Difference Between Custodial And Non- Custodial Wallets

Discover the key differences between custodial and non-custodial wallets. Keep your crypto safe with our expert insights. Read now!

What Is A Custodial Wallet?

It is important to note that both custodial and non-custodial wallets provide access to your crypto funds, but they’re different and have their own unique merits and demerits, which will be covered in this article.

When we say a wallet is custodial it means that a third party offers to protect your digital assets (Cryptocurrency) within their system, which means they hold and manage your private keys and have actual control over your funds, offering you backup and permission to authorize transactions such as sending and receiving funds. Ever wondered why you find the “wallet” section on cryptocurrency exchanges? Well, that is because most exchanges provide custodial cryptocurrency wallets as part of their services and you hear people refer to them as “exchange wallets”. When you store your crypto on cryptocurrency exchanges such as Binance, Kucoin, bybit, etc, the wallets they provide you with are custodial. 

Custodial wallets can be likened to a bank and other financial institutions. Hence, they have full access to your funds and act as an intermediary between you and another wallet. Just like a bank account, you can open a custodial account by submitting personal documents such as your ID cards and bank statement. Custodial wallets are easy to use and require little personal responsibility for storing the private keys, but you can lose your asset if their data gets compromised.

Private Keys

A private key generally refers to an alphanumeric string that is generated at the creation of a crypto wallet address and serves as its password or access code. Therefore, whoever has access to a private key has absolute control over its corresponding wallet, and access to the funds contained within and can transfer or trade assets and use the account for other purposes. 

On a clearer note, these keys are strings of hundreds of numbers and letters all mixed up and impossible to memorize. However, many non-custodial wallets simplify them to unrelated words that you must have to write in order. Most times it is a list of 12 to 24 words which is popularly known as a seed phrase or recovery phrase which the wallet will be able to trace back to your private keys. Custodial wallets do not provide you with these private keys on the creation of an account, as they have custody of it. On the other hand, a non-custodial wallet gives you complete ownership of your keys.

What Is A Non-Custodial Wallet?

A Non- custodial wallet is also known as a self-custody wallet. It is a cryptocurrency wallet that securely stores your private keys, which are required to access your funds on the blockchain, where only you, the user, control the private keys. This means that only you have complete access to your crypto assets and no one else. Let’s say you have lost your phone where you had your crypto, you can recover the wallet again by downloading the app and inputting your seed phrase. 

Therefore, it is significant to always back up and protect your seed phrase. You can memorize it or write it down and keep the paper somewhere safe. If you forget or misplace your seed phrase, you could lose access to your funds forever. Now, looking back at custodial wallets, you do not have direct access to your private keys which to a large degree makes it unsafe to store your crypto, also measuring non-custodial wallets, you can still lose your funds if you do not protect and secure your Private keys. So, which of these wallets do you think you would want to keep your funds?

Before we look at the differences between custodial and Non- custodial wallets, let's see the different Subcategories of cryptocurrency wallet types.

Classification Of Crypto Wallets

Most custodial wallets can be seen to fall under hot wallets as they are mostly available online. non-custodial wallets on the other hand can either be a hot or cold wallet.

Differences Between Custodial And Non-Custodial Wallet

In my opinion, the main difference is the purpose of each wallet and based on individual choice. Here are some key differences people consider while choosing from either wallet.

 

1. Security/Backup: Custodial wallet may offer low security since you do not have complete ownership of your funds but requires trust in the custodian for backup of your private keys and is most accessed via the internet, which could be compromised. On the other hand, Non- Custodial users are wholly responsible for keeping their funds and private keys secure, and hardware wallet offers even more security.
2. Accessibility: To access your funding and carry out transactions, it is a must to login into your Custodial wallet and make a request to a centralized authority. But, there is no such requirement in Non-Custodial wallets. This, in return, signifies that non-Custodial wallets are a better option to enjoy the full blockchain development services in real-time.
3. Usability: As much as the custodial wallet can be less safe, they are user-friendly but the Non-custodial wallets are not user-friendly.
4. KYC (Know your customers): Custodial wallets require lengthy KYC, but Non-custodial do not.
5. On-chain Transaction: Transactions carried out are reflected on the blockchain in real-time in a non-custodial wallet. But, it is not so in the case of Custodial wallets. Here, transactions happen internally and do not reflect directly on the blockchain.
6. Speed of transactions: Faster transactions with a custodial wallet as there is no need for approval from a third party. Possible delays for external transactions due to KYC but fast transactions within the platform, for a Non-custodial wallet.
7. Security breaches: Though custodial wallets are not easy to hack, they are more vulnerable to security breaches than some types of non-custodial wallets. Centralized custodians control millions or even billions of dollars worth of crypto and are attractive targets for hackers. Therefore, before transferring your crypto funds to a certain wallet, it is important to check whether it has passed any security audits and if the users are reimbursed in case the wallet is compromised.
8. Cryptocurrency trading: Most providers of custodial wallets are crypto exchanges and they provide other platforms for trading crypto while Non-custodial does not.

Conclusion

What Crypto wallet is right for me?

Both types of wallets have different purposes, pros, and cons. Therefore, it is up to a user to measure which works best based on specific needs. People out there may prefer a custodial exchange account, others may choose a non-custodial wallet, and others will use a combination of both wallets. Each will appeal to different traders.

Before deciding on which wallet to choose, understand all pros and cons. Taking into consideration your priorities. However, if you prefer to retain complete control over your funds, you might consider a non-custodial wallet. If you are prone to losing passwords and devices, it is better to consider a custodial wallet. Since an exchange or custodian is likely to have better security practices and backup options. In the end, it all comes down to your choice.

DISCLAIMER!!

The information contained in this article is for information / educational purposes and should not be used as a deciding factor when investing in cryptocurrency. Tafabot and its authors accept no responsibility for your profits or losses resulting from reading this article. The information contained is based on data gathered from a variety of sources. Users are responsible for conducting their research and making decisions regarding their cryptocurrency investment.

Neni (tafaadmin)