What is a Hot Wallet?
After an investor decides to buy or mine a digital currency, she must then determine where and how to store the tokens. Unlike traditional currencies, there are not dedicated banks or traditional physical wallets which can be used to keep cryptocurrency holdings secure. Cryptocurrency wallets are tools which are commonly used to store and protect these holdings, and they come in many different forms and varieties. One of the most popular is the so-called "hot wallet." At its most basic level, the distinction between a hot wallet and a cold wallet is that hot wallets are connected to the internet, while cold wallets are not.
- A hot wallet is typically a piece of software which allows cryptocurrency users to store, send and receive tokens.
- Hot wallets are linked with public and private keys which help to facilitate transactions and act as a security measure.
- Because hot wallets are connected to the internet, they tend to be somewhat more vulnerable to hacks and theft than cold storage methods.
Understanding a Hot Wallet
There are different reasons why an investor might want his or her cryptocurrency holdings to be either connected to or disconnected from the internet, and so it's not at all uncommon for cryptocurrency enthusiasts to hold multiple wallets, some of them hot and some of them cold.
Likely the biggest advantage to a hot wallet is that it can be used to help facilitate basic transactions. Individuals looking to actually make purchases with their cryptocurrency assets might choose to use a hot wallet, for instance, as the holdings in that wallet will be transferable across the internet. On the other hand, hot wallets are somewhat more likely than cold storage techniques to face issues of security and hacks. That's not to say that a hot wallet is necessarily an unsafe way of storing your cryptocurrencies. Rather, it's more about the comparison between a hot wallet, which can access (and theoretically be accessed by) other parts of the internet, and a form of cold storage, which is entirely removed from the internet ecosystem.
How a Hot Wallet Works
A hot wallet is a piece of software allowing a cryptocurrency owner to receive and send tokens. Although they are called "wallets," the name is somewhat misleading: hot wallets do not actually store cryptocurrency in the way that traditional wallets do. They simply help to facilitate changes to records of transactions which are stored on the decentralized blockchain ledger for the cryptocurrency in question.
For the cryptocurrency user, the two most important pieces of information related to a cryptocurrency wallet are the cryptographic public and private keys. Public keys are similar to account usernames: they identify the wallet to allow the user to receive tokens without revealing his or her identity. Private keys are more like pin numbers in that they allow the user to access the wallet to check balances, initiate transactions and more. Without either of these keys, the wallet is effectively useless.
Security and Hot Wallets
What goes into determining the safety and security of a hot wallet? Much of it is dependent upon the user him or herself. Items in a hot wallet which are connected to the internet are vulnerable to attack because the public and private keys are stored online. Savvy cryptocurrency investors will only keep a small portion of their holdings in their hot wallet, perhaps even only what they plan to spend in the near future. The remaining assets will likely stay in cold storage until they are needed for specific transactions. In this case, the investor can keep an eye on overall security, betting that hackers will not break into a hot wallet for a small number of coins or tokens.
Some investors choose to keep their cryptocurrencies in accounts linked to popular exchanges like Bitstamp or Poloniex. These companies, which hold your funds within their own infrastructure, can be considered as hot wallet service providers. This means that if an attacker gains access to the Poloniex servers and infiltrates their customer accounts, you might suffer a loss. Because many of the top digital currency exchanges allow users to transfer between various fiat currencies and cryptocurrencies, it's common for most users to hold a small amount of any of a number of currencies in their accounts. Again, moderation is key; maintain a balance that is high, and you risk drawing the attention of hackers or losing a substantial portion of your holdings in the case of a theft.
Other Types of Hot Wallets
There are a variety of hot wallets available, many of which are free to download. Investors should consider all of their options before committing to one particular type of wallet. Some of them offer various types of user interface experience, and there are wallets which are specifically designed to be used in partnership with particular apps or even with certain cryptocurrencies. It's also useful to conduct research into the team behind the development of a hot wallet before downloading and using that service. Developers have varying degrees of expertise, various commitments to security and privacy, and different priorities in mind when creating their wallets. Developers will also adopt different strategies when it comes to updating their products; it's best to find a hot wallet provider that is willing to continue to update their product as hacking efforts change and adapt. It's also a good idea to make sure that the wallet you decide to use is fully compatible with any digital currency exchanges that you also make use of.
There are also software hot wallets. These are downloadable applications that aren't linked to particular exchanges. You maintain control of your private keys, so the cryptocurrency assets in the hot wallet remain under your control. However, your money remains vulnerable to hacking, as a malicious person or group which gains access to your computer would theoretically also be able to drain your wallet via the software application.
Some cryptocurrency users prefer to keep their digital assets in a physical "wallet," most often a device which looks like a USB stick. These are typically not examples of hot wallets; they can only be accessed by being plugged directly into a computer and do not require an internet connection in order for a user to access his or her cryptocurrency funds.