Back to blogs
Written by
Cyfrin Team
Published on
April 30, 2024

What is a Crypto Hardware Wallet and How Does it Work?

Learn what hardware crypto wallets are, how they work, and the pros and cons of storing your assets safely.

Table of Contents

Hardware wallets can make a difference in keeping your cryptocurrencies secure; understanding what a hardware crypto wallet is, how they work, their benefits, and the best hardware wallets to use - will drastically reduce your chances of getting hacked.

In this guide on what is a hardware wallet you will learn:

  • What hardware wallets are
  • Hardware wallets vs. cold wallets vs. hot wallets
  • How hardware wallets work
  • Pros and cons of using a hardware wallet

Differences between cold and hot wallets

When we talk about wallets, we usually refer to two main types of crypto wallets:

  • Hot wallets
  • Cold wallets

Let’s see how the two are different.

Hot wallets: How do they work?

The most commonly known are software-based hot wallets like Rainbow, Rabby, and Metamask. They usually act as an extension to your browser or an application on your smartphone and act as your day-to-day wallet of choice, the first and most beginner-friendly choice for new crypto users.

Hot wallets are defined by how often they are connected to the internet. Browser extension wallets like Meamask and Rabby are considered “hot” wallets since they are connected to the internet most of the time. Due to their constant availability, they are usually considered more user-friendly but also less secure. Some hot wallets have an extra concern, too - who has “custody” of the assets in a hot wallet? If you have a wallet where you don’t have direct access to the private key or shared access, this is an example of a wallet where you don’t fully control access to your crypto. Thankfully, these kinds of wallets are becoming less and less popular.

Cold wallets: How do they work?

On the other hand, cold storage crypto wallets are a type of crypto wallet not connected to the internet. Since cold wallets aren't connected to the internet, they're less likely to be exposed to online threats like malware or phishing attacks and generate your keys offline. Additionally, their separation from smart contracts and their need for offline signatures prevent unwanted approvals that could cause losses. This makes cold wallets one of the best ways to store your cryptocurrencies.

Now that we understand the difference between hot vs. cold crypto wallets, let’s see where hardware wallets fit into this picture.

Cold storage hardware wallets for cryptocurrencies

First, we must note that the terms 'hardware wallet' and 'cold wallet' are not interchangeable, even though a hardware wallet can serve as a cold wallet. Technically, every new account created on your hardware wallet becomes a cold wallet. However, once the hardware wallet connects to a blockchain app, that specific account is no longer a cold wallet. Signing any approval with an account can compromise its security.

What is a crypto hardware wallet?

A hardware crypto wallet is a physical device with small hardware with a few essential functions, a couple of buttons, and maybe a small screen, much like a computer that securely stores a crypto user’s private cryptographic keys offline. These keys can be used later to complete a cryptocurrency transaction. Unlike traditional physical or fiat currency wallets, a crypto hardware wallet technically holds no coins. Instead, it safely stores the user’s keys to access their blockchain assets. Access to the private key enables hardware wallets to seem to be directly holding the coins, but we are getting a little too technical now.

Most hardware wallets, like Trezor and Ledger, can interact with multiple blockchains at once, enabling users to manage various types of coins from numerous exchanges on a single device. The data within a hardware wallet can be easily protected using a PIN code or other authentication methods.

In most cases, hardware wallets come with a companion app that acts as a secure client from which users can manage their assets, send transactions, and generally manage their assets. This is the safest way to trade digital assets, as users have custody of their tokens at any moment.

While setting up this type of account is most user-friendly on a hardware wallet, it’s also possible to use  or paper wallets as your cold wallet. That’s why these terms are not synonymous at all. However, hardware wallets are still the most popular and user-friendly way to set up and manage a cold wallet.

Let’s see how hardware wallets work, how they send transactions using the companion app we’ve just mentioned, and how they’re built.

How do hardware wallets work?

Inside view of a crypto hardware wallet

As we’ve said above, cryptocurrency hardware wallets generate private keys and provide users an offline, “cold”, physical space to store and protect these private keys.

To operate correctly, a hardware wallet must have a few different features, both digital and physical:

  • A Computer Chip:
  • An Operating System Designed For Private Keys
  • An Interface For Interacting With the Blockchain

A Computer Chip

The computer chip serves a critical role in a hardware wallet. This chip stores your private keys securely and isolates them from your computer or smartphone, which might be connected to the internet. The chip in these wallets is often a secure element–the same type used in passports and credit cards. Its purpose is to generate and store cryptographic keys securely, and it provides strong security features to protect the stored information. It is designed to resist physical attempts to retrieve the data, making your keys safe even if the wallet falls into the wrong hands.

Not all hardware wallets use a secure element, and the level of security can vary from one wallet to another.

Operating System Designed For Private Keys

The operating system in a hardware wallet is engineered for handling private keys. It generates and manages these keys in a secure environment and facilitates the signing process during transactions. It ensures the private keys never leave the device, adding an extra layer of protection against online threats. This makes hardware wallets a highly secure method for storing and using cryptocurrencies.

An Interface For Interacting With the Blockchain

When a user wants to interact with their cryptocurrency, i.e., spending, transferring, or swapping assets with another user’s wallet or smart contract, the transaction must be cryptographically “signed” using a unique private key. As we said above, hardware wallets usually use a companion app, software that enables the hardware wallet to connect directly to the blockchain while staying offline.

Let’s see in better detail how hardware wallets process blockchain transactions.

How hardware wallets Process blockchain transactions

Hardware wallets process blockchain transactions similarly to most wallets that use public and private keys. Typically, they first connect to a companion app. The companion app then transfers unsigned transaction data to the hardware wallet that will present you with the intent (essentially the full details of a transaction in an unsigned state), prompt you to sign, and transmit that transaction to the blockchain.

Let’s illustrate how hardware wallets process blockchain transactions step-by-step:

  1. Connect your hardware wallet to its interface on your phone or laptop using a cable or Bluetooth.
  2. Initialize a transaction using the hardware wallet's interface.
  3. The hardware wallet will present the transaction details, also known as the "intent,” with options to sign or reject the conditions.
  4. Approve the transaction by clicking "sign" on the wallet's interface on your smartphone or laptop.
  5. The hardware wallet will then prompt you to confirm the transaction on the device itself. This step is known as two-factor authentication (2FA) and ensures that nobody can remotely transact with your crypto private keys.
  6. The hardware wallet uses the private key stored in its computer chip to sign the transaction in a completely offline environment.
  7. The signed transaction is then sent from the hardware wallet to your smartphone or laptop via the cable or Bluetooth connection.
  8. Finally, the smartphone or laptop sends the already signed transaction to the blockchain for processing without ever accessing your private keys.

In short, the hardware wallet uses the private key to open the lock to a user’s private address on the blockchain.

The most important part about this process is that at no point do the user’s private keys leave the hardware wallet. They are, therefore, secure from malicious online actors.

Hardware wallets pros and cons

Now that we know what hardware wallets are and how they work, let’s look at their benefits and disadvantages:

Benefits of using a Hardware crypto Wallet

  • Control — Hardware wallets are fully non-custodial or “self-custodial”, allowing you to manage your private keys and granting you full ownership and control of your funds.
  • Maximum security — The private keys are stored offline and immune to malicious software, except when the device is compromised. This makes them more secure than a software wallet, as transactions can be signed without the private keys ever leaving the device.
  • Handling Multiple Accounts and Chains - Hardware wallets can create keys for numerous blockchain addresses, allowing diverse account and asset management from one device. A secret recovery phrase is a master key for all device-managed keys, ensuring security and easy account recovery across networks.
  • Offline Transaction Signing - Hardware wallets' crucial role is to sign transactions offline, securing your private keys from potential hackers. This is vital as anyone with your keys can control your entire crypto address. Signing transactions offline keeps your keys safe, even while you manage and sign transactions as needed.

Cons of using Cold storage Hardware Wallet

While the security benefits of a hardware wallet are evident, it's important to be aware of some drawbacks:

  • Upfront Cost — Hardware wallets come with a significant cost.
  • User Experience — The setup process may be challenging for beginners.
  • Accessibility — Hardware wallets are not as convenient for daily transactions as they require you to connect them to a device before accessing your cryptocurrency. They are best suited for those planning to hold their assets long-term rather than for trading.

Now that we know what hardware wallets are, how they work, and their benefits, let's understand how to choose the right hardware wallet

How to choose the best crypto hardware wallet

Image of Trezor a web3 cold storage crypto hardware wallet

There are 7 key things you should look at when choosing the best hardware wallet to store your cryptocurrencies:

  • Security features — Does it offer two-factor authentication and multi-signature? Does it have a backup feature, such as a recovery seed phrase?
  • Interface and ease of use — Some wallets are better suited for beginners, others for more advanced users. Do your research first to avoid disappointment.
  • Open-sourced or Secure Code - It's vital to choose a hardware wallet with open-source software for transparency, or if not open-sourced, the code should be securely developed and audited to ensure it can safely protect your private keys.
  • Supported currencies — Ask yourself if the wallet supports the coins and tokens you want to store.
  • Platform compatibility — Can you connect the wallet to the regularly used exchanges? Does it offer decentralized app (dapp) and decentralized exchange (DEX) integration?
  • Reputation — The reputation and longevity of the wallet maker are essential. Review customer feedback to gain a clearer understanding of what to expect.
  • Reproducible code - Besides open-sourced code, there should be an easy way for the codebase the company says the hardware wallet has to match the code in the wallet. It should be easy for security experts to find all the areas where a wallet could potentially expose the private key. We did a fantastic interview with wallet expert Wallet Scrutiny, who investigated how he assesses how different wallets stay transparent.

Conclusions: what is a hardware wallet

In conclusion, a hardware crypto wallet is a secure physical device for managing cryptocurrencies by keeping your private keys offline, reducing hacking risks.

Despite some drawbacks like cost and potential setup difficulties, the enhanced security and control over your assets generally outweigh these.

It's essential to research before choosing a hardware wallet, considering its security features, ease of use, supported currencies, and reputation. In the cryptocurrency world, where security is paramount, a hardware crypto wallet is a valuable tool for protecting digital assets.

Secure your protocol today

Join some of the biggest protocols and companies in creating a better internet. Our security researchers will help you throughout the whole process.
Stay on the bleeding edge of security
Carefully crafted, short smart contract security tips and news freshly delivered every week.