Introduction
With the growing adoption of cryptocurrencies, securing and handling these digital assets is vital. Your crypto wallet choice significantly influences the safety of your funds and your control over them. Two main options exist: custodial and non-custodial wallets, each with unique traits and benefits. This article will discuss the differences between these wallets, examining their key characteristics, pros, and cons to aid in informed decision-making for asset protection.
What is a custodial wallet?
A custodial wallet, also frequently referred to as a hosted wallet, serves as an electronic storage space for cryptocurrencies. Under this arrangement, your digital assets’ essential private keys for access and control are kept by a trustworthy service provider.
Using a custodial wallet is like using a traditional bank: you entrust your crypto security to the wallet provider. Just as banks safeguard your money and offer easy access, custodial wallet providers manage your crypto, handle security updates and maintenance, and often provide insurance against threats like hacking.
Custodial crypto wallets, therefore, eliminate the burden of private key management from the user, providing an added layer of convenience and ease of use, particularly for novice traders. This is a particularly attractive feature for those crypto users who are not comfortable dealing with the technical aspects of crypto management.
How does a custodial wallet work?
When you create an account with a custodial wallet, for example, Coinbase, you are effectively establishing it to store your cryptocurrencies. Moreover, you provide the wallet with the responsibility of retaining the private key, this way granting the provider ultimate control over your crypto possessions.
When the time comes to initiate a transaction, such as sending Bitcoin to another individual, you simply submit a request within the wallet. Subsequently, it executes the transaction on your behalf by utilizing the private keys they possess. This process mirrors the steps taken when receiving cryptocurrencies.
One notable advantage of utilizing a custodial wallet is that users don’t have to worry about losing private keys, which could potentially lead to the loss of all their crypto assets. Moreover, custodial wallet providers often present supplementary features, including convenient conversion options between various cryptocurrencies, seamless integration with crypto exchanges, and, in some cases, the potential to earn interest on your crypto holdings.
Nevertheless, it is crucial to recognize that by opting for a custodial wallet, you are essentially entrusting the safety of your assets to the wallet provider. Consequently, it’s crucial to opt for a reliable and reputable provider.
What is a non-custodial wallet?
A non-custodial wallet stands out from custodial wallets and is a key digital tool for securely storing and managing cryptocurrencies without the need for third-party services. It allows you to retain control over your assets, giving no access to your private key to a centralized platform. Hence, only you have the key, making you the single custodian of your funds.
For crypto owners or businesses who are driven by the principles of decentralization, security, and autonomy, non-custodial wallets are an essential gadget. One such wallet, which is popular for its features, is Trust Wallet.
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How does a non-custodial wallet work?
With a non-custodial wallet, transaction processing is performed direct through the wallet app, no middlemen involved. Using your private keys, you can confirm transactions by proving asset ownership, all while keeping the keys hidden.
Most non-custodial wallets offer backup and recovery options, typically using a recovery or seed phrase of 12 or 24 words. This phrase helps you regain access to your private keys if you lose access to your wallet. It’s crucial to protect this phrase diligently, as losing it means permanently losing access to your assets.
What types of non-custodial wallets exist?
Non-custodial wallets can generally be divided into several groups. Let’s have a look at each wallet type and its distinguishing features.
Hardware Wallets
A non-custodial crypto wallet can take the form of a hardware wallet. Also known as “cold storage”, it is a physical device (often in a form of a USB stick) specifically designed to secure cryptocurrencies. Its primary function is to store your private keys — the critical piece of information required to authorize transactions — offline and out of reach from hackers. The core feature of a hardware wallet is its robust security. Since it’s not connected to the internet, this type of crypto wallet is immune to viruses and malware.
Web-Based Wallets
A web-based wallet serves as a digital wallet designed to assist users in storing and managing their cryptocurrencies. It grants users the ability to access their funds through a web browser, ensuring convenience and accessibility. These wallets encompass various key features, which may include but are not limited to:
- Multi-currency support
- Real-time balance updates
- Transaction history
- Ability to send and receive cryptocurrencies quickly and easily
- And more
Mobile Wallets
A mobile crypto wallet is also a software solution. In contrast to web-based wallets, which can be accessed only through web browsers, a mobile wallet is specifically designed as an application installed directly on a mobile device, like a smartphone or tablet. It functions locally on the device itself, offering users the advantage of portability and easy accessibility. This enables users to conveniently manage and utilize their cryptocurrencies while on the move.
Difference between a custodial and non-custodial wallet
In order to effectively manage and protect cryptocurrency investments, it’s important to understand the difference between custodial and non-custodial crypto wallets in regard to the level of control and responsibility that a user possesses over their digital assets. Here are some key factors to consider.
1. Private key
A private key refers to a unique, randomly generated sequence of characters that acts as a digital signature for a specific cryptocurrency address. Essentially, it grants access to the funds associated with that address.
For custodial wallets, a third-party entity, like a cryptocurrency exchange or wallet service provider, takes on the duty of storing and overseeing your private keys for you
In contrast, a non-custodial crypto wallet gives you absolute authority over your private keys. In this situation, you personally generate and store the private keys, usually utilizing a software or hardware wallet. Examples of non-custodial wallets include software wallets like Trust Wallet.
2. Transaction type
When you make use of a custodial wallet, the corresponding transactions are overseen and approved by the custodian, which could be a cryptocurrency exchange or wallet service provider. Your role is to trigger the transaction via the wallet’s user interface, while the actual execution is carried out by the custodian. This involves various steps, including signing and transmitting the transaction to the blockchain network.
Conversely, a non-custodial wallet provides you with total control over your private keys, allowing you to manage your transactions independently. In such scenarios, you are required to validate and authorize your transactions by using your private keys. The wallet’s software aids in this by creating the transaction information and enabling you to approve it locally on your device. Once you’ve given your consent, the transaction is sent to the blockchain network.
3. Security
When considering the security of custodial wallets, the safeguarding of your digital currency depends largely on the protocols and protective measures employed by the wallet provider. If the service boasts robust features like encryption, multi-factor authentication, and consistent security audits, your digital assets can be well-protected. Moreover, these custodial services usually have customer support and may offer some degree of protection against theft or cyber-attacks.
Yet, the fact that these wallets are custodial means total reliance on the third-party provider. In a scenario where the provider’s systems are compromised, your digital assets may be exposed to risk. Another thing to consider is potential internal wrongdoing, where employees of the provider could potentially mismanage funds. Regulatory risks should also be factored in, like a situation where the wallet provider could be legally compelled to freeze your assets.
On the flipside, non-custodial crypto wallets provide the utmost level of personal control and discretion. As you have full control over your private keys, there is no intermediary who can confiscate, suspend, or misplace your assets. You also become immune to the risks associated with third-party providers. As a result, keeping your private keys secure ensures the safety of your cryptocurrencies. However, the control that comes with non-custodial wallets also carries its own risks. Loss of private keys usually leads to irretrievable assets. Additionally, if your device is infected with malware, your wallet could be jeopardized.
4. Support
Custodial wallet providers take care of the security and maintenance of your wallet. In case of any issues, you will have a support team to contact. Therefore, these wallets are more popular with crypto beginners.
In the case of non-custodial wallets, there’s limited to no support if you encounter issues or lose access to your funds. You will have to handle most of the troubleshooting yourself or rely on community support.
5. KYC requirements
Know Your Customer (KYC) is a regulatory requirement meant to prevent identity theft, fraud, money laundering, and illegal financing activities. In the context of cryptocurrencies, it involves procedures to verify the identity of customers during account setup.
The KYC process for a custodial wallet usually requires you to submit various personal details, which may include:
- Full name
- Date of birth
- Address
- A scanned copy of a government-issued ID
- A photograph or selfie for comparison with the ID
- Proof of address (like a utility bill)
- And more
Non-custodial wallets generally do not require a KYC process due to their decentralized nature. Therefore, if privacy is your utmost concern, a non-custodial wallet would likely be more suitable.
6. User-friendly
Both custodial and non-custodial wallets are usually user-friendly and provide their clients with intuitive design. However, custodial wallet users can also benefit from robust support services if they encounter any problems. Non-custodial crypto wallets are usually a bit more complex due to the increased personal responsibility. They may not offer as many features as their custodial counterparts, and may require a bit more understanding of the technology to operate them.
7. Backup and recovery possibility
In custodial wallets, the responsibility for backup and recovery typically lies with the custodian. Since the custodian holds the private keys, they are responsible for implementing backup measures to protect the funds. They may store backups of the private keys in secure offline locations, use redundant systems, or employ other security measures to ensure the safety of the user’s funds.
In non-custodial wallets, backup and recovery become the responsibility of the user. Thus, users should store their seed phrases in a safe and offline location, such as a hardware wallet, a piece of paper, or a secure password manager. If you lose your device, you can retrieve your funds by restoring the wallet using the seed phrase on a new device. It’s crucial to remember that if your seed phrase is lost, there will be no way to access your wallet.
8. Offline accessibility
Custodial wallets generally do not offer direct offline access to users. Since the service provider holds the private keys, users rely on the provider’s infrastructure to access their funds. This means that users need an internet connection to interact with their wallets and manage their assets.
Regarding offline access, non-custodial wallets can offer more flexibility. Since users have control over their private keys, they can access their funds offline. Typically, non-custodial wallets enable users to create and authenticate transactions while offline, amplifying security by limiting vulnerability to online risks. Once online, users can then transmit their authenticated transaction to the blockchain network.
9. Future scope
Custodial wallets are expected to remain crucial in the crypto world, owing to their user-friendliness, especially for crypto beginners. Yet, their destiny largely hinges on governmental regulations, which these entities must adhere to. Advancements in technology, including better user interfaces and security measures, will likely drive increased adoption.
Custodial vs. Non-custodial Wallet – Comparison Table
| Difference | Custodial | Non-custodial |
| Private key | Controlled by a custodian | Controlled by the user of the wallet |
| Transaction type | Transactions are executed by a third-party provider on the users’ behalf | Users manage their transactions independently |
| Security | Security of the assets depends on the security of the third-party provider and their reliability | No dependency on custodians, utmost level of personal control |
| Support | Full support | Lack of support |
| KYC requirements | Yes | No |
| User-friendliness | User-friendly with extensive support services | User-friendly, yet a bit more complex to use due to increased personal responsibility |
| Backup and recovery | A custodian is responsible for recovery and backup | The user is responsible for recovery and backup |
| Offline accessibility | No | Yes |
| Future scope | Further adoption | Further adoption |
Non-custodial wallet
Pros
- Robust Security. Non-custodial wallet users enjoy complete authority over their assets, allowing them to personally implement security measures that effectively counter the risks of hacks and unauthorized access.
- Decentralization. This is a prominent feature of non-custodial wallets, granting users absolute control and ownership of their funds without dependence on third-party entities.
- Privacy. Non-custodial wallets place great importance on minimizing the gathering and retention of personal information.
- Asset Freedom. Non-custodial wallets typically support a wide range of cryptocurrencies, granting users the flexibility to manage and store multiple digital assets within a single wallet.
Cons
- User Responsibility. Individuals using non-custodial wallets take the responsibility of safeguarding their private keys and guaranteeing the security of their funds. Funds can be irretrievably lost if access to private keys is misplaced.
- Technical Complexity. Non-custodial wallets may come with a steeper learning curve and can be more technically challenging for new users.
- Limited Support. Non-custodial wallet users may need to rely on community forums or online resources for troubleshooting or assistance.
- Recovery Challenges. Unlike custodial wallets, non-custodial wallets do not typically offer centralized account recovery options. Users must keep their private keys and seed phrases safe and accessible in case they need to recover their wallets or access their funds on different devices.
Custodial wallet
Pros
- User-Friendly. Custodial wallets are often created with an intuitive interface, making them easy to use even for beginners in the crypto space.
- Security Support. Custodial wallets generally offer an added layer of protection by securely storing users’ private keys and sensitive data. This feature can be beneficial for individuals who may not feel entirely comfortable managing their own security protocols.
- Account Recovery. In case a user loses their password or their account is compromised, custodial wallets often offer account recovery options, making it easier for them to regain access to their funds.
- Technical Support. Custodial wallets often have dedicated customer support teams available to assist users with any issues or concerns they may encounter during their crypto journey.
Cons
- Centralized Control. Custodial wallets require users to trust a third-party entity with the custody of their private keys. This centralized control contradicts the core principles of decentralization and can pose risks if the service provider experiences a security breach or mismanages user funds.
- Privacy Concerns. Since custodial wallets hold user data, there is a potential risk of data breaches or unauthorized access to personal information.
- Limited Asset Control. Custodial wallets typically support a limited range of cryptocurrencies, and users may have limited control over their funds, as they must comply with the wallet provider’s policies and restrictions.
- Dependency on Service Provider. Users of custodial wallets are reliant on the availability and continued operation of the service provider. If the provider faces issues or decides to shut down its services, users may experience difficulties accessing their funds or may need to go through complicated recovery processes.
Conclusion: Is a custodial or non-custodial wallet better?
Determining whether to opt for a custodial or non-custodial wallet is mostly influenced by your individual needs, including the significance you attribute to security, convenience, and maintaining direct authority over your cryptocurrency holdings. If you prioritize simplicity and user-friendly features and you’re okay with trusting a third-party provider, you might find a custodial wallet suits your needs best. On the other hand, if you prefer having the highest level of control and are prepared to personally manage the security of your crypto assets, choosing a non-custodial wallet could be your best decision. Regardless of what you opt for, it’s crucial to regularly back up your wallet and prioritize stringent security protocols.
FAQ
Are non-custodial wallets safer?
Both custodial and non-custodial wallets usually come with robust security features. Still, non-custodial wallets, which give you total control over your private keys (your crypto access codes), are often seen as safer.
Can a non-custodial wallet get hacked?
Compared to custodial wallets, non-custodial wallets are considered to be more secure and less prone to hacker attacks. However, it’s still possible.
What’s the difference between a hosted wallet and a non-custodial wallet?
Hosted and custodial wallets are interchangeable terms. Both refer to a type of cryptocurrency wallet where the private keys are managed and controlled by a third-party service.managed and controlled entirely by the crypto holder. Non-custodial wallets, on the other hand, are
Do all exchanges offer custodial wallets?
Custodial wallets, though widely available, are not universally offered by all exchanges. While many platforms provide the convenience of holding users’ funds on their behalf, some prioritize decentralized principles and encourage self-custody.
Why are custodial wallets considered unsafe?
Custodial wallets involve trusting an external party with your money, so they’re often seen as risky. Concerns like cyberattacks, internal fraud, or even government interference could endanger the safety and accessibility of funds stored in these wallets.
