What is a Hot Wallet?
A hot wallet is an app or platform that allows you to send and receive crypto. Its function is similar to that of an online banking app.
Your crypto hot wallet is a unique address on the blockchain that is always accessible online. It allows you to easily trade, withdraw cash, send, or receive crypto.
How Does a Hot Wallet Work?
A hot wallet, meaning an app connected to the internet that stores the keys you need to access your crypto on the blockchain, allows you to send and receive cryptocurrency.
A key mechanism in hot wallets is public and private keys, which are both random strings of letters and numbers.
Public crypto keys function as a wallet address, where someone can send you crypto, similar to your bank account number. To better illustrate this concept, here’s an example of sending crypto to a wallet address using a hot wallet like Metamask as an example.
1. Log in to your hot wallet. Click on the “Send” button.
2. Ask the recipient for their public wallet key, starting with “0x” and enter it in the “Send to” field.
3. Specify the currency and amount you’re sending, review the fees and details for accuracy, and then complete the transaction.
Private keys are a secret to you, and you must use them to verify that you’re the sole owner of the wallet. You’re given a secret key when you create your wallet, and you should never share it with anyone for ANY reason.
Some exchanges also provide crypto hot wallets, such as Coinbase Wallet. There are also dedicated hot wallets like MetaMask or Phantom Wallet, which are not connected to a centralized exchange.
Hot Wallets: Pros and Cons
Pros
- Free to use, whereas cold wallets cost money
- Allows instant and easy crypto transactions
- Access your crypto from anywhere
Cons
- More prone to hacks and security failures than cold wallets
Hot Wallet Security
The key question is, are hot wallets safe? Generally speaking, yes, they are safe to use, especially if you choose a reputable platform and take the following precautions.
- Save your secret key in a secure location that can’t be accessed, for example, an encrypted password tool like 1Password or on paper kept safe in your home.
- Set up two-factor authentication (2FA).
- Change your password regularly.
The main security risk of hot wallets is that someone could potentially access them remotely in the event of a data breach or hack.
Like in every piece of software there could be errors in the code creating vulnerabilities that can be exploited by malicious actors or causing a design flaw that can serve as an open door for fraudsters.
(Pokrovsky, 2020).
As long as you follow the recommended security measures mentioned above, the risk of online attacks is quite low.
Are Hot Wallets Safer Than Exchanges?
Crypto wallets are considered safer than leaving your crypto assets on an exchange.
Hot wallets give you full control over your funds and wallet keys, rather than giving exchanges, a third party, control. This is inherently more risky as the exchange owns your wallet keys and data, and if anything happens to the exchange, like a liquidity issue or hack, it impacts your crypto holdings.
The collapse of FTX and the subsequent $477 million hack demonstrates the need to keep your funds in an independent wallet rather than a crypto exchange.
(Sigalos, 2022).
Types of Hot Wallets
The key types of software wallets are:
- Exchange-specific hot wallets, which live on a crypto exchange for convenience and are either exclusive to the exchange or can be used for holding other funds (i.e, Coinbase crypto wallet)
- Blockchain-specific hot wallets, also called ecosystem-specific, store any crypto from a certain blockchain (i.e. MetaMask hot wallet for Ethereum, Bitcoin Core wallet for Bitcoin)
- Non-custodial hot wallets generally refer to a wallet separate from an exchange or centralized body (i.e. Trust Wallet supports 70+ networks)
Hot Wallet vs Cold Wallet
The defining feature of a hot wallet vs. cold wallet is that they exist offline and online, respectively.
A hot wallet is an app connected to the internet that lets you actively use your crypto for transactions. It’s similar to your bank account.
A crypto cold wallet, or hardware wallet, is a physical device that allows you to access your crypto fully offline. It can be compared to a safe, which stores physical money and valuables, and can only be accessed in person.
Cold wallets and hardware devices offer better security but you risk losing your funds should anything happen to it.
How to Transfer from Hot Wallet to Cold Wallet?
Crypto holdings are transferred between hot and cold wallets through a physical cord or Bluetooth connectivity using a hardware device like Ledger.
Using a cord to connect to the cold crypto wallet is more secure, as even Bluetooth can be intercepted and hacked.
Conclusion
Hot wallets are a necessary tool in the crypto world, functioning as a storage method and a convenient way to make a cryptocurrency transaction. For maximum security, use a cold wallet to store at least a portion of your digital assets, especially if you own large amounts of crypto.
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Pokrovsky, P. (2020). Hot wallet security assessment is essential for safe and compliant transactions. Blockchain Security Group, Kasperky, 3.
https://media.kaspersky.com/en/business-security/case-studies/Kaspersky_CoinsPaid_case_study.pdf Sigalos, M. (2022). FTX says it’s removing trading and withdrawals, moving digital assets to a cold wallet after a $477 million suspected hack. CNBC.
https://www.cnbc.com/2022/11/12/ftx-says-its-removing-trading-and-withdrawals-moving-digital-assets-to-a-cold-wallet-after-a-477-million-suspected-hack.html
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