Custodial versus Non-Custodial Wallets

Most of us have only ever known fiat currency. That is, money that exists by government decree. We use it to buy groceries (medium of exchange), at different relative prices (unit of account) and often have it stored in our bank account (store-of-value). But it hasn’t always been like this.

The money we take for granted today, in the grand scheme of things, is still largely an experiment, and it has not yet endured the tests of time.

Once we recognise that our current monetary system is not even a century old, it becomes less of a stretch to realise that with the rise of cryptocurrency, we have a real opportunity to reimagine the future of money. But as we adopt this new type of money, we also need to adapt our way of thinking about money and change some of the ways we deal with it.

Tapping into a larger conversation about ownership, security, and liquidity, in this post, we will have a look at ‘custodial versus non-custodial wallets’.

Ownership

Unlike conventional money, with cryptocurrency, you have an opportunity to actually own your money. Remember that cryptocurrency only exists on the blockchain and to make any type of transactions you need to have the private keys, or ‘the password’, so to speak. If you hold the private keys to your own assets, your money cannot be confiscated, frozen, or redirected.

But just because you’ve bought cryptocurrency does not mean you necessarily have full control over it: ultimately it depends on whether you’ve stored your keys in a custodial or a non-custodial wallet.

Custodial wallets are services and exchanges that don’t provide you access to private keys, and instead store them on servers. For example, if you’re into trading crypto on a centralised exchange, although you have your own account and a personal balance, your funds are actually stored in the exchange’s ‘meta-wallet’. This means the custodian — in this case, the exchange — holds the ultimate power over your funds.

Non-custodial wallets give you full control over your funds and often provide serverless solutions. Your private keys are stored in an encrypted manner on your device, and only you decide what happens to your money. Whenever you make a transaction, it is recorded on the blockchain, ownership is transferred, and once confirmed that transaction cannot be reversed.

Security

Choosing what type of wallet you use for your funds is only one aspect of keeping your funds secure. But it’s an important part of it.

With custodial wallets, you are ultimately dependent on the security measures the custodian takes to keep your funds safe. A common technique used by exchanges is to keep a part of customer funds in cold storage, but for any trade to be possible some of it will have to be ‘online’ and as we’ve seen throughout the years: exchanges are high-profile targets for hackers. And once your funds get stolen, there is not much you can do.

However, and it must be mentioned, if you lose access to your account — for example, you forget your password — an exchange should have mechanisms in place to help you regain access to your account.

With non-custodial wallets, you are solely responsible for the safety of your funds. Make sure you set-up your wallet in a way that it requires a password to open it, make sure it auto-locks quickly, don’t share your login details with anyone.

Non-custodial wallets are arguably much safer than custodial wallets, but bear in mind, that if you forget your password or lose your device, the only way to recover that wallet — and the funds kept inside — is with the seed phrase given to you when you first set up the wallet. This seed phrase consists of twelve words that you should write on a piece of paper (or engrave into metal) and preferably keep in two separate locations. If, for some reason, you lose this seed phrase, there is no way to recover your wallet and you will never be able to access your funds again.

Usability

For the reasons mentioned above, custodial wallets allow for more customer service to be built into the product, ultimately making it easier to use as a customer. You can have a mobile wallet installed on your phone for example and if your phone happens to break, you can just download the app again on another device and login with your customer account details. This is possible because your funds are held by the company that has built the app, and you only need to login to access it. With Bitspark for example, you can create an account on the website, load it with funds, and then later download the mobile app and log in to access the same funds under your account.

A non-custodial mobile wallet would not be that easy to restore, as you would need the seed phrase. But it does provide you with much greater security.

If you’re keen on using crypto for occasional payments, a non-custodial wallet may also be the best solution for you. You keep your money with you, and whenever you want, you make the required transactions.

In the end, your choice depends on your overall aim.

Originally published at https://www.bitspark.io.