The key to knowing how Bitcoin wallets work is understanding that you are not actually storing the Bitcoin itself. This is because Bitcoin is not actually an object, but rather an encrypted address stored on the blockchain. What you actually own is a unique key that unlocks a specific Bitcoin location which is why protecting this key, known as your private key should be your top priority.
There are various ways to store your Bitcoin, with the most popular and secure being a cold storage device or hardware wallet. These wallets are external devices like USB sticks that you can connect to your computer and upload your private keys. One of the benefits of a hardware wallet is the complete anonymity in which you can send and receive transactions unlike an exchange where your funds are allocated to your personal account. There is no personal data linked to a hardware wallet. Another added benefit to using a hardware wallet is that because they are kept offline, they are resistant to hacks which is why choosing an exchange is the far riskier option. Most hardware wallets have a master seed which will allow you to recover your funds in the event of you physically losing your hardware wallet. This master seed should be written down and kept somewhere safe.
Paper wallets are another very secure method of storing your bitcoin. They can be set up for free and truly allow you to be in control of your own investment. The keys are printed on a piece of paper in the form of QR codes which you can scan for all your future transactions.
Paper wallets are formed using a program that will randomly generate a public and a private key for you. The hardest part about storing a paper wallet is making sure it’s in a secure place that no one can gain access too. Another factor you need to be aware of is making sure your printer ink is of top quality, ensuring it will not likely fade over time as unlike a hardware wallet, there is no backup seed.
Some good paper wallet generators can be found at
Bitaddress.org, walletgenerator.net and bitcoinpaperwallet.org
The term hot wallet refers to a wallet on an exchange which keeps a certain amount of funds online for liquidity. This is similar to how much money your bank holds at any given time. Unlike a cold storage device like a trezor or ledger, these wallets are connected to the internet 24/7.
Hot wallets are the least secure method of storing cryptocurrency but are the easiest. Many people keep their cryptocurrency on exchanges for the ease of use, allowing for quick tranfers, orders and withdrawals. Many traders opt for this method, as sending your cryptocurrency from a cold storage device to an exchange and then still having to sell can take hours.
There are ways to make your hot wallets more secure like using 2-FA. 2-FA or two factor authentication adds an additional layer of security to your account which makes attacks from external sources much harder.