Custodial vs. Non-Custodial Wallets: All You Need To Know
Custodial Vs Non-Custodial Wallets. | Credit: Shutterstock
Key Takeaways
- Custodial wallets are managed by third-party providers, while non-custodial wallets are owned and managed by the individual user.
- Custodial wallets are generally user-friendly and require minimal technical knowledge, making them suitable for beginners.
- Non-custodial wallets provide greater control and security but require more responsibility and management.
- Custodial wallets are vulnerable to hacking and con-custodial wallets offer more security and privacy.
As the world undergoes an increasingly rapid process of digitization, traditional methods of storing financial assets are being replaced by digital wallets.
In the realm of cryptocurrency, there are two predominant types of wallets: custodial and non-custodial wallets. The main distinction between these two categories is centered around the ownership and control of private keys, which enable access to stored assets.
Custodial wallets are typically managed by third-party providers who assume responsibility for securing and managing private keys on behalf of their users. For example, exchanges like Coinbase and Kraken offer custodial services to their customers whereby their users can leave their cryptocurrency on their exchange.
In contrast, non-custodial wallets are owned and managed by the individual user, who retains complete control over their private keys and stored assets. For example Trezor, Exodus and Ledger. Imagine an individual who just purchased cryptocurrency would send the Bitcoin from the exchange to the offline wallet and store it safely.
The latter provides for a greater degree of autonomy and flexibility, but also imposes a higher degree of responsibility on the user for the security and management of their assets. Which basically means that the individual who adopts self-custody must protect their private key or seed phrase.
The Main Difference: Who Owns Your Keys?
Custodial wallets are usually adopted by beginners and those who are new to the world of cryptocurrency as they offer an easy-to-use platform which provides security and features that are often overlooked by non-custodial wallets.
These third-party providers offer the security and storage of the assets. Users do not need to worry about the technical details of managing their private keys or securing their own wallet and a newcomer to the cryptocurrency space can get started with minimal effort and knowledge.
Custodial wallets often feature customer support and insurance to beginners, providing a sense of security for users who are new to the industry. Non-custodial wallets tend to be better suited for experienced and knowledgeable crypto speculators or investors. These people want complete control over their assets and the ability to transact without the need for a third-party intermediary like Coinbase.
When a person holds cryptocurrency in a non-custodial wallet, that person is practicing the concept of self-custody. Some newcomers may feel apprehensive to hold a non-custodial wallet due to the possibility of losing access to their wallet if they forget their password or send funds to the wrong address. These concerns are often forgotten over time, as non-custodial wallets become more familiar and offer significant benefits over other payment methods.
What is a Custodial Wallet
Non-custodial wallets, also known as self-custody wallets, are becoming increasingly popular among experienced crypto holders due to the greater control and security they provide. However, for beginners, custodial wallets may be the better option due to their ease of use and added security features.
Some pros of custodial wallets include:
- Ease of use: Custodial wallets are generally user-friendly and require minimal technical knowledge, making them an excellent option for beginners who are just starting to explore the world of cryptocurrency.
- Added security features: Whereby custodial wallets are managed by third-party service providers that typically offer additional security measures, such as two-factor authentication, to protect user accounts from unauthorized access.
- Instant access to funds: Custodial wallets are connected to online exchanges, users can easily buy and sell cryptocurrencies and have instant access to their funds.
Some Cons of custodial wallets include:
- Lack of control: Custodial wallets are managed by third parties, meaning that users do not have full control over their funds and private keys. If the service provider i.e. exchange is fraudulent or is hacked, users’ funds are in danger of being lost or accounts frozen.
- Vulnerable to hacking: Custodial wallets are stored online and are therefore more vulnerable to hacking when compared to offline, or cold wallets. Which are more protected because they lie offline.
- Potential fees: Custodial wallet providers may charge fees for their services, such as transaction fees or monthly maintenance fees, which can add up over time.
Overall custodial wallets can be a great option for beginners due to their ease of use and added security features.
Examples of Custodial Wallets
When deciding between a custodial and non-custodial crypto wallet, it’s important to consider your individual needs and use cases. Here are some examples:
- A simple and easy-to-use wallet: A custodial wallet like Coinbae would be a good option because it holds a user-friendly interface with a range of features. Coinbase allows its users to buy and sell cryptocurrencies and keep track of their portfolio at any given time.
- Active traders: For those who frequently move funds between different exchanges and wallets, a custodial wallet such as Binance is always an option. Binance allows the user for a quick and easy transfer between a wallet and an exchange, streamlining the buying and selling process.
What is a Non-Custodial Wallet
Long-term investors who want complete control over their private keys and cryptocurrencies will need to upgrade to a non-custodial wallet. This ensures their holdings are securely stored. This type of wallet offers several advantages over custodial wallets, but also comes with some disadvantages that need to be considered.
Some pros when using non-custodial wallets include:
- Complete control: One can enjoy complete authority over their private keys, resulting in exclusive control of their digital assets. This eliminates third-party interference, reducing the risk of coins being stolen.
- More secure: As you are not relying on a third party to hold and protect your assets. You can manage your assets independently, and mitigate against risks associated with third-party custodial services such as potential identity breaches and loss of coins.
- Greater privacy: As you do not need to share personal information with a third party to obtain a non-custodial wallet, a higher degree of anonymity exists as there is no need to disclose personal information to external parties.
- Flexibility: Holding an offline wallet may still allow you to integrate the wallet with multiple platforms and exchanges. This means that you can connect your wallet to an exchange and make trades using that non-custodial wallet.
Some cons when using non-custodial wallets include:
- More responsibility: As you are solely responsible for the security and management of your assets, failure to be responsible might result in loss of your coins.
- Potential for human error can be a major risk: Such as losing your private keys or sending funds to the wrong address..
- Limited customer support or absolutely no customer support: As there is no third party to assist with issues or provide account recovery options.
Despite these potential drawbacks, non-custodial wallets are becoming increasingly popular among experienced crypto holders who prioritize security and privacy. If you are interested in using a non-custodial wallet, be sure to research different options and choose a wallet that meets your specific needs and security preferences.
Examples of Non-Custodial Wallets and Innovations in the Space
Some non-custodial wallets include hardware wallets such as Trezor and Ledger which allow for physical storage of private keys on a USB type drive, ensuring that only its user has access to the funds. Developers working on cryptocurrency projects may also find a non-custodial wallet useful. Wallets like Electrum offer customizable security settings and support for multiple cryptocurrencies, making them a good choice for securely storing project funds.
Electrum also offers Hierarchical deterministic (HD) wallets, designed to offer improved security and convenience compared to traditional wallet models. These wallets use a single seed, a random sequence of words or numbers, to generate a hierarchical tree-like structure of public and private keys.
The main benefit behind this is to create and manage multiple wallet addresses from a single seed, enhancing privacy and simplifying the process of securing and managing numerous addresses and private keys. When setting up an HD wallet like Electrum, you are provided with a 12-word seed phrase that you must securely store.
This feature makes managing funds more efficient and user-friendly, as you can generate new wallet addresses for each transaction without the need to back up the wallet again, reducing the chance of others tracking your transaction history.
Other breakthrough innovations which can be done via non-custodial wallets is the integrating of DeFi into the wallet applications. This essentially means that holders of a wallet such as MetaMask can interact with the Ethereum blockchain and its respective Dapps.
This means that MetaMask allows users to access a variety of DeFi services and applications directly from their wallet interface, such as lending, borrowing, trading, and staking. This aims to create a seamless and efficient experience for users, as they can manage their digital assets and interact with DeFi platforms without needing to navigate multiple platforms or interfaces.
Future of Crypto Wallets: What wallet should you choose?
The choice between a custodial and non-custodial wallet ultimately depends on your personal needs and preferences. If you are new to the crypto space and want an easy way of buying and holding crypto coins then, a custodial wallet may be the best first choice.
This is because a custodial wallet typically offers a more user-friendly interface and features like customer support, account recovery, and the ability to buy and sell cryptocurrencies easily. If the user is experienced in crypto who values security and self-custody then a non-custodial wallet is likely the better option. With the rapid growth of technology, it’s likely that wallets will become even more integrated in the future, making it easier for everyone to use and store cryptocurrencies securely.
One area of potential innovation in crypto wallets is the incorporation of social features. Some wallets may begin to integrate social elements, like messaging or sharing wallet addresses with friends. This could eventually lead to the creation of social networks built on top of blockchain technology.
Ultimately, the choice depends on individual needs and priorities, however, with wallet technology set to become increasingly sophisticated and secure in the future. There is plenty of opportunity for the crypto space to innovate in ways to help onboard people into the system.
FAQs
What are custodial and non-custodial wallets?
Custodial wallets are managed by third-party providers, while non-custodial wallets are owned and managed by individual users.
Which wallet is more suitable for beginners?
Custodial wallets are user-friendly and require minimal technical knowledge, making them ideal for beginners.
What are the advantages of custodial wallets?
Custodial wallets offer ease of use, added security features, and instant access to funds through online exchanges.
Why do experienced crypto holders prefer non-custodial wallets?
Non-custodial wallets provide complete control over private keys and offer greater security and privacy.
