What it is, how it works, theft protection

What is a cold wallet?

“Cold wallet” is a term used to refer to devices that store cryptocurrency private keys offline. Private keys are transferred from a device with an Internet connection to a device that does not. This data security technique has been used for several decades by businesses, governments and individuals to keep data inaccessible or to store it for later use. In most cases, this is called cold storage, but cryptocurrency fans and users prefer to call a device that stores keys offline a cold wallet.

Cold storage methods are useful for individual investors and users, but some of the best cryptocurrency exchanges and companies involved in the crypto space also make use of this type of storage.

Why do you need a cold wallet?

When your checking, savings or credit card account at a traditional bank is compromised, the bank can reimburse you for the lost or stolen money. Banks can find out where money went because the transactions are digital, and they can be traced by account numbers and names. Money can be moved back to your account, and the thieves can be dealt with.

However, if your cryptocurrency wallet is compromised and your tokens are stolen, you cannot get your coins back or otherwise be reimbursed. First, they are not insured or backed by a government or institution. Second, this is due to the way blockchains are designed. Wallet addresses are publicly available, but no names or personal information is stored or publicly available – and because of the way information is chained to a blockchain, transactions cannot be reversed.

They protect your keys

A cryptocurrency wallet is assigned a public key that serves as the wallet’s address, much like an email address. This key does not need to be stored anywhere safe, but keeping it private ensures your anonymity.

Private keys are the alphanumeric codes used to access cryptocurrency—that’s what thieves are looking for. All cryptocurrency storage methods involve protecting the private keys because they provide access to the tokens. Private keys are similar to the password or PIN you use to access your bank account program—if someone steals them, they can wreak havoc on your finances.

How does cold storage work?

Private keys stored on an Internet-connected wallet are vulnerable to network-based theft. All the functions needed to complete a transaction are done from a single online device—linked wallets are therefore one of the weak links in a network. This is because these are devices that use software, which can be modified by hackers.

Cold storage reduces the chances of private key theft by removing it from an online environment. In most cases, transferring private keys to cold storage is not as complicated as it may seem.

Types of cold storage

There are many ways to store cryptocurrencies, and many of the methods you read about on the Internet have changed over time—so it’s worth discussing storage types. As of December 2023, there are two common types of storage. One is where someone else holds your keys for you, called a vault. The other is where you keep your keys, which is called non-custodial storage.

The subtypes are the methods you can read about—paper, software, hardware, cold, and hot. So, you can give your keys to your wallet to keep for you in its enterprise security level vault, which would be a safekeeping method for cold storage hardware.

If you want to keep the keys yourself, you can put them on a USB device designed for crypto key storage. It would be a non-volatile storage method that transitions between hot and cold as you plug and unplug it from your computer. You can also write or type your keys on a piece of paper, delete them from your wallet app, and put the paper in a vault—that’s also non-custodial cold storage.

Paper wallets

The most basic form of cold storage is a paper wallet. A paper wallet is simply a document on which public and private keys are written. In the case of a bitcoin paper wallet, a bitcoin holder can print the document from the bitcoin paper wallet tool online using an offline printer. The paper wallet or document usually has a quick response (QR) code embedded so that it can be easily scanned and signed to complete a transaction.

The disadvantage of this medium is that if the paper is lost, made illegible or destroyed, the user will never be able to access the address where their money is. If you choose this method, make sure you have a safe or some other secure storage method for the paper wallet itself.

Hardware wallets

Another form of cold storage is a hardware wallet that uses an offline device or smart card to generate private keys offline. The Ledger USB Wallet is an example of a hardware wallet that uses a smart card to secure private keys. Two other popular hardware wallets are TREZOR and KeepKey. The device looks and functions like a USB drive; a computer and a Chrome-based application are required to store the private keys offline. You can use anything from a standard USB storage drive to an advanced device with a battery, Bluetooth, software and other features. Like a paper wallet, it is essential to store this USB device and smart card in a safe place, as any damage or loss can terminate access to your cryptocurrency.

Air gap devices have no connectivity and are more secure than those that can connect wirelessly. You can buy commercial hardware wallets from retailers and merchants; many are waterproof and virus-resistant – some even support multi-signature (“multi-sig”) transactions. Multi-sig is a cryptocurrency signature method that requires more than one user to approve a transaction with private keys.

Software wallets

Software wallets are applications that run on a device, such as a smartphone, tablet or personal computer. Because these devices are generally connected or can connect to the Internet, they are usually hot wallets and should not be used to store private keys.

Users looking for cold storage options can also choose offline software wallets, which are very similar to hardware wallets, but are a more complex process for less technical users. An offline software wallet divides a wallet into two accessible platforms—an offline wallet that holds the private keys and an online wallet that stores the public keys.

The online wallet generates new, unsigned transactions and sends the address of the user to the receiver or sender on the other side of the transaction. The unsigned transaction is moved to the offline wallet and signed with the private key. The signed transaction is then moved back to the online wallet, which broadcasts it to the network. Because the offline wallet never connects to the Internet, its stored private keys remain secure. Electrum and Armory are often cited as the best offline software wallets in the crypto economy.

Sound wallets

Sound wallets are an obscure and expensive way to store your keys, depending on your chosen medium. Audio wallets involve encrypting and recording your private keys in audio files on products such as CDs or removable USB drives. The code hidden in these audio files can be deciphered using a spectroscope application or high-resolution spectroscope.

Deep Cold Storage

It is safe to put your hardware wallet in your vault, but it is not considered deep cold storage because it is easy for you to access. Deep cold storage is any method that is very inconvenient and requires time and effort to retrieve your keys. This can be anything from placing your hardware wallet in a waterproof container and burying it six feet down in your garden to using a third-party service that stores your cryptocurrency keys in a vault that requires several steps to gain access.

Burying your keys deep in the garden has several disadvantages, including a lot of digging and remembering where you buried them, but so does the ultra-secure vault service. Vault Services generally require your identity, proof of address or other means of identification. Additionally, it can take hours or days to access your keys, depending on where they are physically stored.

The Bottom Line

Called cold wallets by cryptocurrency users, cold storage is the most secure way to store your cryptocurrency’s private keys. This involves transferring the keys to a device or medium that is not connected to the Internet.

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