Custodial Wallets vs. Non-Custodial Wallets: What’s the Difference?
Securely storing your digital currencies and tokens is arguably the most important aspect of investing in crypto. Choosing the right wallet is, therefore, imperative for every crypto holder. Read on to learn about the difference between custodial and non-custodial wallets to find out which one is right for you.
What Is a Crypto Wallet?
A cryptocurrency wallet is a software application or a physical device that enables you to store your digital currencies and tokens.
While we use the term “store” to simplify the explanation in this guide, your digital assets are actually stored on the blockchain. Your wallet gives you the private keys to access the assets stored on the blockchain. A crypto wallet – to be technically correct – enables you to manage your public and private keys to access and use your crypto assets.
There are different types of crypto wallets, such as desktop wallets, web wallets, mobile wallets, paper wallets, and USB stick-like devices. They can be categorized as either software or hardware wallets. The latter is disconnected from the internet, making them the more secure option for long-term storage.
Moreover, crypto wallets are either custodial or non-custodial, which is what we will look at in more detail in this guide.
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What Is a Custodial Wallet?
A custodial wallet is a type of wallet in which a user’s private keys are held by a third party. The service will have control of the funds while the user has the access to send or receive funds.
This method tends to be easy to onboard first-time users, as they can quickly get familiar with the process of initiating and completing crypto transactions. They are exempted from the complexity of managing arguably complex public and private keys to access their funds.
Custodial wallets are offered by centralized services, such as crypto exchanges like Coinbase and Binance, but there are also wallet providers that hold their users’ private keys.
Moreover, custodial wallets tend to have lower security levels and higher transaction costs than their counterpart: non-custodial wallets.
What Is a Non-Custodial Wallet?
A non-custodial wallet is a wallet that gives users complete control of their assets. Only the user has access to the wallet’s private keys, making non-custodial wallets more secure and, above all, censorship-resistant.
While non-custodial wallets are arguably more complex to set up and use than custodial wallets, they provide users with complete financial sovereignty as they are the only ones that can access and manage their funds.
With users holding their own private keys comes the risk of permanently losing access to the funds held in the wallet if the wallet is not backed up correctly. Losing private keys or seed phrases or forgetting decryption passwords has led to millions (if not billions) in crypto that is lost forever.
Examples of popular non-custodial wallets include Exodus, MetaMask, Trust Wallet, and Ledger Nano X.
Custodial vs. Non-Custodial Wallet: Pros & Cons
| Custodial Wallets | Non-Custodial Wallets | |
| Ease of use | Custodial wallet interfaces tend to be easier to use for beginners getting started with crypto transactions. | Non-custodial wallet interfaces often are more complex for beginners to make transactions. |
| Wallet security | Often offer moderate security and are more vulnerable to hacks/ centralized attacks. | Tend to offer higher security and are less vulnerable to data breaches than custodial wallets. |
| Control of funds | The custodial service has control of the user’s assets; the user has permission to make transactions. | The user has full custody or control of their crypto assets. The saying “not your keys, not your crypto” is often cited in favor of having these wallets. |
| Back-up and recovery | Account recovery, in the case of forgotten passwords, is easier with custodial wallets, as the wallet provider can provide a recovery mechanism. | Recovery tends to be difficult, if not entirely impossible when a user loses or forgets their private keys. A loss of keys is a loss of all funds in a non-custodial wallet. |
| Censorship | A custodial service can be halted or stopped from offering its users services in certain regions. The service may also elect to freeze a user’s assets under certain conditions. | Non-custodial wallets are censorship-resistant. They are far more difficult to ban, hack or freeze than custodial wallets. |
| Transaction costs | Users are obliged to predetermined fees set by the custodial service; some might be high. Therefore, users don’t control the transaction costs. They could also be free for in-wallet transactions, which is an added advantage. | Different non-custodial wallets offer various rates of transaction costs, which can be significantly lower than custodial wallet transaction rates. |
| Service diversity | Custodial wallets limit their users to a specific number of services (e.g. exchange, deposit & withdrawal on a limited number of crypto assets), subject to legal flexibility and liability on their part. | Non-custodial wallets offer users direct access to blockchains and smart contracts, which diversify the number of applications or services (e.g. decentralized finance) they can interact with from the same wallet. |
| Offline access | Users must log in to their custodial wallets. Therefore, they must be online to transact on their wallets. | Users can have offline access with non-custodial wallets as they don’t have to sign in to complete all transactions. |
| Data privacy | Custodial services require identity verification prior to approving a user’s account. Anonymity is impeded in these services through various KYC requirements, which bring concerns about the wallet provider’s security mechanisms in place to protect user data. | Non-custodial services provide services to users with little to no requirement of their identity documentation. Privacy and anonymity are preferred in these types of wallets. |
| Trade execution | Exchanging cash for crypto is easier and faster on custodial services, which provide multiple on and off-ramping methods connecting to banking and financial services. | Trade execution on non-custodial wallets is slower, and funds often have to be transferred to custodial wallets for more convenient access to cash /fiat gateways. |
| Burden of responsibility | The custodial service bears the burden of responsibility to maintain users’ wallets. | Non-custodial wallets require individual users to bear all responsibility and risk of maintaining their wallets. |
What Wallet’s Best for You?
If you are a beginner, you may find it easier to start with a custodial wallet to make basic transactions and get accustomed to exchanging fiat for crypto assets. If you have a preference for non-custodial wallets, that’s also great, as long as you understand how to manage the risks associated with each type of wallet.
As an intermediate user, with a better understanding of wallet security, managing your own keys, and securing your crypto assets, you can begin to move funds in non-custodial wallets. The more you gain confidence in crypto transactions and comfort with non-custodial wallets, you should eventually move all your crypto assets to non-custodial wallets. Going for hardware or offline wallets is advisable if you are well versed in managing risks related to non-custodial wallets.
As an advanced crypto user, you’ll be well placed to exclusively use non-custodial wallets to manage your crypto assets.
For long-term storage, you need to hold your funds in a non-custodial wallet. But make sure that you have clear and well-referenced documentation of your wallet information (especially your recovery phrase and your decryption password). Also, always follow wallet security best practices to avoid an otherwise extremely painful loss of your crypto.
FAQs
Why Do Custodial Wallets Receive a Bad Reputation?
The difference between custodial wallets and non-custodial wallets is that custodial wallets hold the wallet’s private keys on behalf of the users, giving the service provider de facto control over the user’s funds.
Personal financial sovereignty lies at the core of Bitcoin and crypto-technologies, which is why self-custody using a non-custodial wallet (where the user holds their own private keys and thus has control over their assets) is considered the “correct” way to securely store your cryptocurrency.
What Is a Crypto Wallet Address?
A cryptocurrency wallet address is an alphanumeric string of characters that represents the public keys of a crypto wallet that is used to receive crypto payments from third parties.
What Is a Crypto Wallet Used for?
Cryptocurrency wallets are primarily used for storing crypto assets (or rather the private keys to access them). However, today’s leading digital asset wallets provide a range of features, including the ability to access decentralized applications (DApps), swap one cryptocurrency for another, and buy crypto with a bank card.
CryptoWallet, for example, allows you to buy and securely store five leading crypto assets and enables you to spend your cryptocurrency using a crypto debit card.
