What Is a Cold Wallet?(part1)

The world of cryptocurrencies can feel like the wild west sometimes. Markets can react to the slightest good or bad news and new and innovative tech comes by every month. Transactions are instant, stakes are high and security threats are very real.
In all of this, one thing is constant: the responsibility of storing your digital assets safely, away from hackers. It may seem a daunting task, given the volatility and unpredictability of the crypto world. However, a solution exists exactly for this — a specific type of crypto wallet called a cold wallet.
Cold wallets provide the ultimate level of wallet security for your digital assets, keeping it safe from malicious actors (and sometimes even your own mistakes!).
In this article, Ledger Academy will unpack what is a cold wallet and how they differ from other types of crypto wallets.
Let’s dig in.

What Is a Cold Wallet?

A cold wallet is a crypto wallet that does not interact with any internet network and PC or grant any permissions to smart contracts. If this sounds confusing, make sure you check out our article on what a crypto wallet is first. But essentially, Cold wallets are a form of offline storage where you store your private keys on something physical. Physical devices can range from specialized hardware wallets, to even a piece of paper with your private key.
The key role of these cold wallets is to act as a “vault” for your cryptocurrencies — which means they do not interact with anything except themselves. 
When you need to make a transaction, you can transfer the necessary funds from your cold wallet to a “hot wallet”. Your hot wallet is responsible for processing your transactions and connecting to different Web3 applications on the internet.
If you realize you don’t need some funds, you can always transfer them back to the cold wallet for long-term storage. So, to sum up, cold wallets act as “long-term” savings accounts while hot wallets handle day-to-day funds.

What Is a Cold Wallet For?

Due to its isolated design, a cold wallet is the preferred option for protecting high-value crypto assets long-term. 
Storing your crypto assets in a cold wallet keeps you safe while you navigate the dynamic, high-stakes world of cryptocurrencies. Here are the two main ways that a cold wallet can protect your assets:

Keeping Your Private Key Offline

Both cold wallets and hardware wallets keep your private key — the element that helps you sign transactions — completely offline and away from internet-connected devices. 
Ledger adds another layer of security through our proprietary Secure Element Chip. Secure Element is the highest level of security on a chip, which you can find in passports and security cards to keep highly sensitive information safe. That’s why Ledger uses this industry-grade chip to generate and store your private key. Secure Element protects your crypto assets from various physical and software attacks by adding hacker-resistant countermeasures directly into the chip.

Protecting Your Assets From On-Chain Threats

Every crypto transaction requires you to allow a third-party application or contract to access your wallet. Just like smartphone applications require certain permissions to function correctly, smart contracts require similar access to carry out interactions.
Now, the issue here is that not all of these smart contracts have your best interests in mind. Some smart contracts could drain more funds from your wallet than you agreed to, or even share your information with untrustworthy parties. For instance, in 2022, $2.7 billion was lost to smart contract hacks. So, in short, you need to be very careful about what you approve.
Using a Ledger device protects you from most of these physical and software hacks — but it’s important to remember that self-custody is your responsibility. No matter how hack-resistant your hardware wallet is, it cannot protect you from social engineering and other related scams.
Segregating your assets is a proactive measure that you can take in these scenarios. To explain, this means holding different amounts of cryptocurrencies in separate wallets, with the most valuable ones in a cold wallet. The best way to segregate your crypto assets is by different risk levels of transactions or asset types. 
This type of segregation helps because each wallet permission and transaction approval are completely separate. So, even if you approve a bad transaction on an account that is connected to the internet, your main holdings are still intact.

Types of Cold Wallet

Not all cold wallets are created equal. Each type of cold wallet fulfills the primary purpose of keeping your private keys offline. However, there are key differences in security, user-friendliness, and accessibility. In this section, Ledger Academy will unpack the three different types of wallets — paper, sound, and hardware wallets.

Paper Wallets

Paper wallets are where you record your private key and corresponding address as QR codes and print them on a piece of paper. Users can then transact with the wallet by sending cryptocurrency to and from the paper wallet address. Paper wallets were one of the first hardware wallets to exist, and were popular around 2013 and 2014. 
While this method keeps your keys offline, paper wallets are susceptible to physical damage or loss. Plus there is no way to recover your keys like recovery phrases, backups etc.
Transferring cryptocurrency from a paper wallet can also be challenging. Essentially, you will need to import your paper wallet into a software wallet using your internet connection. This invalidates its whole purpose–and puts your assets at risk. Plus, if this paper falls into the wrong hands, it leaves your assets vulnerable. 
So, while paper wallets can be a basic cost-effective way to store your assets, they are not the ideal option in the current crypto wallets. Paper wallets just do not provide the level of security, convenience and user-friendliness that crypto enthusiasts need.

Sound Wallets

Sound wallets are a unique cold wallets where you store private keys or seed phrases on a CD, flash drive or vinyl via audio files. While sound wallets are innovative, they are prone to physical damage. This can be scratches on a CD, temperature fluctuations or just long-term degradation. Such damage could corrupt your audio files, making you lose access to your wallet if you don’t back it up.
Sound wallets can also be expensive to maintain. They require special software like a spectroscope application or device to decode the private keys if they need it later. This adds a layer of complexity, but usually, transacting to and from the wallet only requires the wallet address.