Fundamentals: Cold Storage Wallets

12/22/22 • 6 min

A cold storage wallet is used for storing crypto assets where the private keys and access to the wallet are offline thereby protecting the funds from unauthorized access, hacks, and other vulnerabilities. There are physical devices, like Ledger’s Nano S or Trezor’s One, or simply something analog like a sheet or paper containing the private keys to the wallet. With the physical devices, the unit is connected to a computer to authorize transactions and generally has a passcode to gain access to the device itself.

The security advantage of storing funds on a cold wallet is that they cannot be hacked unless someone either:

Has access to your 12- or 24-word seed phrase (or written private key in the case of a paper wallet)
Has access to your physical device and the device’s passcode

The security advantage of storing funds on a cold wallet is that they cannot be hacked unless someone either:

Has access to your 12- or 24-word seed phrase (or written private key in the case of a paper wallet)
Has access to your physical device and the device’s passcode

Previous Episode

Fundamentals: Exchange & Hot Wallets

Exchange wallets are funds held on centralized exchanges (CEXs). If a taxpayer purchases crypto assets on a CEX like Coinbase or Kraken, then the assets are in the exchange’s wallet. When investors leave funds on exchanges, they are relying on a third party to secure their assets. Exchanges have been hacked and bad actors inside an exchange have stolen and mismanaged funds; in the strange case of the Quadriga Ex exchange founder who suddenly died under suspicious circumstances, the private keys to $190 million of users’ funds vanished.

Relying on exchanges to secure funds is only for active traders and those comfortable with the security vs. convenience tradeoff that this provides.

Hot wallets are the next step up in security after exchange wallets because they allow the user better control over the protective measures they implement. The user can create complex passwords and cybersecurity features to reduce the chances of their funds being compromised.

These wallets are “hot” because they live on your computer, generally as an app or as a plugin to a web browser. As they require an internet connection to use, malware, keyloggers, and other common hacking tools can be used to gain access to this type of wallet.

Hot wallets are only as good as the security measures put in place to protect them. As a result, they should only be used with small balances of cryptocurrencies to reduce risk exposure.

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Fundamentals: Multisig Wallets

Multisig wallets require multiple signatures (multiple wallets approving the transaction) to sign or confirm transactions and can be secured with either a hot or cold storage wallet. This method provides for much greater security as there is no one single point of failure. A multisig wallet secured via cold storage is the gold standard for security with crypto assets, but this protection comes at the expense of convenience. This type of storage should be employed for large asset balances that are kept for longer time frames.