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Hard wallets & cold storage explained

Hard wallets & cold storage explained

    Entering the crypto space can be as disorientating as travelling to a foreign country. Everything feels different, and most importantly, everyone speaks a different language. Two related phrases newcomers are likely to hear and certain to be confused by, are hard wallets and cold storage. They may have a very unfamiliar ring but they relate to something that everyone should immediately understand - safely storing your wealth.

    Every good teacher will understand the importance of making any new idea relatable. In other words, using something the student already knows as a bridge to a new piece of knowledge.

    Though crypto can at times feel completely alien, there are many elements that are relatable to how we manage traditional money. Starting with wallets.

    Everyone should know what a wallet is. This is the definition Google gives us:

    ‘Wallet - a pocket-sized flat folding case for holding money and plastic cards.’

    Wallets were originally designed to make carrying banknotes more convenient. Before the use of banknotes, their predecessor was the purse, designed to carry coins, .

    As spending behaviour moved from cash to digital money, physical wallets more commonly carried the tools that connect us to our digital money - bank cards.

    But the term evolved to also describe software applications - eWallets like Paypal or Venmo or bank Apps - that allow us to access and move money in digital form only.

    So wallets are really just a means to an end. They are a convenient method to store our wealth and enable us to spend it. There are other methods of storing wealth, which are less convenient, but more secure. Like a bank deposit box, a safe or a piggy bank.

    All methods of storing wealth are a trade-off between those two elements - security and convenience - and cryptocurrency is no different in that respect.

    Introducing the crypto wallet

    A crypto wallet is a device for storing, sending and receiving cryptocurrency.

    They have familiar eWallet/banking app features - like a balance, currency symbols and the ability to Send/Receive funds. What is slightly less familiar, is that funds are sent to and from addresses, rather than account numbers.

    You can find a detailed explanation of addresses and how wallets work in our knowledge base, but what is important to understand is that there are a variety of crypto wallets which balance the trade-off between security and convenience of enabling you to spend and send your crypto. 

    It is easier to explain what the terms hard wallet and cold storage mean within that context.

    Hot/Cold Wallets - Describe whether the wallet is online or offline, by default. By default a Hot Wallet is connected to the internet, making it convenient for transacting but less secure. 

    Conversely, a Cold Wallet is by default offline, making it more secure but less convenient to transact. 

    A connection to the internet isn’t the only security threat to your cryptocurrency, but it is by far the most important. If you are online you are constantly at risk from bad actors, and crypto attracts the worst.

    You may want a Hot Wallet for frequent transactions, and a Cold Wallet for storing significant amounts (aka hodling). In this way you can think of soft wallets like current/checking accounts - everyday spending - and hard wallets for savings - money you rarely touch.

    The terms Soft and Hard, are just shortened versions of software and hardware. So the terms describe whether the wallet is just a piece of software (like an App) or a physical device. 

    So what exactly are Hard Wallets & Cold Storage?

    So we can now return to the original question, and - given what we’ve learned - explain the what the terms Hard Wallet and Cold Storage mean.

    A Hard Wallet is a physical device that connects by USB to a computer and enables you to access your cryptocurrency via dashboard, to send, receive or spend it. The main brands are Ledger and Trezor, but many others are emerging.

    On the convenience vs security spectrum hard wallets are squarely at the secure end, because they are offline by default. When they aren’t connected their size means they can be stowed away somewhere making your crypto 100% safe from online fraud or theft. 

    The flip-side is that this makes Hard Wallets pretty inconvenient if you wanted to regularly move the crypto they store, but people use them because they want to trade-off convenience for greater security.

    This is what the term Cold Storage really means. Your cryptocurrency isn’t in a freezer, but is offline and only accessible via a device that you have complete control over. 

    You can think of hard wallets as the modern evolution of a physical safe. They are really inconvenient for regular access, but recommended for storing large amounts.

    The table describing the different types of wallet should, hopefully, make sense now, except that in learning two new things, we’re now throwing in another new related term - Custody.

    If you feel cheated, thinking that having learned what Cold Storage and Hard Wallets mean, today’s lesson was over, it is worth following the thread to its ultimate conclusion.

    Custody is one of the most important concepts in crypto, because it describes who is in ultimate control of your crypto. That means custody is also a trade-off between convenience and security, and a key differentiator in wallet design.

    With the money you are familiar with there are a couple of ways of looking after it.

    1. Look after it yourself 
    2. Trust someone else to look after it on your behalf

    Option 1 might mean a safe or vault, with a key or code that only you hold. Option 2 - allowing someone else to look after it - most likely means using a bank, who you trust to store it, but gives you convenient access via an account, and maybe an App.

    With cryptocurrency you have the same two options; you can assume full responsibility yourself, or trust someone else to look after it.

    1. Look after crypto yourself - Use a non-custodial wallet
    2. Trust someone else to look after your crypto - Use a custodial wallet

    As crypto is entirely digital but its monetary units don't exist as files on your file or laptop. What is being custodied is a piece of information that whoever holds, can spend the associated funds. A Private Key.

    • Self-custody - You control your Private Keys & therefore your funds
    • Custody - You trust a 3rd party to look after your Private Keys & they give you access

    Seeds - Usable Versions Of Private Keys

    It is unrealistic to remember the 64 character Private Key for every address holding cryptocurrency, as it is not uncommon to have multiple addresses, in the same way you might have multiple bank accounts with different details. 

    Luckily wallet designs have evolved to solve this. Hierarchical Deterministic wallets - HD Wallets for short - can derive all Private Keys from one start point known as a Seed.

    A Seed is a string of between 12 and 24 unique phrases. You may also see a Seed referred to as a Recovery Phrase or Backup Phrase. 

    So the fundamental difference between custodial and non-custodial wallets is whether you ultimately have access to the private keys/seed or not, giving you control over the funds.

    This is so important because there is no bank, which means no customer support. So if you take the responsibility for your funds and something goes wrong, there is no chat support or complaints process.

    Conversely, allowing a service to look after your funds puts a lot of faith in their security. Just as there is no safety net for you, there isn’t a fallback for the service looking after your private keys.

    This is by design; cryptocurrency gives the individual power over their money, and as we know, with great power, comes great responsibility. Hard wallets, which hold your funds in cold storage are the ultimate expression of that sovereignty.

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