What’s a Hot Wallet?

Key Takeaways

Crypto and Web3 offer millions of novel opportunities that users can interact with. To become a part of this thriving ecosystem, you need  to access it with a crypto wallet. Hot wallets are often the most popular choice and for good reason. But what is a hot wallet? 

The jargon surrounding cryptocurrency can make it tricky to understand the different tools available. Let’s take a closer look at what a crypto hot wallet is, how it works, and the hot wallet hacks and risks you should be aware of.

What Is a Hot Wallet?

A hot wallet is a type of cryptocurrency wallet that stores your private keys online. It makes your crypto accessible through your phone or computer. Hot wallets provide an interface for interacting with the blockchain, visualising and managing your assets, signing transactions and using Web3 applications. They are also free and easy to install, making them more common pick than their counterparts, cold wallets. 

Technically speaking, hot wallets can be of two types – custodial or non-custodial. A custodial wallet gives a third party control of your private keys, and you’ll never have direct access to your blockchain addresses. Conversely, a non-custodial wallet provides you with a seed phrase when you set it up, meaning you’ll always have direct ownership and control of your private keys. In this article, we’ll focus mainly on non-custodial hot wallets.

How Does a Hot Wallet Work?

Hot wallets function by storing your private keys on an internet-connected device. When you perform a transaction, the wallet uses your private key to sign it, ensuring it’s authorized and can be added to the blockchain. 

Existing online makes hot wallets convenient for frequent transactions and Web3 interactions – simply log in and start transacting. However, they also introduce security risks, as online keys are exposed to potential cyber threats.

Different Types of Hot Wallets

Different types of hot wallets all store private keys online, but they do so in different ways. The types of hot wallets include:

• Desktop Wallet: A program installed on a computer.
• Mobile Wallet: An app on a smartphone.
• Browser Wallet: An extension usable through a web browser.
• Exchange Wallet: Custodial wallet provided by a crypto exchange.

Desktop Wallet

A desktop wallet is a type of software installed on a computer, storing private keys locally on the hard drive. Once your wallet is set up, you’ll access the application via login details. 

With a desktop wallet, you’ll have control over your private keys, and you’ll have direct access to your blockchain addresses. You won’t rely on a middleman for access to your assets, and if your wallet interface stops working, you can recover your crypto on another wallet.

However, there are also some drawbacks. You’ll be responsible for managing your all-important recovery seed phrase. There are also risks associated with keys being online, including malware and hacks deployed over your internet connection, designed to get access to your crypto.

Some of the most famous desktop wallets are Electrum, Exodus and Atomic Wallet. 

Mobile Wallet

A mobile wallet is an application on a smartphone that keeps your private keys within its software. Mobile wallets are usually non-custodial: they provide you with a seed phrase as you set up, and you’ll have sole custody of your assets at all times. Accessing your crypto is also easy, as you’ll use a simple login each time you want to use the wallet.

Again, your private keys will be within reach of cyber attacks, such as hacks of the wallet software or spyware deployed to your device.

Some examples include Trust Wallet and MetaMask. Mobile wallets are non-custodial, giving users control over their private keys.

Browser Wallet

A browser wallet is a web browser extension, like MetaMask, Phantom and others, that allows users to interact directly with Web3 applications. 

These wallets store private keys in the browser’s storage, offering ease of use for decentralized applications and smart contracts. You’ll control your keys but, since those keys are stored online, you’ll face risks like a hack of the wallet software, or a malware deployed to your own device.

Exchange Wallet

An exchange wallet is a custodial wallet provided by a cryptocurrency exchange, such as Binance, Coinbase, Kraken, Bybit and others. Unlike the previous examples, an exchange wallet does not give you direct access to your keys. The exchange controls them and you access your assets via login credentials provided by the platform.

This simplifies the user experience, since you can easily reset your password if you lose your credentials, and never need to deal with a recovery phrase. However, making the exchange a middleman between you and your crypto comes with risk.

For example, the exchange can become the target of a hack, losing your assets. Crypto is still in a grey area in many countries so government censorship or a complete shutdown of the exchange is also possible. Last but not least, there’s always the risk of mismanagement in the exchange, like the famous FTX case.

How To Create a Hot Wallet

Creating a hot wallet is a quick process that doesn’t require any technical knowledge. You’ll just need a pen and paper (preferably) and a few minutes. To create a hot wallet, follow these steps:

1. Choose a suitable hot wallet by looking at what blockchains it’s compatible with. This is important because some wallets are restricted to a single blockchain. Ideally, you’d want one that supports a wider range.
2. Install the software on your device or browser.
3. Set up a new wallet or import an existing one using a seed phrase. If this is your first crypto wallet, select “new wallet” and be prepared to write down your seed phrase.
4. Secure your wallet with a strong password and, if available, enable two-factor authentication
5. Back up your seed phrase in a secure location, offline.

Once you’ve written down your seed phrase, you’re good to go and use your newly created hot wallet. Just make sure you never share the seed phrase with anyone.

Risks Associated With Hot Wallets

Hot wallet risks stem from the fact that private keys are stored online. There’s no way around this as it comes from the very way the wallets work. The main risks involved include:

• Malware and spyware: Malicious software that can steal your login details.

• Hacks and exploits: Vulnerabilities in wallet software can expose your private keys.

• Man-in-the-middle attacks: Hackers can intercept and alter communication between the wallet and the blockchain.

• Malicious smart contracts: Signing bad contracts can drain your wallet.

Malware and Spyware

Malware and spyware can be used to monitor your device and extract your login details, giving attackers access to your wallet. Keeping your device secure with antivirus software and avoiding suspicious downloads can mitigate this risk. Some of the famous malware we’ve seen include Trojans such as Trickbot and Emotet and hidden miners like CoinMiner.

Hacks and Wallet Exploits

Wallet software that keeps your keys online can be targeted by hacks designed to extract your keys. For example, the Trust Wallet hack exposed users’ private keys. To minimize the chances of falling prey to such attacks, make sure that you’ve downloaded a legitimate crypto wallet, and regularly update that software.

Man-in-the-Middle Attacks

In a man-in-the-middle attack, a hacker can access your network and change the display of your phone or computer screen, causing you to send crypto to the wrong address. Using a VPN and securing your network can help prevent these attacks.

Malicious Smart Contracts

The most common threat of all is signing a malicious smart contract or wallet approval. This action can drain your wallet and it’s not even specific to hot wallets but all crypto wallets. Always read carefully and check the type of transaction you’re about to sign through your wallet.

How To Stay Safe With a Hot Wallet

The main risks associated with hot wallets come from their very nature. To use a hot wallet, you need to be connected to the internet and that always holds some potential threats. You can mitigate some of the danger by safely managing your wallet and following some general rules. Here are some tips for staying safe with your crypto hot wallet:

• Stay on top of hot wallet software updates: Programs can be exploited and developers are in a constant race against malicious parties. If there’s one program that deserves constant updates, it’s your crypto wallet. Regular updates fix potential vulnerabilities and you don’t want to become a victim.

• Segregate your assets: Spread your crypto across multiple wallets. As the old saying goes, it’s not wise to hold all your eggs in one basket. So why hold all your crypto assets in a single wallet? By segregating your crypto into different wallets, you can decrease the chances of losing assets to various threats. 

• Use a VPN: Secure your network against man-in-the-middle attacks and malware. VPNs are often neglected but they can make all the difference as a life of defense against man-in-the-middle attacks. By using a VPN, nobody can intercept your internet traffic.

• Store your seed phrase securely: Never share it and keep it offline. Just remember one thing, nobody would ever ask you about your seed phrase. It doesn’t matter if they’re an employee from a big exchange, a potential employer or a friend.

• Be Web3 literate: Learn to understand smart contract jargon. If you’re going to spend time in the cryptosphere, it’s definitely worth learning some of the terms.

• Stay in control of your wallet approvals: Even if you click on a malicious link, it’s not too late. Use tools like Revoke.cash to manage approvals from any websites you deem suspicious.

Closing Thoughts

Understanding and using a hot wallet is crucial for anyone involved in cryptocurrency and Web3. While hot wallets offer convenience and accessibility, they also come with certain risks that must be managed diligently. By choosing the right type of hot wallet, following security best practices, and staying informed, you can safely navigate the world of digital assets and avoid falling prey to any malicious parties.

Frequently asked questions

What’s a Desktop Wallet?

A desktop wallet is a software installed on a computer, storing private keys locally. Users have full control over their keys and need to secure their devices against threats.

What’s Binance Hot Wallet?

The Binance hot wallet is a custodial wallet provided by the Binance centralized exchange, holding users’ private keys and allowing easy trading and asset management within the platform.

Is MetaMask a Hot Wallet?

Yes, MetaMask is a hot wallet in the form of a browser extension. It allows users to store private keys and interact with decentralized applications and smart contracts.

What’s a Risk Associated with Hot Wallets?

A major risk associated with hot wallets is exposure to online threats, such as malware, spyware, hacking attempts, and man-in-the-middle attacks. All of these can lead to the theft of private keys and the loss of funds.