'A place for everything and everything in its place.'
It is good, common sense -- not to mention investment strategy -- to store valuable things securely. Heirloom jewellery might be nestled in a jewellery box, first edition comic books locked in a safe, and life savings invested or kept in the bank.
Anything of value should be safely stored.
And so it is with cryptocurrencies.
Unlike traditional currencies whose security and storage are at least in part ensured by banks, governments and institutions, responsibility for the safekeeping of cryptocurrencies lies solely with the individual. And with no way to recover lost or stolen coins, storage decisions are of paramount importance.
So, how do you store digital money?
What's a wallet?
Wallets are to cryptocurrencies what accounts are to traditional currencies: they keep track of your dealings in digital money and make transactions possible.
However unlike the wallet you'd find in your back pocket, cryptocurrency wallets don't exactly store coins or units of value in cryptocurrency.
Units of cryptocurrency exist on the blockchain; their ownership and transaction details are written into the blockchain ledger. Wallets simply store the information required to access and transact those coins on the ledger.
All wallets used by cryptocurrencies fall into one of two categories: 'hot wallets' and 'cold wallets'. Also termed 'online' and 'offline' wallets, and 'hot storage' and 'cold storage', these wallet options each have specific uses and serve different purposes.
Hot wallets are those that are connected to the internet; they are 'live'. Much like the purpose of a wallet that keeps your cash and credit/debit cards, these wallets are ideal for enabling quick and convenient everyday transactions.
However, just as the cash in a wallet is less secure than savings in the bank, hot wallets are also more vulnerable to hackers than their cold wallet equivalents because they are connected to the internet.
For this reason, cryptocurrency users are generally advised to store only small amounts of cryptocurrency in a hot wallet. It is considered best practice to transfer larger sums of cryptocurrency to a cold wallet as soon as possible.
Hot wallets are best thought of as everyday transaction accounts.
Hot wallets include: wallet software on a computer or mobile device, and accounts on cryptocurrency exchanges.
Hot wallets are:
- Easy to set up
- Easy to access
- Generally free
- More versatile than cold wallets (support more cryptocurrency options)
- More vulnerable to hackers than cold wallets due to live internet connection
- More likely to be regulated than cold wallets
Cold wallets are those that are not connected to the internet. This makes them an inherently safer method of storing cryptocurrency transaction details -- more akin to savings held in a bank vault than the cash found in your purse.
Cold wallets are ideal for storing larger sums of cryptocurrencies for safekeeping and/or investment.
Cold wallets include: specialised cryptocurrency wallet hardware devices, USBs, paper records of transaction details and keys locked in a safe.
Cold wallets are:
- More secure than hot wallets (no live internet connection to be hacked)
- Ideal for storing larger cryptocurrency transactions
- Generally must be purchased
- Less versatile than hot wallets (support fewer cryptocurrency options)
Tips for choosing and using a wallet
- Hot and cold wallets each have a use and purpose. Most users have both wallet options, and use a cold wallet for longer-term storage/investment and a hot wallet for transactions and exchanges.
- Hot wallets are generally used when receiving cryptocurrency funds, however funds are then generally transferred to a cold wallet for safekeeping.
- When trading using an exchange, it is good practice to move your coins to another wallet soon after. Although most exchanges use state-of-the-art internet security, they are still connected to the internet and thus theoretically vulnerable to security breaches.
- Do due diligence on wallet options. Undertake the research required to determine the right wallet options for you.
- Remember, cryptocurrency security and safekeeping is the user's responsibility. There are many great wallet options available; choose those that give you peace of mind for the security of your investments.
Congratulations on finishing chapter 3
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