Protecting Your Digital Assets: Cold Wallets and Their Benefits

Cold wallets are a wise choice for long-term crypto investors

Digital assets like Bitcoin and Ethereum help to level the financial playing field and put the individual on equal footing with the banks by empowering you to take control and custody of your own assets.

Controlling your private keys through self custody enables you to buy, hold, send and receive digital assets without the need for the permission of a third party. As we’ve seen too many times, leaving your holdings on a crypto exchange and trusting an intermediary to safeguard your crypto assets has unfortunately led to significant losses of user funds time and time again.

With great power comes great responsibility. Part of your responsibility as an owner of digital assets is to choose how to safely and effectively store and hold these assets in the way that’s right for you. There are many different options to choose from, and different types of cryptocurrency wallets are the right fit for different types of crypto users and investors.

The two primary types of crypto wallets are known as hot wallets and cold wallets. In this article, we’ll define what a cold wallet is, discuss the different types of cold storage wallets, and the pros and cons of using cold storage in this article.

What is a cold wallet?

Quite simply, a cold wallet, or cold storage wallet, is a crypto wallet that is not connected to the internet. In contrast, hot storage wallets are connected to the internet and are considered always online.

Primary examples of cold wallets

Cold wallets can take on several different forms — they are often physical devices, also known as hardware wallets, that can resemble USB sticks, credit cards or other hardware devices.

But a cold wallet doesn’t necessarily have to be a high-tech device. Paper wallets are another type of cold storage wallet. This low-tech but always-offline solution is exactly what it sounds like — a piece of paper with a public key and private key written down on it.

For reference, a public address is like your username — this is the address that you use to send and receive cryptocurrency. Private keys, on the other hand, can be compared to the password that you need in order to sign off on a crypto transaction.

Paper wallets can also include a scannable barcode or QR code to simplify the process of using them to receive cryptocurrency.

Why go cold?

The primary advantage of using a cold wallet comes down to safety and security.

By forgoing an internet connection, cold wallets are a safer option that offer a heightened level of security as they are immune to remote hacking attempts and unauthorized access that can arise from malicious attacks like malware and phishing attacks.

The private keys that grant access to your cryptocurrencies are generated and stored offline within the cold wallet. This means that even if someone gains access to your computer or online accounts, they cannot access your cryptocurrency funds without physical access to the cold wallet.

Disadvantages of cold wallets

On the other hand, the primary disadvantage of using a cold wallet is that the tradeoff for this elevated level of security is less convenience.

This isn’t necessarily a bad thing in and of itself — sitting tight and keeping your assets in cold wallet storage can be the ideal choice for long-term hodlers and investors holding significant amounts of cryptocurrency who don’t plan to sell any time soon and who don’t make frequent trades or cryptocurrency transactions on a daily basis. But for everyday use like trading or sending and receiving small amounts of crypto, hot wallets are the way to go as they offer more convenience.

Expecting the Unexpected

An additional risk to keep in mind when using a cold wallet such as a physical device is that if you lose physical possession of the device, or the device is damaged, you can lose access to your cryptocurrency holdings. A cold storage device can be misplaced, lost, stolen or simply damaged.

Similar risks apply to paper wallets, which can also be lost or stolen. Paper can also degrade over time, making the address unreadable. The event of flooding or a house fire could also be catastrophic for hardware wallets and paper wallets alike.

While you may think that this could never happen to you because there is no way you’d be that careless with your valuable crypto holdings, it just takes one mistake or accident to cause a permanent loss of significant funds. For example, in one high-profile and particularly unfortunate incident, an individual in the U.K. lost a hardware device that had 7,500 Bitcoin on it when he mistakenly threw it out when cleaning out his house in 2013. The unlucky individual, a 35 year old man from the United Kingdom, said that the mistake occurred because he had two identical-looking hard drives, and he accidentally discarded the drive that contained the private key he needed to access his Bitcoin holdings. At today’s prices, this Bitcoin stash would be worth over $250 million.

And he’s not alone — a software programmer from San Francisco can no longer access the 7,002 Bitcoin because he lost the piece of paper where he wrote down the password needed to access the hard drive that his private key was stored on.

But you don’t need to lose access to hundreds of millions of dollars worth of Bitcoin for the results to be financially devastating. According to data from Chainalysis, up to 20% of all Bitcoin in existence may be lost or stranded.

That’s why when using a cold wallet, it’s important to expect the unexpected and to have a sound backup plan in place. When using cold wallets, it’s absolutely essential to securely back up the private keys and seed phrases associated with these wallets. It goes without saying that this backup key should be stored in a separate, safe location — if it’s with your physical cold storage device when that gets lost or stolen, that defeats the point. It’s also important to note that backup key information shouldn’t be saved on your computer or on an internet-connected device, as this could leave it vulnerable to hacking, eliminating the advantage of cold storage.

BitGo’s Cold Wallet Solutions

BitGo, the crypto-native company leading the way in providing secure and scalable solutions for the digital asset economy, offers a number of cold storage solutions for the crypto market.

The typical cold wallets discussed above may not be suitable solutions for institutional investors or high-net wet worth individuals or financial firms holding considerable sums of cryptocurrency. BitGo’s self-managed cold wallets are ideal for firms that make infrequent but large crypto transactions.

With self-managed cold wallets, BitGo customers control two of the three keys (a client key and a backup key used for disaster recovery), and do so offline instead of online. Customers initiate and half-sign cryptocurrency transactions offline, then upload them to BitGo for countersigning — without the user key ever being exposed to the online environment, giving users an extra layer of security.

Self-managed cold wallet users enjoy plenty of flexibility through the ability to customize the policies on their accounts, such as user permissions and transaction limits.

For customers in certain jurisdictions, self-managed cold wallets can ensure that they are complying with local regulations that require custody to occur in a specific place while continuing to rely on BitGo’s best in class security technology, which it first pioneered in 2013.

BitGo is also the industry leader in custodial wallets. With custodial wallets, BitGo holds all three keys, and keeps them in secure offline storage, isolated from the internet and beyond the reach of hackers, offering unparalleled security.

To move funds, the owner must initiate a transaction with the BitGo team and pass a series of additional security checks. This option provides users with unmatched security.

It’s a Cold World

Cold wallets are an ideal option for crypto investors holding larger amounts of digital assets and those who plan on holding for the long term. If you aren’t frequently making routine day to day transactions, cold wallets are an excellent option for keeping your holdings in secure, long term storage.

By keeping the private keys offline, cold wallets help keep digital assets safe and offer crypto holders peace of mind by significantly limiting the risk of a security breach and offering ample defense against online attacks like hacks, phishing attempts, and malware attacks. However, when using a cold wallet, users must also take steps to safeguard the physical cold wallet and its backup key in order to ensure that they don’t risk permanently losing access to their funds.

To learn more on how BitGo can help you to utilize cold storage wallets for the secure and long-term storage of your digital assets, connect with us.

For more information, please visit www.bitgo.com.

©2023 BitGo Inc. (collectively with its affiliates and subsidiaries, “BitGo”). All rights reserved. BitGo Trust Company, Inc., BitGo Inc., and BitGo Prime LLC are separately operated, wholly-owned subsidiaries of BitGo Holdings, Inc., a Delaware corporation headquartered in Palo Alto, CA. No legal, tax, investment, or other advice is provided by any BitGo entity. Please consult your legal/tax/investment professional for questions about your specific circumstances. Digital asset holdings involve a high degree of risk, and can fluctuate greatly on any given day. Accordingly, your digital asset holdings may be subject to large swings in value and may even become worthless. The information provided herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. BitGo is not directing this information to any person in any jurisdiction where the publication or availability of the information is prohibited, by reason of that person’s citizenship, residence or otherwise.