Hot Wallet Definition: What It Is And How It Works

Written by Sean GraytokUpdated: 3rd Jan 2022
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A crypto wallet is either “hot” or “cold” depending on its connection to the internet.

Understanding the differences between these wallets will help you decide which is best for you, and when one kind of crypto wallet might be better than the other.

Most crypto holders will have multiple wallets, including both a hot and cold wallet. This article explains what a hot wallet is, how it works, and more. Let’s dive in.

What is a Hot Wallet?

A hot wallet is connected to the internet, making it more user friendly but less secure than its cold wallet counterpart. Hot wallets allow users to easily send and receive tokens because it is connected to the internet.

Hot wallets are typically used for daily transactions because their funds are easily accessible. For example, you will probably keep your assets in hot wallets if you are day trading cryptocurrency.

However, this convenience comes with a security tradeoff. Because the wallet exists in the digital space, so do its public and private keys – which serve as the foundation for asymmetric encryption.

In theory, nefarious hackers could access these keys and steal your crypto.

How a Hot Wallet Works

Crypto wallets do not “store” the currency like the function of regular wallets. Instead, they act as a tool that interacts with the blockchain. Your hot wallet provides it with the necessary information to facilitate secure transactions.

These wallets use public and private keys to interact with a blockchain network and ensure the digital assets are being sent or stored in the right place.

The public key ensures a person is the owner of the wallet address. The person’s private key allows them to access the actual crypto.

A crypto wallet provides an address for the currency to be sent to, which is technically just a location on the blockchain.

This address tells the cryptocurrency that is purchased on an exchange where to go.

Learn More: Best Cryptocurrency Exchanges

Types of Hot Wallets

All hot wallets are connected to the internet in some way, but their medium of connectivity varies. Let’s examine the technology behind desktop, mobile, and hybrid hot wallets.

Desktop Wallets

Desktop wallets are downloaded on a desktop computer and give the user complete control over the wallet.

A desktop wallet will provide you with an address that can receive crypto from another person or from an exchange.

These wallets have simple user-interfaces, making it easy to send crypto or view your transaction history and wallet details.

While you control your private keys, your crypto is still vulnerable to attacks because it exists on your computer, which can be accessed by hackers.

The best desktop wallet providers are Electrum and Exodus.

Mobile Wallets

Mobile wallets are the most popular because they are convenient. These free applications store all your wallet details locally on your phone’s memory rather than online.

They function the same as desktop wallets, but they are on your phone instead of your computer.

The best mobile wallets integrate QR-Code technology to make transactions easier. Simply scan the receiver’s wallet address and send payments without having to manually enter the address.

It is important to note that as blockchain technology continues to develop, so will mobile wallets.

The top mobile wallets are Mycelium, BRD, and Edge.

Hybrid Wallets

Hybrid wallets were created after several web-based or “online wallets” were hacked. These are superior to web-wallets because the user owns the private keys inside their wallet.

Hybride wallets use Javascript in the user’s browser to manage private keys and create payments.

The private key, which is required to send money, is encrypted in your browser before it reaches the provider’s servers. This ensures that the provider, or any hackers, cannot spend your bitcoin.

Hybrid wallets can be accessed on tablets, mobiles, and the desktop. The best hybrid wallets are KeyWallet and Strongcoin.

Related: How to Buy Bitcoin

Pros of Hot Wallets

We’ve discussed some of the advantages of hot wallets, but let’s make sure we didn’t miss any.

  • More convenient for trading and daily transaction
  • User-friendly
  • Easy access to funds via the internet or cell phone
  • Most hot wallets are free
  • Easy to set-up
  • Accept all kinds of cryptocurrencies

Cons of Hot Wallets

  • Less secure because they’re connected to the internet
  • Susceptible to possible regulation
  • Vulnerable to technical difficulties

Custodial vs Non-Custodial Hot Wallets

Not your keys, not your crypto. You do not have full ownership over your crypto if you purchase it and store it on third-party exchanges like Geminior Coinbase.

These exchanges use “custodial” wallets and maintain the crypto’s private keys that “belongs” to you.

Crypto purists advocate for non-custodial wallets because they allow users to hold and own their private keys.

This gives them full ownership over their funds compared to relying on a third-party platform to manage their assets.

Non-custodial wallets use a 12-24 word “seed phrase” composed of random words to access an account.

If you were to lose access to your wallet, the seed phrase serves as a backup password recovery method to regain control of your funds on-chain.

Some crypto owners do not want the responsibility that comes with full ownership of their funds. They choose to sacrifice some level of security and keep the funds on third-party platforms.

Hot Wallet FAQs

Is Coinbase a hot wallet?

Any wallet connected to the internet is a hot wallet, so yes Coinbase is a hot wallet.

Related: Coinbase Review

What is the best crypto cold wallet?

The Ledger Nano X ($119) and Trezor Model T ($170) are considered the best cold wallet storage devices. Additionally, the Ledger Nano S ($59) is regularly touted as the best bang-for-your-buck option.

Are Hot Wallets Safe?

Hot wallets have become increasingly safe over recent years with added encryption. However, they are less secure than their cold storage counterparts. Again, cold wallets are not connected to the internet and are not susceptible to hackers.

Related: Is Cryptocurrency Safe?

Bottom Line: Cryptocurrency Hot Wallet

The function of hot and cold wallets is the same as leather wallets and bank vaults. Should a person walk around town with all the money they own in their leather wallet? Absolutely not.

They should keep enough in their wallet for daily transactions and the rest safely secured in a bank vault.

It is the same with the crypto. Keep most of your digital assets in cold storage and only the amount you are willing to lose in hot wallets.

More Crypto Resources:

Sean Graytok
Sean Graytok

Sean Graytok is our Co-Founder and leading expert in investing and financial management. His work has been cited in leading industry publications, such as InvestorPlace and Business Insider. Sean is interested in the people and technologies that are improving the world.