What are Crypto Wallets?
Think of a software or an application that functions as a wallet for your coins and tokens. It is called a wallet because it is used similarly to a wallet in which you put cash and cards. But technically, crypto wallets don’t store crypto by itself. Instead, it generates an address that locates the user’s digital assets on the blockchains.
Digital wallets achieve this practice by storing private and public keys you use to sign your transactions. A public key is like a bank account number and can be shared with others. Meanwhile, a private key functions as a password to access funds or sign a transaction.
As usual, people seek ways to safeguard their ‘passwords’, or private keys, to protect their wallets from cyber breach. Depending on who controls or has access to private keys, wallets can be either custodial or non-custodial.
What is a custodial wallet?
If you consent to let a third party (for example, a crypto exchange) manage your private keys, you are using a custodial wallet. Instead of having custodial access to your funds, a service provider gets complete control of your money.
This might seem absurd, but managing private keys is not an easy task. Losing your private key means losing access to your funds forever as there is no way to recover a new private key.
Of course, service providers must comply with existing regulatory regimes so that they cannot just simply take away your money. You can also opt for custodial wallets that offer insurance coverage for theft or misuse of funds.
What is a non-custodial wallet?
A non-custodial wallet is a wallet in which you are responsible for storing and managing your private keys. With this kind of wallet, you have full control over your digital assets.
These wallets are ideal for experienced traders as if they lose access to their private keys, they lose all their crypto assets. However, non-custodial wallets offer better protection against data breaches compared to custodial ones.
Custodial vs non-custodial wallets
The primary difference between custodial and non-custodial wallets is the presence of a third party. Custodial wallets give a third party permission to hold your private keys, while non-custodial wallets give you sovereign control over your private keys.
Private key ownership
For custodial crypto wallets, the responsibility of securely storing a user’s private key lies with the wallet provider. As a consequence, users do not have complete control over their assets; instead, the custodian manages the funds, which can lead to potential misuse. Conversely, users can independently manage their private keys through non-custodial wallets.
Security
Security should be the utmost priority when choosing a crypto wallet. Since custodial wallets store users’ keys in centralised servers, they are more prone to attacks and cyber breaches. With non-custodial wallets, it’s extremely deterrent for hackers. Users can store their keys off-chain by using a hardware wallet to further reduce security vulnerabilities.
Transaction time and fees
If you use a custodial wallet, every transaction requires approval from the central provider. At peak hours, there could be a delay in the transaction throughput, and the transaction history is also not recorded on the blockchain in real-time. Moreover, fees are in most cases higher as intermediaries are involved.
When you make transactions with a non-custodial wallet, it’s much faster since there is no intermediary involved. Transactions are also recorded in real-time with cheaper fees.
Funds backup and recovery
Custodial wallet users can rely on the custodian to retrieve their keys if they lose them. However, non-custodial wallet users need to be extremely careful since retrieving private keys is impossible. Losing private keys means losing all their assets. To protect their digital funds, users must store their recovery phrase or seed phrase, a 12-, 18-, or 24-character mnemonic phrase used to regain access to the wallet.
Creating a new account
If you opt to choose a custodial wallet, you might need to complete some verification processes such as Know your Customer (KYC) and Anti Money Laundering (AML) forms. Conversely, non-custodial wallets do not require KYC or AML.
Offline accessibility
Custodial wallets can only operate with internet connection, and that’s why they are more vulnerable to cyber attacks.
Non-custodial wallets are more flexible as they can operate both online and offline. You can access a non-custodial wallet online from a website or a mobile app or offline through a hardware wallet.
Which one suits you best?
Both custodial and non-custodial wallets have pros and cons. When choosing which one to use, you can consider all the factors listed above and decide whether a factor fit your needs.
If you enjoy peace of mind or simply are not a careful person, you can choose custodial wallets so that you don’t need to worry about losing your private keys. In case of losing any sensitive data, you can just contact customer support and regain access. Custodial wallets also usually have a more user-friendly interface so novice users can interact easily.
By contrast, non-custodial wallet holders have sovereign control over their private keys. They also have better security and faster transaction time at negligible costs.
FAQs
What is the main difference between custodial and non-custodial wallets?
What distinguishes custodial from non-custodial wallets is how they handle private keys. In a custodial wallet, a third party stores and oversees a user’s private keys, whereas with a non-custodial wallet, the user is responsible for storing and managing their own private keys.
What is a private key?
A private key is a string of characters generated through cryptography. It serves as a password to manage user funds and create a backup wallet on a new device. This key is essential for proving asset ownership, generating digital signatures, and executing transactions on the blockchain.
Are custodial wallets secure?
Yes, custodial wallets are generally secure, but users should conduct research before selecting one. It’s advisable to choose custodial wallets that adhere to regulations and provide strong security measures and insurance coverage.
Are non-custodial wallets safe?
Yes, non-custodial wallets are typically safe for users, but users must ensure the security of their private keys and maintain proper backups.
