Custodial and non-custodial wallets are the two main types of cryptocurrency wallets.
A custodial wallet stores your private keys and cryptocurrencies on a centralized platform, while a non-custodial wallet gives you complete control of your private keys and assets. Understanding the differences and benefits of each is crucial when it comes to securing your cryptocurrency.
However, as cryptocurrency popularity continues to soar higher, with more people and organizations investing in cryptocurrency and launching DeFi projects on the blockchain, the need for a secure method of storing your cryptocurrencies is highly required.
Now, if you’ve done your own research about the best methods of storing cryptocurrencies, you would have come across two distinct options, in the form of custodial and non-custodial crypto wallets, in your search for the most reliable and secure method of storing your financial assets.
What is a cryptocurrency wallet? What are custodial and non-custodial wallets? Which one is the best method of storing cryptocurrencies?
These and many more questions will be answered in this detailed analysis of custodial and non-custodial crypto wallets.
This Post Contains
- What Is A Cryptocurrency Wallet?
- Custodial Wallets.
- Pros & Cons Of A Custodial Wallet.
- Non-custodial Wallets.
- Pros & Cons Of A Non-custodial Wallet.
- Custodial vs Non-custodial wallets- Key differences.
- Custodial or Non-custodial Wallet- Which One Should You Use?
What Is A Cryptocurrency Wallet?
You might be wondering, why didn’t we just jump to Custodial and Non-custodial Wallets?
It’s because there’s a misconception of what Crypto wallets are. More than half of cryptocurrency investors have incomplete conception of what a cryptocurrency wallet is (Their definition isn’t wrong, it’s just not comprehensive enough).
They believe that a cryptocurrency wallet is “an app with which you can send and receive cryptocurrencies” (Software wallet/Hot wallet).
Meanwhile, A cryptocurrency wallet can be in the form of a piece of paper (Paper wallet) or a physical device that is not connected to the internet (Hardware wallet/Cold wallet).
In short, A Cryptocurrency wallet is a software program or physical device that stores your private key and public keys (public addresses), keeping your cryptocurrencies secure and accessible and allowing you to send, receive, and spend cryptocurrencies.
The private key is a kind of password which you use to secure your assets,
While you can share the public keys (public addresses) with anyone and use it to receive cryptocurrencies.
There’s only one Private key for each Crypto wallet, but on the other hand you can have more than one public address, you can have one for Bitcoin and another one for Ethereum.
From the term ‘custodial’ you can understand that custodial wallets involve a third-party such as an exchange taking custody of your private keys giving the third-party (Wallet provider) full control of your funds.
Custodial wallets are crypto wallets in which the wallet provider takes care of the private key and cryptocurrencies of the users on their behalf. Freewallet and Binance are good examples of a custodial wallet.
- Pros & Cons Of A Custodial Wallet
Custodial wallets are easy to use and therefore suitable for beginners. You don’t need advanced knowledge of cryptocurrencies before you can use a custodial wallet. All you have to do is create an account with your email and password, pass KYC and then login into the custodial wallet.
However, custodial wallets negate the basic goals of cryptocurrency which is decentralization, in other words taking control away from centralized authorities. Custodial wallets take away this basic essence of cryptocurrency, you have to grant the wallet provider custody of your private key and cryptocurrencies trusting them with the security of your funds.
In addition, the wallet provider may lock you out of the wallet without notice and restrict your access to the wallet, most especially if you break the rules and regulations of the platform.
Non-custodial wallets are the exact opposite of custodial wallets.
The users have absolute control of their private key and cryptocurrency.
The wallet provider doesn’t store any of the user’s information on their servers and can’t restrict their account or block the users from accessing their funds.
- Pros & Cons Of A Non-custodial Wallet
Non-custodial wallets are more than just a mere alternative to custodial wallets, they’re decentralized in nature which means that the users have complete ownership of their cryptocurrencies. In addition, they offer more security for the user’s funds and private key than custodial wallets.
However, users having absolute control of their private key and funds means they’re responsible for the security of their private key and cryptocurrencies.
The private key of a non-custodial wallet is a 12 to 24-word mnemonic phrase (recovery phrase) that can be used to regain access to the wallet.
Users have to store the recovery phrase in a secure location. Away from the internet and in a place where other people can not access it and use it to gain access to the user’s funds.
Users can write down the recovery phrase on a piece of paper or store it on a hard drive and keep it in a safe or another method of secure backup of the wallet.
If they forget their password and lose their private key they lose access to the wallet, which automatically leads to loss of funds as they’re the only one accountable for the wallet.
Custodial vs Non-custodial wallets- Key differences
In terms of security, Custodial wallets face more security challenges than non-custodial wallets. The fact that they’re on the internet means that their security can be compromised by hackers and a good number of custodial wallets have been hacked in the past.
Non-custodial wallets offer a more secure method of safeguarding the user’s cryptocurrencies as only the user have control over their private key.
However, users have to secure their private key and ensure they’re the only one that has access to it so a third-party doesn’t gain access to their funds.
- Decentralization vs Centralization
With non-custodial wallets, only the user has access to their private key and cryptocurrencies.
This also implies that they have full control of their wallet and are not subject to any form of rules and regulations of the wallet provider. This makes non-custodial wallets decentralized in nature.
Meanwhile, users of a custodial wallet share access to their private key and cryptocurrencies and are therefore obligated to follow the rules and regulations of the wallet provider or risk losing their funds if the wallet provider denies them access to the wallet. Therefore, centralization is evident in custodial wallets.
- Recovery Of Funds
It’s impossible for non-custodial wallet users to recover their cryptocurrencies if they lose their recovery phase as it’s the only way they can regain access to their wallet if they forget their password.
Contrastingly, if users of custodial wallets lose their login credentials, they can follow the instructions laid down by their wallet provider and regain access to their wallet.
Custodial wallets are more user-friendly, they also have a interactive interface that allows users to carry out transactions seamlessly.
Custodial or Non-custodial Wallet- Which One Should You Use?
When considering the type of wallet to use as a cryptocurrency user, security is a big factor that you should consider, which therefore puts non-custodial wallets in a better position.
In addition, with a non-custodial wallet, you’re at no risk of having your cryptocurrencies seized from you by your wallet provider. You’re the sole controller of your private key and funds unlike a custodial wallet user.
Therefore, if you are looking for the most reliable and secure method of storing your cryptocurrencies, non-custodial wallets are the best choice.
However, Custodial wallets are more suitable when it comes to cryptocurrency trading; they’re also more beginner-friendly. Therefore if you’re a newbie or a cryptocurrency trader, you’ll need a custodial wallet.