Digital Asset Custody: What are Hot and Cold Wallets?

At times in 2021, the total market value of cryptocurrencies and similar assets (also known as “digital assets,” which is the term we will use throughout this article)  climbed to over 2 trillion dollars. With well-known companies and investors publicly  jumping into the cryptomarkets, including by purchasing large quantities of bitcoins, the need for clear digital custody options has become even more clear. The number of retail users, along with corporate users, is growing rapidly, and with that growth,, the issues of security, regulatory compliance, and digital asset custody are becoming more and more relevant.

If you are asking yourself, “What are digital assets?” then wee recommend reading our blog on Digital Assets to learn more.

What is Digital Asset Custody?

Digital asset custody is the holding, administration, safekeeping, and safeguarding of digital assets or private cryptographic keys used to hold, store, or transfer digital assets.

You can think of custody like a storage unit. When you hold digital assets, you need a secure place to keep them all. Since blockchains, where digital assets are created and reside, are decentralized ledgers, lacking a central authority, the storage of your digital assets can be complicated, and if carried out carelessly, can result in loss of digital assets by means like misplacing private keys or theft. Solutions to the need for custody include hot storage, cold storage, and third-party custodians, each of which hold the private keys to your digital assets in a different way.

Let’s break down those three mainstream options for digital asset storage:

What is a Hot Wallet, a.k.a Hot Storage?

A hot wallet is a computer application (which can be browser based or on your computer or phone) that enables a digital asset owner to store, receive, and send digital assets.

Unlike traditional hard currencies, digital assets (and their associated private keys) are generally not  held in physical wallets where you might carry around some dollar bills. Hot wallets are probably the closest of the three options discussed to a physical wallet (or a checking account), in terms of ease of access and use, but are also similar in their relative increased vulnerability to loss or theft..

Key factors of digital asset hot storage:

  • Usually connected to the internet
  • Users can control their digital assets via a digital private key, which the hot wallet stores for them
  • Users generally access the hot wallet with a username and password, similar to other applications
  • Relative increased ease of access to the digital asset
  • Relative increased vulnerability to hackers, since the wallet connects to the internet
  • Convenient for daily use

What is a Cold Wallet, a.k.a Cold Storage?

A cold wallet, sometimes referred to as a hardware wallet or offline wallet, is a digital asset storage system that operates (to some extent) offline.

If hot wallets are like debit cards tied to your checking account, cold wallets are like savings accounts in a different bank, so you can’t as easily access and spend the money. A benefit to this type of digital asset storage is that, since it is designed to keep your private keys offline, it is generally considered more secure than hot wallet storage. Cold wallets generally store the user's address and private keys in an offline unit that works in conjunction with compatible software on the computer, which connects to the Internet to transact on the blockchain.

Key factors of digital asset cold storage:

  • Private keys to access digital assets stored offline
  • Usually adds a manual aspect to accessing digital assets
  • Generally, a relatively reducedrisk of being hacked, as compared to storing private keys on Internet accessible wallets
  • Relatively less convenient for daily use, as generally, there is more security and steps required to access the digital assets

The main difference between a hot wallet and a cold wallet is that hot wallets are connected to the Internet, while cold wallets are (partially) not.

What about Third-party Custodians?

Third party digital asset custody solutions generally hold large quantities of digital assets in environments that can be online or offline, with many solutions advertising their security precautions. These custody solutions have helped to facilitate corporate and institutional capital management in the crypto industry.

Some third-party custodians offer asset insurance on the digital assets stored within third-party custodial systems. Digital asset insurance is new, and the insurance products offered advertise coverage against loss or theft of digital assets.

Security-oriented third-party digital asset custody providers tend to focus their marketing on a possible  reduced risk of hacks compared to individual hot or cold storage. However, these solutions are still new, relatively untested, and are unavailable to many average crypto holders.

What type of wallet is best for me?

As with any decision made in the crypto-space, it is essential to research the options you are considering and decide based on your specific situation. That answer may be a hot wallet application, full cold storage, a third-party custodian, or some combination of the available asset storage options. There are many valuable resources on this topic and reviews of various hot, cold and third party providers available on the Internet. As always, please be diligent in your research.

*Legal Disclaimer:

This material has been prepared for general informational purposes only and should NOT be: (1) considered an individualized recommendation or advice; and (2) relied upon for any investment activities. All information is provided on an as-is basis and is subject to change without notice, we make no representation or warranty of any kind, express or implied, regarding the accuracy, validity, reliability, availability, or completeness of any such information. Binance.US does NOT provide investment, legal, or tax advice in any manner or form. The ownership of any investment decision(s) exclusively vests with you after analyzing all possible risk factors and by exercising your own independent discretion. Binance.US shall not be liable for any consequences thereof.

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