Introduction
A wallet has transcended its physical aspects as technology gained prominence and widespread adoption in recent times. A wallet used to be something made of leather or canvas that people use to carry money notes and coins around to purchase goods and services. And as time past, money notes and coins seemed to have given way to cards — both credit and debit cards which serve as a medium for merchants to initiate a payment transaction through the network provided.
And in the recent times when mobile phones have become better and more powerful, wallets have taken the digital form in which it exists as applications in phones. A sub-category of digital wallet is crypto wallet. The uniqueness of a crypto wallet is its ability to interact with the blockchain and store information about the private keys that it holds. Crypto wallets have also taken the digital forms in desktop, mobile phones, and even in physical devices.
To further understand crypto wallets, we shall first explore the different categories of crypto wallets which include: custodial, non-custodial, hot, cold, warm, smart contract, MPC, and multi-signature. For simplicity's sake, we are going to focus on the categories of hot, cold, and warm wallets for institutional users.
Hot wallet
Hot wallets are generally referred to crypto wallets that are connected to the internet. Given that hot wallet is often connected to the internet, it provides users greater convenience when doing transactions. On the flip side, such convenience opens up the possibility of your wallet being compromised.
Hot wallets are often the choice of many users because of their ease of use and and ease of set up. Retail investors use hot wallets as a gateway to the world of crypto. Take Metamask for an example, the ease of set up, especially in both browsers and mobile phones, has allowed users to send tokens, receive tokens, and start a transaction on the Ethereum blockchain within 10 minutes. Another use case for using hot wallets would be using the hot wallet as an authorisation tool to sign in to crypto applications. Developers can use such hot wallets to quickly validate their solutions and ensure their products work as intended.
As mentioned earlier, such convenience makes it easy for fraudsters or hackers to gain access to your assets that are stored in these hot wallets. A recent report on Cointelegraph mentioned that there is an ongoing effort by scammers who are sending emails to phish users of their Metamask’s seed phrases. It is undeniable that Metamask, being one of the most popular crypto wallets in the world, is vulnerable to scams and hacks like this. One advice to mitigate a risk like this is to reduce the amount of assets stored in hot wallets. Another method is to keep the bare minimum required for transactions in hot wallets.
Examples of hot wallets — Metamask, imToken, Minerva, Guards, Phantom
Cold wallet
Cold wallets on the other hand, are crypto wallets that are usually offline and not connected to the internet. On the convenience and security tradeoff, cold wallets win on the side of security. Being disconnected from the internet, cold wallets do not have the inherent risks of getting hacked or being exposed to social engineering scams. And because of this, cold wallets lose on the side of being convenient. It would require some effort from the users to complete a transaction using the cold wallet.
Cold wallets are used extensively by many users from retail investors to institutional investors. Many of them use such products because they do not want their assets to be exposed to scams or hacks. This is not to say that cold wallets are totally safe and immune to scams or hacks — such tactics used by scammers and hackers may come in different forms because you are using a cold wallet. Risks like losing your hardware wallet or having the paper that contained your private key can get destroyed which will still result in you losing your assets. Nonetheless, many still adopt a strategy of putting most of their funds in the cold wallets and keep their operational funds in their hot wallets. Users would only initiate a transaction whenever the funds in the hot wallets are low.
Examples of cold wallets — Ledger, Trezor, keepkey, walletgenerator.net, bitcoinpaperwallet.com
Warm wallet
Warm wallets are an interesting mix because they have the properties of a hot wallet and a cold wallet. Warm wallets generally offer the level of convenience of being connected to the internet. This allows users to initiate a transaction easily on the blockchain of their choice. Also, warm wallets take on additional security measures to ensure that the wallets are not as exposed to potential frauds or hacks as compared to hot wallets. Some safeguards that warm wallets have as compared to hot wallets are use of technology like multi-signature, multi-party computation (MPC), or even use smart contracts to approve transactions before they are broadcasted to the blockchain.
Many retail users are opting for warm wallets in light of the events that have happened in the crypto space recently and especially so after the collapse of multiple companies like FTX, Three Arrows Capital, Blockfi, Voyager Digital, and Celsius Network. Undoubtedly, retail investors have also opted to use hardware wallets like Trezor, after the recent FTX collapse, which was reported to have its sales revenue increased by 300% week-on-week. Institutional investors have also adopted warm wallets that offer convenience but with more security features. A common strategy that institutional investors use are that they would keep the assets that are required for their operations in the warm wallet, and a majority of their assets will remain in their cold wallets.
Warm wallets have been such a great addition to the crypto space that it has allowed a greater majority of people to participate in the crypto movement. However, the learning curve involved in using warm wallets can be quite steep as well. Take MPC in Fireblocks as an example, users would have to first create a MPC wallet and then decide which devices will hold the part of the private key. During the transaction approval process, users would have to use the different devices with the key shares to approve the transaction in the allocated time frame. Inability to do so would result in a failed transaction and hence no assets will be transferred.
Examples of warm wallets include — Fireblocks, ZenGo, Argent, Qredo
Summary
For retail investors, adopting a strategy that many institutions use is a good practice. As more institutions grow in size and in tandem their assets, institutions are forced to adopt a more robust strategy in order to cater to the needs and functions of their business. A good mixture of all the different wallets seems like a sound strategy for institutions of different size. Take a startup as an example. Let’s assume that this startup has less than 10 staff, including the founders, and they just managed to raise 5 million dollars. One way they could manage their asset is by depositing 60% of their funds into a company-owned cold wallet, 30% of it into a founders controlled warm wallet, and the remaining 10% into multiple different hot wallets that are required for their business to operate.
CoinsDo has been developing wallets for institutions since 2017. And the heart of our design philosophy is being security-centred. Our products are first and foremost non-custodial — our customers who use our wallets own all the assets in the wallets. Secondly, our wallets provide users with the flexibility to initiate transactions, approve transactions, and lastly execute those transactions. Lastly, our wallets provide users visibility. All transactions that happened on-chain will be captured and displayed in our system in the form of dashboards in your browsers. Also, all actions that are related to giving permissions and changing the settings of the wallets are captured in our system as well. We have taken this three-pronged approach to ensure that all transactions broadcasted to the network are done by personnel with permissions. These design practices ensure that the data is tamper-proof so that users can have the peace of mind to use our tools for their business.
If you would like to open a demo account with us and try out our system, please contact us here. For more information on our tools — dispatching wallet, collection wallet, signature tool, liveness detection tool, and Coinsdo wallet.
Additional Information
Nichanan Kesonpat has written an article on medium titled: “Seedless Self-Custody: On MPC and Smart Contract Wallets” which is an elaborate piece on the different types of wallets. This graphic on the wallets in different categories is referenced from her article here.
