Have you bought some cryptocurrency and now wonder where to store it? It’s an important question to think about since hackers and thieves are always on the prowl for virtual coins.
Any holder should turn to a crypto wallet to keep coins safe. Wallets come in a range of options, from physical ‘hardware’ wallets to mobile applications that can be opened with just a click. Crypto wallets are categorized into custodial and non-custodial options, and it’s also important to understand the distinction between both when it comes to choosing the right wallet for your needs.
Discussions about custodial vs. non-custodial wallet options are often not as emphasized as much as other topics within the virtual currency world, like about how cryptocurrencies work, and the potential of blockchain technology.
But as many more understand the immense value in picking the right wallet to keep their assets safe, discussions about how custodial vs. non-custodial wallet options stack up become more important.
What are the differences between custodial and non-custodial wallet options? Keep reading to learn more about both types and how to choose the right wallet.
All About Custodial Wallets
With a custodial wallet, an outside party like a centralized business controls your private keys, which are the passwords that give you access to funds.
Many crypto exchanges operate custodial wallets, which can be very convenient for crypto users who want the least hassle. While a custodial wallet lessens personal responsibility, it does require a degree of trust in the custodian since they maintain control over private keys.
All About Non-Custodial Wallets
Non-custodial wallets offer the opposite experience. These tools give users complete control over their private keys, which means users need to ensure they take efforts to secure their wallet and never lose their private key.
Well-known hardware wallets like Ledger and Trezor are non-custodial, but crypto users can also find app-based wallets. In May 2022, the popular Robinhood trading app announced it was working on a non-custodial wallet allowing users to store and trade cryptocurrencies.
Key Differences Between Custodial Vs. Non-Custodial Wallets
There’s a few notable differences between custodial and non-custodial wallets.
Private Key Custody
The most prominent difference between each wallet type is asset custody. An outside third-party manages the private key with a custodial wallet. In contrast, non-custodial wallets let users maintain control. Non-custodial options are more popular among crypto enthusiasts interested in privacy, self-governance over funds, and the ability to maintain control over their banking experience.
Types Of Transactions
Notably, custodial wallet transactions do not appear on the blockchain in real-time, as approval from a central authority must occur beforehand. Non-custodial wallet transactions occur instantaneously.
Custodial wallets will require users to go through some form of Know Your Customer (KYC) verification to gain access to funds. Users also have to trust that the custodian will keep sensitive information and data safe. This requires the custodian to invest in top-of-the-line security measures and cultivate a strong reputation to maintain user trust.
Non-custodial wallet users do not have to go through KYC steps or other verification procedures. This means users can send cryptocurrency in a much more private manner. Security is also enhanced as all information remains in the user’s hands.
Custodial wallets offer users a high degree of liquidity when it comes to buying and selling crypto, since many are already connected to an exchange. Non-custodial options usually lead to longer trade times as the crypto will initially be sent to an exchange as part of the transaction process. High-frequency traders or those looking to quickly buy and sell coins might become frustrated with this process.
Custodial wallets require an active Internet connection to open, while non-custodial options do not. Users focused on security and privacy often opt for non-custodial options, as wallets that do not connect to the Internet offers much greater protection against cybercriminals. Custodial wallets do offer better recovery prospects as the private key is stored with a third-party central authority. With non-custodial wallets, the private key remains in the hands of the user, which could become a disaster if this sensitive information is lost. It’s always wise to carefully write down private keys and seed phrases and store the information in a secure and private area. These types of details should never be stored on a smartphone or computer.
Well-known examples of custodial wallets include BitGo, BitMex, FreeWallet, and Blockchain.com. Popular non-custodial wallets include Trezor, Ledger, Exodus, and Electrum.
The Pros and Cons Of Custodial Wallets
- Outsourced Security Measures: One of the biggest advantages of custodial wallets is the ability of a third party to keep private keys and other sensitive information safe. This is particularly useful for those who do not have a lot of knowledge about computer security or crypto beginners still looking to get comfortable with the technology. Even if a custodial wallet user loses their private key or forgets their mnemonic phrase, the third party can help recover access to funds.
- Backup Protection: Aside from helping recover lost login credentials, custodial wallet central authorities often offer ways to back up and restore digital wallets from previous versions. This can be a lifesaver for those looking to redo transactions.
- Free Transactions: Any sort of transaction within the blockchain will incur a fee. However, some custodial wallets let users send funds for free within the ecosystem. Freewallet’s sidechain technology allows for instant free transactions to other Freewallet users. The wallet's creators explained in a blog post how 2018 research revealed that users had already saved over $500,000 in network fees.
- Lack Of Control Over Private Keys: One of the biggest custodial wallet drawbacks is the lack of autonomy users have over their funds, as a third-party control the private keys. This means custodial wallet users need to place trust in a wallet provider. In December 2021, thieves were able to steal $196 million from the BitMart crypto exchange by stealing a private key. In 2018, criminals managed to steal private keys from hot wallets controlling more than $1 billion.
- Tight Rules And Regulations: Custodial wallets also require customers to go through identity verification processes and Know Your Customer (KYC) standards. Many within crypto worry about these types of requirements as they believe it goes against the ethos of a free ecosystem that allows anyone to participate in economic activity. Wallet users also have to trust the custodian will properly secure sensitive identification and other details.
- Hacking Risks: Custodial wallets are unsurprisingly the target of hackers and thieves as many store large amounts of funds. In November 2021, scammers managed to target users of the MetaMask and Phantom crypto wallets to steal more than $500,000. In one of the most famous crypto hacks to date, thieves stole 850,000 Bitcoins from the Mt. Gox exchange in 2014 after stealing private keys from the hot wallet.
- Lack Of Features: Some custodial wallets offer less advanced trading features and functionality than their non-custodial counterparts. This can be disappointing for advanced crypto users looking to buy, sell, and trade with the help of advanced tools. Sometimes, custodial wallets also limit crypto users' abilities to purchase certain forks of coins.
The Pros and Cons Of Non-Custodial Wallets
- User Autonomy: Non-custodial wallets continue to grow in popularity as they empower users with full control over their funds by giving them the responsibility to keep their private keys safe. Many within crypto remain interested in removing the influence of third parties, which is achieved through a non-custodial wallet.
- Enhanced Security: While it is still technically possible to steal funds from a non-custodial wallet, it is much harder to do so, as non-custodial options like hardware wallets are not connected to the Internet. Even web-based wallets like MyEtherWallet do not keep private keys. The mitigation of potential for human error or corruption (with the lack of an outside third party), promotes security.
- Fast Withdrawals: The lack of a third-party central authority also makes it possible for instantaneous transactions and withdrawals, as decisions do not need to be approved by an outsider. This is particularly advantageous for crypto users looking to buy, sell, and trade very quickly.
- Extra Responsibility: Non-custodial wallet owners need to remember they are solely in charge of their funds. Losing a private key would render a wallet totally inaccessible. Losing a hardware wallet like a Trezor or Ledger also means funds are lost. Non-custodial wallet holders must also practice good security measures to keep their crypto safe from thieves and hackers.
- Basic and Confusing Interfaces: Many non-custodial wallet options have UI/UX experiences that might be trickier to understand and navigate than custodial options. This could pose an issue for those new to the crypto world and unfamiliar with the hardware and available tools.
- Trading Delays: Traders using a non-custodial wallet will need to understand there will be a transaction delay as a buy or sell order will need to flow through an exchange.
The big difference is private keys with custodial wallets are managed by an outside third party. With non-custodial wallets, private keys are managed by wallet users themselves and they maintain full control over funds. Non-custodial wallets are essential when interacting with decentralized exchanges like Uniswap or PancakeSwap.
A private key is usually a string of letters and numbers that functions as a ‘password’ to unlock a crypto wallet. Users who have their wallet’s private key can rest assured their money is safe and can be managed anywhere with an Internet connection. A public key allows users to send and receive funds and works like an email address.
Many crypto users turn towards non-custodial wallets as they can maintain control over their funds. While there’s many well-regarded non-custodial wallets available, some wonder how they can build their own. Creating a non-custodial wallet should only be done in tandem with a legitimate and reputable blockchain-focused development company.
In basic terms, a third party will ask a crypto user to transfer funds to a particular place. This authority manages funding, with users understanding they need to be involved with any transaction.
Final Thoughts On Custodial and Non-Custodial Wallets
Ultimately, choosing between a custodial or non-custodial wallet is an important decision.
There’s plenty of good options within each category and choosing one often comes down to a crypto holder’s personal preference, risk tolerance, and how much control they want to have over their private keys (and the responsibility that comes with it).
One of crypto’s best attributes is the empowerment it gives users to make the best decision for themselves. However, any wallet users should still always follow best security practices to protect themselves.
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