Cold Wallets, Hot Wallets, Custody — What’s the difference?

Dear ICONFi users,

Deciding on how to store digital assets can be an overwhelming experience. Today, we will introduce three of the most common storage methods. These are cold wallets, hot wallets and custody solutions.

What is a crypto wallet?

The private key acts as the secure login details for a wallet. These keys are cryptographically generated. In simple terms, this means that they are created through advanced mathematical equations. For example, a BTC wallet’s private key is a number between 1 and 2256. That means that someone would have to guess the correct number between 1 and 115 quattuorvigintillion to access your wallet. In case it is your first time hearing that word, it is an astronomically large number. In other words, it is virtually impossible for someone to hack into a crypto wallet.

The public key acts as a URL for your wallet. People use this as an address for viewing transactions and depositing funds.

Let’s equate this to a Venmo account. Only you hold the login details (private key) to access your funds. You can share your handle (public key) for sending and receiving funds.

Types of wallets

The former two wallets are examples of non-custodial methods for managing digital assets. With these, you are 100% responsible for the security of your funds and private keys. The latter option involves delegation of your funds to an external party.

Let’s review each of these options in order of increasing trust delegation.

Cold Wallet

Cold wallets are the most secure of non-custodial wallets, because private keys are generated offline. Since the private key is not exposed to the internet, there is a lower chance for account hijacking and theft of funds.

Being non-custodial, the owner of a wallet is responsible for the management of its private key. The major risk with a cold wallet is user error, which could occur through loss of private key details or sharing of the private key.

Examples of cold wallets are hardware wallets, like Ledger and Trezor, or paper wallets, which involve paper.

Cold wallets can be considered to be the digital equivalent of savings in a bank. Users must connect to the internet and potentially expose their private key each time they wish to transact with their cold wallets. Because of this, cold wallets are generally used for assets that do not need rapid liquidity.

Hot Wallet

The main benefit of hot wallets is that they are easy to use. Because they are always online, users can transact without needing to reconnect to the internet. But because they are always connected, users generally hold smaller portions of their digital assets in hot wallets.

Like a cold wallet, hot wallets are non-custodial, so the owner is completely responsible for its security. But since hot wallets are connected to the internet, users carry the additional risk of online exposure to hacks, phishing and other fraudulent behaviour.

Hot wallets can be considered as the digital equivalent of a wallet you use for physical cash. Like a physical wallet, having funds available in a hot wallet is convenient for day-to-day transactions. It may be unwise to carry around your life savings in a wallet, in case of loss or theft.

Custodial Solutions

Private key management can be cumbersome and risky. One mistake, or a loss of one’s private key, could result in a complete loss of a user’s digital asset portfolio. This is like how people store their fiat currency with banks instead of holding sacks of cash at home. They delegate their trust to an external organization that they perceive as being more trustworthy than themselves for managing their funds.

Some digital asset custodians (e.g. exchanges) offer these services for free. This incentivizes account holders to use their funds towards other purposes within the platform. Other custodians target institutional investors who hold large digital asset portfolios. These vendors charge an annual fee for securing funds on behalf of their clients.

Earn interest with ICONFi

Users who are looking for liquidity, like a hot wallet, may opt for an ICONFi Flexible Earn account. Flexible Earn offers interest rates of up to 3.5% APR and allows users to withdraw funds at any time. For long-term HODLers, users can receive up to 12% APR on deposits with an ICONFi Fixed Earn account.

With ICONFi, users enjoy a traditional username and password login experience. Users can recover their accounts thanks to ICONFi’s rigorous security and KYC requirements. This is a benefit over non-custodial solutions, where losers are out of luck if they lose their private keys.

As an added source of confidence, ICONFi has announced plans to maintain a public reserve of ICX to act as insurance for user funds.

Summary

If you would like to enjoy the peace of mind and interest rates offered by ICONFi, download the ICONFi mobile application for iOS and Android today.

Questions?

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About ICONFi

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A new crypto staking and earn service for the ICON community.