Custodial, Non-custodial & MPC Wallets: High Level Overview
Author: JhonyAccording to crypto data aggregator DefiLlama, almost $5 billion has been lost due to exploits in decentralised finance, or DeFi. Asset security has become a topic of concern in the Web3 field, and currently, a number of solutions exist. These include: Custodial, Non-custodial and Multi-party Computation (MPC) wallets.
Crypto wallets are tools that help users to interact with the blockchain and access cryptocurrencies easily from anywhere. When downloading a wallet, users create a new address capable of sending and receiving cryptocurrencies. The addresses are akin to bank account numbers, it is a public cryptographic code that will allow anyone to send us crypto. On the other hand, each address is associated with a private key that works as a master password and controls access to owned cryptocurrencies.
Custodial v Non-custodial Wallets
Given the importance of crypto wallets in the Web3 world, i.e., to send and receive cryptocurrency, use decentralized applications (DApps), it is crucial that individuals select the most appropriate wallet for their own convenience. As its name implies, custodial wallets involve a third party (generally a centralized crypto exchange) that manages your assets on your behalf. In essence, they act as the custodian of the user’s private key, thus holding control over their funds. On the other hand, non-custodial wallets sometimes referred to as decentralized wallets, give users complete control over their private key, and thus their assets.
In effect, most custodial wallets are web-based custodial exchange crypto wallets, whereby the centralized exchange (CEX) acts as the custodian of user assets. As a result, to ensure asset security, it is paramount that crypto users opt for custodial wallets offered by reputable crypto exchanges. Users should also check out whether the CEX has regulatory approval, how they store private keys, and whether user assets are insured.
These types of wallets are usually more user-friendly in comparison to non-custodial wallets and don’t require as much responsibility. For instance, if an individual forgot their CEX account password, resetting it would be much less troublesome compared to using a non-custodial wallet. Popular custodial exchange wallets include Binance, which according to the reputable digital assets data provider Kaiko, has around 80% market share relative to the other 11 exchanges.
For beginners, custodial wallets are more convenient and easier to use, as they offer a much more user-friendly interface. In the case of Binance, they built and implemented a Merkle tree to allow users to verify their assets that are deposited in the platform. This Proof of Reserves mechanism shows that Binance has funds that cover all their user assets 1:1, as well as some reserves. For more information, please refer to the Proof of Reserves (PoR) page on Binance.
“Not Your Keys, Not Your Coins”
To safeguard user assets, popular custodial exchange wallets are the holders of private keys and often implement authentication mechanisms. In addition, it is important to note that custodial wallets require an internet connection, thus making them highly vulnerable to attacks by hackers. Take the notorious case of Mt. Gox, a Bitcoin exchange that once handled over 70% of BTC transactions by early 2014. Security breaches, internal theft and mismanagement made them lose most of their bitcoin; the company filed for bankruptcy and users ended up losing all their assets.
Another major drawback of using custodial wallets for beginners is that they require KYC (Know Your Customer) and AML (Anti-money Laundering) checks, making account creation much more complex and user anonymity impossible.
When using non-custodial crypto wallets, the user takes the responsibility of safeguarding their recovery phrase and private keys. If they lose their private keys and the seed phrase, then they could not recover access to their account. The private keys are the only way to access or recover your funds from non-custodial wallets, and losing the keys means losing your funds permanently.
In the event of CEX hacks, such as the aforementioned case of Mt. Gox, user assets will not be affected when using non-custodial wallets. Also, KYC or AML processes are not necessary for account creation, and more advanced features are available in comparison to custodial wallets.
Conflux Network: Fluent Wallet
As the only regulatory compliant, public, and permissionless blockchain in China, Conflux Network is building a borderless transactional and technological ecosystem for globally-minded crypto projects.
Conflux is leading the transformation to a sustainable, borderless economy by providing a unique advantage for projects building and expanding into Asia, and operates as a PoW/PoS hybrid chain. Conflux aims to connect decentralised economies to strengthen the overall DeFi ecosystem globally.
Fluent Wallet is a non-custodial multichain wallet built for Web3 and powered by Conflux. It supports Hierarchical Deterministic (HD) wallets and hardware wallets, as well as being compatible with Google Chrome, Mozilla Firefox and Microsoft Edge. Fluent allows users to easily store, send and receive funds on Conflux; easily manage multiple wallet accounts and explore blockchain applications.
Fluent supports connections to Conflux Core Space, Conflux eSpace, and Ethereum. Fluent also supports a native cross-space bridge that allows you to bridge your assets between Conflux Core Space and Conflux eSpace. For more information, please refer to the Fluent Wallet website.
Finding The Perfect Wallet
Apart from being custodial or non-custodial, crypto wallets in the market can also be classified as:
- Hot wallets: Connected to the internet, mostly free to use and easily accessible from either a web browser or as a software. For example: MetaMask.
- Cold / Hardware wallets : Highly secure and virtually impervious to hacking as they’re offline, not connected to the internet. For example: Ledger Nano X
- Software wallets: A type of hot wallet, entirely digital and less secure compared to hardware wallets. For example: Exodus
Wallets can also support additional functions, such as multichain: allowing users to keep their crypto assets across different blockchain networks whilst using only a single private key. Moreover, it is worth noting that either due to human error or external hackers/malware, all the wallets above bear the risk of being vulnerable.
Multi-Signature Wallets
Concerns around asset security gave rise to more sophisticated wallets such as Multi-Signature (Multisig) wallets. This type of digital wallet require two or more private keys in order to authenticate any transaction.
In short, this requirement of needing multiple parties to sign off a transaction provides an additional layer of asset security, and is similar to a vault that can only be opened when a set of unique keys are inserted at the same time.
Multisig wallets rely on smart contracts when requiring signatures from at least M of N total signers to execute a transaction, and are highly secure compared to single private key wallets.
Multi-Party Computation Wallets
Multi-Party Computation (MPC) wallets are crypto wallets that use MPC to ensure asset security. It is a cryptographic security measure that allows multiple parties to assess a computation without revealing any private information that is held by each party. It has become a crucial solution to the problems of data security and privacy which arise in Web3, especially in the context of blockchain applications.
In short, MPC breaks down a private key into different segments; which are then handed over to a decentralised network for encryption. Then, when a private key signature is needed, these segments become one to form a private key. This avoids problems such as single point of failure and decentralises control to achieve risk diversification.
There are numerous benefits when using a MPC wallet, including data privacy, asset security and less reliance on cold storage. However, due to its complex technical standards and the lack of scalability, MPC technology is most appropriate for high-value or confidential transactions.
Currently, the most prominent MPC wallet in the market is ZenGo: a self-custodial MPC wallet that boasts itself as never been hacked and has no private key vulnerability.
ZenGo is the first wallet to use MPC and can be used to connect to over a thousand NFT and DeFi applications. In addition, it is a multichain wallet: ZenGo supports over 70 crypto assets, including Bitcoin, Ethereum and Tezos. For more information, please refer to the ZenGo website.
China: Consortium Chains & Peculiarities
Over the past few years, stringent cryptocurrency regulations have been introduced in China, including:
- The ban of cryptocurrency transactions.
- The ban of cryptocurrency exchanges.
- The ban of Initial Coin Offerings (ICO).
- The ban on cryptocurrency mining.
As a result, the adoption and real-life application of blockchain technology in China is considerably different compared to the rest of the world. For example, in the rest of the world public, decentralised public blockchains make up the majority of the market, while in China it is ruled by consortium blockchains: a type of blockchain that has much less transparency and is often approved by the state-backed Blockchain Services Network (BSN).
As a matter of fact, users of NFT marketplaces that are built on Chinese consortium chains can only make purchases with the Chinese fiat currency RMB, and secondary trading is widely prohibited to prevent speculation. Some of the largest consortium blockchains in China include:
- AntChain (powered by Alibaba): 2298 blockchain patents, over 100 million digital assets uploaded onto AntChain on average every day.
- Zhixin Chain (powered by Tencent): Partnered with QQ Music, Xiaohongshu, Kugou, and China Reading Group to provide technical solutions for digital collection projects, and also launched its own NFT marketplace: Magic Core.
- Xuperchain (powered by Baidu): Almost 3.5 million users, processed 450 million transactions and currently hold 425 independent intellectual property patents in blockchain-related areas.
In China, the most popular digital wallet is by far its central bank’s digital yuan wallet; with 261 million individual users (20% of its population) and over 87.5 billion yuan ($12.57 billion) worth of transactions.
Closing Thoughts
In light of the recent FTX crash, consumer confidence has plummeted among the crypto market and has resulted in the massive fall of liquidity in CEXs. Choosing the right cryptocurrency wallet has become even more important, since many users have learned from the hard way that asset security has become a luxury, and not a guarantee.
One could even say that to a certain extent, there is a moderate paradigm shift from CEX to DEX. It remains to be seen whether this is a spur-of-the-moment phenomenon, or there is a true decentralisation movement within the Web3 realm.
