Cold Wallet, What It Is, How It Works, & Best Crypto Wallets

A cold wallet is the safest way to store your private keys and prevent theft. However, there are several different cold storage options to choose from.

Picking the best method can be confusing if you’re a new cryptocurrency investor, and I’m here to help you decide confidently.

What is a cold wallet?

A cold storage wallet stores your cryptocurrency keys offline instead of on internet-connected devices.

It’s usually physical hardware, similar to a USB stick, that you keep. It can also be a software custodial wallet that a third-party stores and you access digitally.

This contrasts with a hot wallet that keeps your keys on the cryptocurrency exchange for instant trading but is more susceptible to theft and hacking.

How does a cold storage wallet work?

The primary function of a crypto cold wallet is to store your private keys in a secure, offline location safe from theft, hacking, malware, and misuse.

Your crypto tokens remain on the blockchain and cannot move unless you unlock the private key. Exchanges let you decide whether to put your cryptocurrency balance in hot or cold wallets.

A hot wallet is for instant trading and has fewer safeguards while a cold crypto vault protects your long-term holdings until you’re ready to move them to your trading balance.

Here are some of the core features of cold storage:

• Ownership: Keeping your keys within your possession provides peace of mind as you don’t rely on an exchange to store your keys. Self-custody flexibility also provides protection if the trading platform closes or stops supporting a particular token.
• Manage multiple accounts: Self-custody wallets can store assets from several trading accounts on the same device. Further, the device generates unique keys for each blockchain address to protect your privacy.
• Insured custodial wallets: While not as secure as hardware wallets, most exchanges and crypto IRAs offer software-based cold wallets so you don’t need a physical storage device. They usually carry insurance against custodian-liable theft and digital crime. 
• Offline storage: Your tokens stay on an air-gapped device or server disconnected from the internet or trading platform. Anticipate using a companion app to sign transaction requests and access your blockchain. 
• Password protection: Cold wallets only connect with your permission, usually after entering a 12-word or 24-word “seed phrase.” It’s also possible to make backup phrases to avoid losing login access if your device is lost or inoperable.
• Crypto staking: Many platforms are able to award staking rewards from cold storage assets. As a result, you can earn passive income by providing network liquidity while enjoying the best security practices. 
• Transaction fees: Unfortunately, exchanges charge fees to transfer assets off their platform. Additionally, hardware wallets have one-time purchase costs while software-based cold storage is usually free when the platform maintains custody.  

The first cold wallets became operational in 2011, in the early days of cryptocurrency.

Moreover, the first hardware wallets launched in 2014 to make ultra-secure self-custody achievable. Investors realized the importance of storing private keys offline.

I highly suggest keeping any crypto assets you don’t intend to sell or swap soon in cold storage for ultimate security. It’s fairly easy to set up a cold wallet, and it’s my default storage method.

A custodial wallet through your exchange is usually the easiest way to start.

They are typically free to use and insured against criminal activity if the custodian experiences a security lapse. You’re not at risk of losing your device or seed phrase. 

However, a physical self-custody wallet is more secure as you have full control over storage security.

First, you keep the keys instead of the exchange or third-party custodian to avoid data breaches. Additionally, you decide when to connect online and approve transaction requests. 

Why having a cold wallet is important?

A cold storage wallet protects you from criminal activity such as theft, exchange hacks, misuse of funds, and ransomware attacks.

These incidents can result in permanently losing your cryptocurrency balance if your on-exchange trading balance is uninsured. 

While the risk is low, exchange breaches occur periodically and hardware wallets keep assets offline.

Exchange-provided cold storage can also store your keys offline in a network of wallets that usually qualify for commercial crime insurance. 

The most notable exchange hack is Mt. Gox from 2011 to 2014, resulting in over 744,000 stolen Bitcoin.

The Bitfinex hack in 2016 is another prime example, as hackers stole just shy of 120,000 Bitcoin from the exchange’s hot wallet that’s always connected to the Internet. 

Cold storage isn’t risk-free, yet this safeguard greatly improves your portfolio security.

This practice can help you sleep peacefully at night, especially as your crypto balance grows.

Types of Cold Storage Wallets

There are several kinds of crypto wallets to choose from that safeguard your keys differently, along with varying advantages and risks.

Hot wallets

A hot wallet is constantly connected to the Internet and is accessible by web, mobile, or desktop.

Cryptocurrency immediately available for trading or transactions remains in this wallet type.

It is the most convenient and most straightforward to use. However, it has the most security vulnerabilities and is better for short-term holdings.

Consider only keeping a small portion of your cryptocurrency balance in this account as it’s eligible for fewer insurance benefits.

Exchange-provided hot wallets are usually free to use and guarded with bank-level encryption.

Paper wallets

Crypto paper wallets are an outdated practice but are easy to start and remain in use today.

You simply write or print your public and private keys on a piece of paper or save them in a digital file.

They were more popular in the early years of Bitcoin and altcoins before exchange wallets and hardware cold storage became widely available.

It can still be a good option for protecting small balances, gifting crypto, or not relying on digital apps. Random key generators can generate random keys and QR codes for additional security.

Unfortunately, it can be challenging to find a trustworthy platform as many apps today are open-source and can be easily hacked to track your keys.

As you’re storing a physical document or engraved metal plate, you risk losing your keys if you accidentally throw away, misplace, or destroy the paper.

It’s also susceptible to fire, flood, and theft. Digital files or the storage device can become corrupted, inoperable, or compromised.

Hardware wallets

Hardware wallets balance accessibility with security and are the best crypto cold storage wallet for most situations.

These devices usually cost between $50 and $200, support most tokens, and can store keys for tokens purchased from multiple exchanges. 

You have complete control over your cryptocurrency since you store your keys on an external device that’s offline and remains in your physical possession.

It connects by USB, Bluetooth, or near field communication (NFC) while remaining phishing and malware resistant.  

Permanently losing access to your crypto keys is a common concern if your device becomes lost, stolen, or damaged.

Thankfully, many providers offer key recovery and device replacement to restore access as long as you still have your secret phrase. 

Many devices can serve as a multi-signature wallet, providing multiple devices with partial keys.

This comes in handy if you want to share an account with a spouse or business partners and prevent a single point of compromise, as two parties must approve transfers.

Select crypto IRA companies, such as Swan Bitcoin, offer “two of three” self-custody IRAs where you store your keys with two devices and the custodian keeps a third.

Software wallets

This Bitcoin wallet is online-based and a third-party custodian stores your keys on a cold storage server.

It is more convenient as you’re not responsible for safekeeping a physical device. 

Be sure to verify if the wallet provider uses hot or cold storage for their software wallet. 

Reputable exchanges offer cold storage, including Coinbase, Kraken, and Gemini. You can seamlessly decide how much of your portfolio to set aside in custodial cold wallets on secure servers. 

This is also the default storage method for the best crypto IRAs where your custodian keeps your keys behind multiple security layers, including multi-signature transaction approval.

Your balance is eligible for commercial crime insurance when the exchange or wallet custodian is liable for allowing a data hack to occur.

Covered incidents and limits vary by platform. 

Cold software wallets are safe, but are more prone to account hacking than a hardware wallet that you must manually connect.

Sound wallets

Sound wallets excel at protecting the most valuable portfolios due to their complexity.

You need special audio recording software to encrypt your keys on a CD, USB flash drive, vinyl record, MP3, etc. 

Your keys are cloaked as distinct audio tones within a sound file.

Playing the file through special software reveals your keys. If you choose this storage route, consider making new backups at regular intervals since CDs and physical media degrade over time.

Deep cold storage

Deep cold storage involves keeping your hardware device in an unconventional location for maximum security.

For example, you might bury it in your backyard or hire a vault service that requires delivery when you request access.

The goal is to thwart thieves from looking in common storage spots, such as a home safe. 

Depending on where you store your device, it can take several hours or days before you can hold your physical wallet. Take precautions like making a treasure map or using a waterproof container to avoid loss.

Benefits & Drawbacks

Here are the advantages and disadvantages of keeping crypto on cold storage.

Benefits

• Offline storage: Only connecting online with your permission makes cold storage the most secure way to store your private keys.    
• Multiple security measures: Wallet custodians use two-factor and multi-signature authentication to help manage shared accounts and prevent unauthorized logins or transactions. 
• Flexible use cases: There are several ways to protect your keys, including hardware and software wallets. Less common practices, like a paper or sound wallet, can also be a good option. 
• Total control: Hardware wallets are non-custodial and can essentially store unlimited private keys from multiple exchanges. As a result, you can use the same device for all of your long-term holdings and not rely on a trading platform to protect your keys. 
• Custody insurance: Custodial wallets storing your assets in cold storage usually insure against digital crime and theft. You can receive reimbursement when the custodian is at fault and you properly secure your account.

Drawbacks

• Not risk-free: A misplaced seed phrase or device without a backup can result in permanently losing access to your private keys.   
• Fees: Most hardware wallets usually cost between $50 and $200 to buy. Additionally, you will likely pay transaction fees when transferring keys off and on the exchange.
• Transaction delays: The multi-layer security makes cold wallets impractical for daily use as several steps are involved to transfer keys back to your hot wallet.

Cold Wallet vs. Hot Wallet

Here are the similarities and differences between the two wallet types.

Criteria	Cold wallet	Hot wallet
Best For	Long-term storage	Frequent trading
Supported cryptocurrencies	5,000+ tokens	5,000+ tokens
Internet connection	Always offline	Always online
Storage location	Hardware-based	Software-based
Security	Offline, non-custodial storage	Online, with multi-factor security
Ease of use	Less user-friendly	Very easy to use
Cost	$50 to $500	Usually free

How to Use a Cold Wallet

There is a slight learning curve to setting up your cold wallet, but it’s easy even for first-time crypto buyers.

1. Compare wallet: There are a few producers to choose from. They are secure, but you will want to ensure they support any altcoins you plan to store and are compatible with your operating system. I also read customer reviews for in-depth insights.
2. Buy a hardware wallet: You can purchase a physical wallet for as little as $50. Pricier devices are more durable and have more storage capacity for third-party apps.
3. Install the companion app: After receiving your device and inspecting it for potential tampering, install the desktop or mobile app to sync your device. 
4. Generate passcodes: You will generate a PIN code and seed phrase to unlock your device and private keys. Store these phrases in a secure place to avoid permanent account lockouts if you need to recover a device.
5. Add accounts: Your companion app can sync with most exchanges and third-party wallets where you currently store cryptocurrencies. 
6. Send crypto keys: You will receive a public wallet address to send your keys to. Start with a small test transfer. Transactions sent to incorrect addresses cannot be canceled or reversed.
7. Disconnect your wallet: Keep your device offline for maximum security after your transfers.

3 Best Cold Storage Wallets

Below are three trustworthy cold wallet providers that have their unique traits while remaining easy to use and providing recovery support.

Ledger

Ledger supports over 5,000 cryptocurrencies and NFTs, along with being compatible with more than 50 third-party wallets.

This functionality and above-average ease of use with Android and iOS devices are why many traders choose this brand.

Trezor

Many people like Trezor for its open-source code that anybody can inspect to look for bugs.

Its devices are affordable yet somewhat limited by only supporting 1,800+ tokens. They may also be incompatible with iOS mobile devices or Bluetooth.

Shop for a Trezor today!

Tangem

Tangem offers innovative hardware designs with a credit card that fits in your analog wallet or wearable ring.

Both products come with a 25-year warranty and are battery-free. They also feature open-source code and are NFC-enabled.

Is keeping your crypto in a cold wallet a good idea?

Cold storage is the most secure way to keep any cryptocurrency you don’t plan on trading within the immediate future away from hackers and data leaks.

Taxable exchanges and retirement plan custodians utilize this storage whenever possible to manage risk. 

For many, hardware wallets provide the most peace of mind as you have exclusive access to your private keys and decide when to connect the device online.

For a tax-advantaged crypto Roth IRA, custodial wallets blend security, convenience, and no storage fees.

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