principle seems to be applicable, but with some restrictions. While keeping 20% of funds in a hot wallet and 80% in cold storage you always need to check your liquidity. A proper exchange will process withdrawal request immediately but only when exchange uses an integrated and well-designed hot wallet with sufficient funds otherwise it can be delayed even for few hours. Elseways all surplus liquidity should always be transferred to the cold wallet.