What Is A Hot Wallet, It’s Key Features, Types & How it Work

A hot wallet is a particular kind of cryptocurrency wallet that keeps up constant internet access and real-time communication with the bitcoin network. It is characterized by this continuous internet connectivity. Other names for hot wallets include software wallets and online wallets.

What is a Hot Wallet and How They Work

Definition and Purpose

• Hot wallets are made to be constantly linked to the internet or another networked device. This enables users to simply manage assets, carry out quick transactions, and instantaneously check token balances.
• Your cryptocurrency keys can be used and stored through them.
• They are mostly used for frequent transactions and everyday interactions with the cryptocurrency network. Generally speaking, it’s best to maintain a small percentage of cryptocurrency assets in them and only utilise them for transactions.

Key Components: Private and Public Keys

• To access and manage cryptocurrency addresses, hot wallets use private keys.
• Users sign transactions using their private key while sending or receiving cryptocurrency.
• The passwords or personal identification numbers (PINs) required to finish a cryptocurrency transaction and confirm token ownership are comparable to private keys.
• Public keys are the address of the wallet to which and from which transactions are sent, much like a bank account number. While only the user or owner knows the private key, the public address is exposed to everyone.

Key Features of Hot Wallets

Accessibility: Hot wallets simplify cryptocurrency access. Internet-connected PCs, tablets, and phones can access them.

Convenience: They are widely utilized and enable fast, efficient transactions because to their user-friendly interface.

Real-Time Updates: Users may keep an eye on their balances and follow transactions in real time.

Speed: Without the need for human involvement, a machine can start a blockchain transaction quickly.

Price: Since many hot wallets are software or apps that can be made in a matter of minutes, they are available for free download.

Types of Hot Wallets

A hot wallet can be identified by its general rule: if it is connected to the internet or another device, it is a hot wallet. Typical varieties consist of:

Software Wallets: Installed on gadgets like cellphones and PCs after being downloaded. One example is Exodus Wallet.

Web Wallets: Accessible via a web browser, which is frequently offered by bitcoin exchanges. Blockchain.com (noncustodial) and Coinbase (custodial) are two examples.

Exchange Wallets: Provided by well-known cryptocurrency exchanges such as Coinbase, which serve as custodial hot wallets, storing and managing users’ bitcoin keys.

Desktop Wallets: Software that runs on a computer (Windows, Mac, or Linux) and acts as a hot wallet when it’s online. Electrum for Bitcoin and MetaMask for Ethereum are two examples.

Mobile Wallets: Applications for cellphones that provide payment convenience and portability. Edge, Mycelium, Exodus, and Trust Wallet are a few examples. Their private and public keys are stored locally, yet they are online because they rely on backend services through APIs.

Hardware Wallets (with a caveat): Some hardware wallets are not “air-gapped” (separated from networks), even though they are usually referred to as cold wallets. If an attacker gets physical access, the gadget may be as vulnerable as hot wallets. It’s important to avoid buying a hardware wallet thinking it’s cold.

The Evolving Threat and Vulnerabilities of Hot Wallets

Hot wallets are always online, making them more vulnerable to cyberattacks than cold wallets. In 2024, hackers directly accessing hot wallets have lost exchanges billions of dollars using increasingly advanced methods.

Typical hot wallet attack methods that result in significant losses include:

• Hardware based Hot Wallet Attacks: They make the assumption that the hot wallet is a hardware wallet that isn’t air-gapped, giving an attacker complete physical access to parts like the disc and RAM to retrieve private keys or seed phrases all of which are frequently obtained through phishing.
• USB Debugging Hot Wallet Attacks: By searching memory for private keys, login credentials, or passwords, an attacker can do an artefact analysis if a device contains confidential data.
• Software level Hot Wallet Attacks:
  • Exploiting Vulnerable Libraries: Attackers take advantage of vulnerabilities in software libraries that the crypto wallet uses to obtain unauthorized access and change features, which may result in theft.
  • Impersonation Techniques: To gain control of digital assets, attackers pose as the server or the user, particularly when using Remote Procedure Calls.

Case Study: The WazirX Hack (July 2024)

This incident brings to light serious weaknesses:

• Due to a security compromise, more than $234 million worth of bitcoin assets were taken from the multi-signature hot wallet of WazirX, a well-known cryptocurrency exchange in India.
• Attackers employed chain hopping, which involves fragmenting transactions across blockchains to obfuscate tracks, payload manipulation, which involves changing transaction data, and zero balance transactions, which makes tracing more difficult.
• Merkle Science’s ‘Tracker’ blockchain forensics technology was utilized to visualize and track the movement of pilfered money.
• There were concerns of possible money laundering because the stolen assets included MATIC, SHIBA, and ETH, and because significant deposits were made to an algorithmic trading platform that is known to receive money from past cryptocurrency hacks.
• The hack demonstrated how difficult it is to trace stolen assets, even with multi-signature arrangements, and how intricate attacks may be.

Strategies to Mitigate Hot Wallet Attacks

Strict security protocols must be put in place for both platforms and individual users.

For Cryptocurrency Exchanges:

• Cold Wallet Storage: Keep a sizable amount of your money (usually more than 95%) offline in cold wallets and move just a small fraction (less than 5%) to hot storage for immediate withdrawals.
• Regular Security Audits: Employ independent auditors and carry out assessments on a regular basis.
• API Key Management: Implement rate limiter and restrict the use of API keys.
• Intrusion Detection Systems (IDS): Install IDS software to keep an eye on network traffic for unusual activity.
• Encryption: Encrypt private keys and other sensitive information.
• Emergency Response Plans: Create thorough strategies for breaches that address incident response and communication.
• Employee Training: Give staff members security training.
• Continuous Monitoring: Make use of blockchain analytics tools such as Compass and Tracker to identify any dangers.
• Collaboration with Security Experts: Collaborate with cybersecurity professionals to remain informed.

For Individual Users:

• Use Hot Wallet Only for Transactions: For instant use, only a small percentage of your cryptocurrency holdings should be kept in your hot wallet.
• Store Most Assets in Cold Wallets: When necessary, transfer your necessities to the heated wallet.
• Consider Exchange Custodial Services: Some exchanges allow clients to store their keys in cold storage, but doing so entails entrusting the exchange with your keys and exposes you to their security procedures and possible security breaches. Customer losses are covered by insurance for certain exchanges.
• Exchange Cryptocurrencies to Fiat: Despite potential fees, reduce risk by converting large cryptocurrency balances to fiat money and putting them in a bank account if not holding as an investment.
• Backups, Updates, and Passwords: Secure your password, encrypt your wallet, backup it, and update your software.

Hot Wallet vs Cold Wallet

The fundamental difference is connectivity: While a hot wallet is online, a cold wallet is offline.

Security: The offline nature of cold wallets’ private keys makes them more resistant to attack via an internet connection.

Convenience: Faster and more convenient transactions are provided by hot wallets.

Storage Capacity: Generally speaking, cold wallets may hold more data, whereas hot wallets are best suited for lesser quantities required for regular trade.

Price: Unlike cold wallets, which frequently need hardware purchases, many hot wallets are free.

Best Practice: Having both a hot wallet and a cold wallet is typical for bitcoin users. Short-term cryptocurrency should be kept in hot wallets and long-term storage in cold wallets.

Here is a clear comparison table of Hot Wallets vs. Cold Wallets: