What The Difference Between Custodial vs. Non-Custodial Wallets?

In this post, we'll discuss What The Difference Between Custodial vs. Non-Custodial Wallets in Crypto?

With a non-custodial wallet, you have sole control of your private keys, which in turn control your cryptocurrency and prove the funds are yours. With a custodial wallet, another party controls your private keys. Most custodial wallets these days are web-based exchange wallets.

Once you’ve purchased cryptocurrency, you must decide whether to use a custodial vs. non-custodial wallet to store your funds. 

With a non-custodial wallet, you have sole control of your private keys, which in turn control your cryptocurrency and prove the funds are yours. While there is no need to trust a third party when using a non-custodial wallet, this also means that you are solely responsible for not losing your keys and requires that you take your own precautions to protect your funds.

With a custodial wallet, another party controls your private keys. In other words, you’re trusting a third party to secure your funds and return them if you want to trade or send them somewhere else. While a custodial wallet lessens personal responsibility, it requires trust in the custodian that holds your funds, which is usually a cryptocurrency exchange. 

Most custodial wallets these days are web-based exchange wallets. The following information can help you decide which is right for you.

What is a Custodial Wallet?

A Custodial Wallet is defined as a wallet in which the private keys are held by a third party. Meaning, the third party has full control over your funds while you only have to give permission to send or receive payments. 

 Pro and Cons

Most — but not all — web-based crypto wallets are custodial wallets, and it’s very likely that the first time you purchase crypto, it will end up in a custodial exchange crypto wallet. In this case, the exchange is your custodian, which holds your keys and is tasked with securely storing your funds. It is crucial that you use a reputable custodial wallet such as those offered by major U.S. crypto exchanges, where the majority of customer funds are held in cold storage hardware wallets and highly secure. 

While a custodial wallet may be considered less secure than a non-custodial wallet, many prefer them because they don’t require as much responsibility and are usually more convenient. Losing your password to a non-custodial wallet could be financially devastating if you do not take sufficient precautions. However, if you forget your exchange account password you’ll likely be able to reset it. Be sure to follow the exchange’s recommended security measures to best protect the digital assets within your crypto wallet.

Other custodial wallet solutions include investing in crypto ETFs and ETPs. These newer options are gaining popularity, especially with institutional investors seeking more investment exposure to cryptocurrency and tokens. They offer an option to invest in cryptocurrency that doesn’t require managing keys or transacting on the blockchain. They do, however, charge higher fees and only provide exposure to a fraction of the cryptocurrencies and trading pairs offered on exchanges.

Benefits of Considering Custodial Wallets

Free transactions:

One of the biggest benefits of a Custodial wallet is that it, unlike other wallets, do not demand a transaction fee. It enables customers to make transactions for free within the ecosystem. A perfect example of this is Freewallet – a custodial wallet that helped consumers save around $500,000 on network fees back in 2019.

No major effect of lost private keys:

A third party manages your custodial wallet. So, even if you lose your private key or forget the mnemonic phrase, it is easy to regain access to your wallet and your stored funds.

Higher backup possibility:

Another advantage of custodial wallets is that the central authority managing your wallet offers backup facilities. This makes it easier to undo any transaction or restore a previous version.

Drawbacks of Custodial Wallets

Custodian’s control over your money:

The biggest disadvantage of going with Custodial cryptocurrency services is that you do not have autonomy over your wallet.

The third party, i.e, the custodian, has complete control over your funds and associated processes. They have the freedom to take action on the funds, including freezing the stored amount.

Need for KYC:

Another drawback of introducing Custodial wallet to your services is that this wallet type strictly recommends users to perform KYC (Know Your Customer, ID Verification). You cannot gain access to your funds or any of the related services without proving your identity. This necessity of identifying verification impedes the basic principle of Cryptocurrency, i.e, anonymity. 

Data breach threat:

With custodial vs non-custodial exchange, the first time you purchase crypto, it is likely that it will end in a custodial exchange online crypto wallet.

In the case of Custodial cryptocurrency exchanges, a huge amount of users’ funds is stored in cold and hot wallets. While these wallets may not be an easy target for hackers due to the involvement of various conformations, they are still vulnerable to security breaches. 

One such incident is that of Japanese exchange Mt. Gox in 2014, where over 70% of the bitcoin transactions were hacked, which resulted in a loss of around $450M. 

No offline facility:

Last but not least, the Internet connection is a must for logging in the Custodial wallets or to perform any transaction. 

With this covered, let’s dive into the concept of Non-Custodial wallets to get a crystal clear idea of both before we jump to the part where we look into the Custodial vs. Non-Custodial comparison.

What is a Non-Custodial Wallet? 

It is a type of Blockchain wallet that lets you be your own bank. This implies that users have full control over their funds and on the associated private key. 

Taking Personal Responsibility for Your Assets

Non-custodial crypto wallets give you complete control of your keys and therefore your funds. While some people store large amounts of crypto on exchange accounts, many feel more comfortable with a non-custodial wallet, which eliminates a third-party between you and your crypto. 

Non-custodial wallets can be browser-based, they can come in the form of software installed on mobile devices or on desktops, or they can be hardware devices, among other options. Although they can take many forms, the most secure way to hold your cryptocurrency is using hardware wallets. These crypto wallets usually look like a USB storage device with a screen and analog buttons. 

Turned off when not in use, these hardware, non-custodial crypto wallets must be connected to a computer or mobile device via USB ports or bluetooth to transact. Although they are technically connected to the internet during a transaction, the signing of the transaction by the private keys is done offline within the hardware wallet itself before being sent online to the blockchain to be confirmed. For this reason, even a malware-infected computer or phone can’t access your funds when you’re using a non-custodial hardware wallet. 

While non-custodial wallets don’t require you to trust a third party, they require you to trust yourself to keep your keys and your wallet secure. If you were to lose your wallet, destroy your wallet, or forget your password, and you haven’t taken precautions to be able to regenerate your wallet, you could lose access to your funds. Any non-custodial wallet with significant funds should be password protected, and that password should be kept in written form in a location only you know. In addition, you should not allow anyone physical access to your non-custodial crypto wallet. Were someone to discover the PIN or password, they could drain your funds without your knowledge.  

However, if you do end up losing access to your crypto wallet or forget your password, there is a back-up procedure. Typically, you will have generated a sequential string of 12, 18 or 24 words that is displayed upon setting up your crypto wallet. 

Like your password, this should remain completely private and safely stored. This recovery phrase, also known as a “seed phrase,” would allow anyone to “regenerate” your crypto wallet on another device, giving them access to all crypto balances associated with your private keys. With your seed phrase someone could regenerate your crypto wallet  even without physical access to your original hardware wallet. 

Benefits of Non-custodial Wallets

Users’ control over funds:

The prime reason why Non-Custodials are gaining a huge momentum is because they provide users an individual access to their funds. The users need not look up to any third party to manage their fundings or perform any related activity.

Safety in funding:

Since all the details associated with your online Crypto wallet and its funds relies on you, the risk of data breach is much lower. This is one of the primary reasons why 66.5% of crypto holders are relying on non-custodial and mobile storage solutions these days.

Instant withdrawals:

Unlike best Custodial wallets, these wallets do not need confirmation from a third party for performing every transaction. This streamlines the whole process and makes it easier to enjoy instant withdrawals.

With this covered, let’s look into the limitations of non-custodial crypto wallets to make a neutral decision.

When it comes to the drawbacks of Non-Custodial wallets, there is nothing major that can be highlighted. The wallet type offers the best Blockchain facilities. However, to relish its benefits, it is necessary for users to store their key securely.

Drawbacks of Non-custodial Wallets

Trade delay:

It will be hard to trade the currency quickly, as in noncustodial it will initially be sent to an exchange.

More responsibility:

Being accountable for your own security means a lot of responsibility. Even the tiniest of mistakes could lead to robbery, deletion, or unplanned consequences.

User interface:

User Interfaces are presented in a way that is a bit more difficult to understand.

Keys lost equals money lost:

On the off chance that you lose your key and seed phrase, there won’t be anyone to assist you restoring your wallet or data. Losing a private key or mnemonic seed can make the user lose access to their wallet, with no backup and recovery possibility.

DISCLAIMER: The Information in the post isn’t financial advice, is intended FOR GENERAL INFORMATION PURPOSES ONLY. Trading Cryptocurrency is VERY risky. Make sure you understand these risks and that you are responsible for what you do with your money.

If you’re a beginner. I believe the article below will be useful to you ☞ What You Should Know Before Investing in Cryptocurrency - For Beginner

What Is The Difference Between Custodial And Non-Custodial Wallet?

1. Custodian of private key

The foremost factor to consider when comparing the Custodial vs non-custodial wallets is who holds the private key.

In case of Custodial wallets, the third party manages the private key. Whereas, in the case of Non-Custodial wallets, all the blockchain custodian services reside with users.

So, in case you want to introduce a wallet where users can be their own bank, go with the idea of creating non-Custodial blockchain wallets.

2. Transaction type

Another factor to consider during Custodial and Non-Custodial crypto wallet comparison is the transaction type. 

The transaction is reflected on the chain in real-time in Non-Custodial. But, it is not so in the case of Custodial wallet. 

This again shows that the former leads the show.

3. Security

In the case of custodial online crypto wallets, all the sensitive user data is stored in hot and cold storage, which are often hacked by data intruders. Because of this, the security level is low in custodial, unless the authoritative party implements strong security measures.

Whereas, in case of Non-Custodial crypto wallet comparison, the whole information remains with users. This reduces the risk of data being stolen, unless the user shares the details with someone, or their device gets stolen.

So, here again, Non-Custodial wins the Custodial vs Non-Custodial wallets battle.

4. Backup and recovery possibility

When it comes to backup and recovery possibilities, non-Custodial crypto wallets lag behind the Custodial one.

The Custodial wallets keep the private key with themselves. So, even if you lose the access to data, you can regain the access by requesting the third party. 

However, this is not possible in the case of Non-Custodial wallets where you are the sole authority.

5. Offline accessibility

To access your funding and corresponding details, it is a must to login into your Custodial wallet and make a request to centralized authority. This makes it imperative to have internet connectivity.

But, there is no such requirement in Non-Custodial wallets. This, in return, signifies that Non-Custodial wallets are a better option to enjoy full blockchain development services in real-time.

6. Future scope

As per the cryptocurrencies market trends, Non-custodial wallets will continue to get an edge over Custodial due to the growing data breach cases and users becoming more conscious about their data privacy and security. 

7. Examples

Some of the popular examples of best Custodial wallets are: Free Wallet, Binance, BitMex, Bitgo, Blockchain.com.

Some examples of best Non-custodial wallet 2021 are: Electrum, Exodus, Ledger Nano X, Trezor One, Zengo, Wasabi, among others.

While the aforementioned ‘Custodial vs. Non-Custodial wallets’ comparative factors will help you in picking the right Blockchain wallet, we highly recommend Non-Custodial Wallets. For, these list of non-custodial wallets offer ample opportunities and hold a better future in the marketplace – something which in turn establishes itself as a profitable business decision.

Now let’s dive into the understanding of Custodial vs. Non-Custodial wallets part where the advantages and disadvantages of both the crypto wallets are discussed.

Choosing between a custodial wallet and non-custodial wallet is a key decision when it comes to securing your cryptocurrency holdings. Some prefer a custodial exchange account, while others prefer non-custodial wallets, and some end up using a combination of the two. You’ll also have to decide if you want a hot or cold wallet, and whether to spread your cryptocurrency holdings between various crypto wallets. Regardless of your choice, be sure to always follow best security practices.

Read more: What is a Crypto Wallet | All You NEED To Know

I hope this post will help you. Don't forget to leave a like, comment and sharing it with others. Thank you!

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Mobile Wallet Development, eWallet App Development, Digital Wallet App Development

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