The essential guide to crypto wallets: Custodial vs Non-Custodial Wallets

Intro

If you’ve ever used cryptocurrencies before, you know that having a crypto wallet is essential for transactions, trading, or using other blockchain applications. When it comes to crypto wallets, there are many different types of wallets. However, these can be split into two general types: custodial and non-custodial. While both have their benefits, it’s important to understand the key differences between them before deciding which one is right for you. In this blog post, we will break down the pros and cons of each type of wallet to help you decide which is a better fit in your metaphorical pocket!

How Crypto wallets work

Wallets are termed this because they function similarly to a wallet in which cash and cards are stored. Instead of physical goods, it ‘stores’ the passkeys you use to sign crypto transactions and offers the interface via which you may access your assets.

The word “wallet” is slightly inaccurate since they don’t store your assets, per se. Instead, they scan the public ledger for all bits of related data to display the balances in your addresses, as well as the private keys that allow you to conduct transactions. When you send tokens, you are effectively signing the transaction with your private key and publishing it to the blockchain network. The network will then include your transaction to update both your and the recipient’s addresses with the amended balance.

Custodial and non-custodial wallets defined

Custodial wallets:

A custodial crypto wallet, as the name implies, is one in which your assets and your private keys will be held and managed by a third party on your behalf. In other words, you will not have complete control over your cash, nor will you be able to sign transactions. Custodial wallets work like banks and are usually referred to as ‘bitcoin banks.’

When communicating with a centralized exchange, you will usually require a custodial wallet.

Non-custodial wallets:

A non-custodial crypto wallet is one to which only the account holder has access and control over the private keys. Non-custodial wallets are the ideal alternative for individuals who desire complete management over their cash. Because there are no middlemen, you may exchange cryptocurrency directly from your wallet.

When communicating with a decentralized exchange (DEX) or decentralized application (DApp), you will require a non-custodial wallet.

Pros and Cons of each

Being your own bank can be rewarding and often comes with perks. However, it can also mean a lot more responsibility and a little bit more risk! Let’s explore some of the pros and cons of both wallet types.

Pros of Custodial wallets:

Not all of us have great memory or organizational skills. If you can relate, then there is a risk that you may lose access to your private keys — especially since it’s safer not to write your password down anywhere it is easily locatable. If your private keys become lost and you have a custodial wallet, generally, you will be able to recover them by simply contacting your custodian’s customer service.

Cases, where people can’t access their inheritance due to the keys being held solely by the original owner, can be avoided using custodial wallets.

If you are a less experienced trader, non-custodial wallets can be tricky as they are not generally as user-friendly. Finding a trusted service provider makes security and trading a lot simpler.

Like banks, some custodians will give you a return on your crypto-based savings. So, despite the extra fees involved with custodial wallets, this is somewhat compensated.

Cons of custodial wallets:

A key con of custodial wallets is that they are centralized, rely on third-party governance, and therefore do not offer you full control of your finances. Centralization contrasts strongly with the foundation upon which cryptocurrencies were built — decentralization and financial autonomy.

Custodial wallets, as mentioned above, requires you to trust and rely on a third party to hold your private keys. Security is left to a third party, if things go wrong, they are not always liable to return your crypto investment.

There are often additional fees, that are not always cheap depending on the service provider, and withdrawals can take longer as they often need approval.

Funds are less secure as they are usually stored in hot wallets (online wallets) and are, therefore, more vulnerable to being hacked or lost.

Pros of non-custodial wallets:

Non-custodial wallets are decentralized and thus offer complete control over your keys and funds, which means your assets are much more difficult to seize. In simpler terms, your assets are yours and yours only.

You incur fewer fees. Custodial wallets usually require that you pay fees to the custodians, which can sometimes be costly. Non-custodial wallets avoid these fees altogether. Additionally, withdrawals can be quicker and easier as no approval is required from a third party.

Non-custodial wallets usually offer access to advanced features such as swapping crypto, DeFi, and non-custodial access to the Lightening Network, a two-party transaction method that makes it less expensive and quicker for parties to send or receive payments from each other.

You can opt into different levels of security depending on your threat model.

Cons of non-custodial wallets:

If you lose access to private keys, you may lose access to your assets forever. Since you are the sole owner of your private key, you are entirely responsible for its safety and the security of your funds.

Non-custodial wallets are generally less user-friendly. The interfaces tend to be harder to understand, so it may cost time to research if you are a first-time crypto user.

While withdrawals may be quicker and easier, trading crypto through a non-custodial wallet is not. Often it is harder to trade cryptocurrency quickly with a non-custodial wallet as you must first send the funds to an exchange.

Humans make mistakes. There is a risk of human error occurring concerning security. Since you are solely responsible for the safety of your funds, you must know how to keep them safe. There is more risk if you lack experience or are using a hot wallet — an online wallet.

Closing thoughts

Now that you know the difference between custodial and non-custodial wallets, as well as the pros and cons of each type, you can decide which might be better for you. If you’re still undecided, that’s okay too! Many resources are available to help you research which wallet is right for you. Take some time to consider your options, then let us know what type of wallet you’re considering and why in the comments below.

To learn more about the different types of crypto wallets, click here

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