Once you’ve decided to acquire some cryptocurrency, your most important consideration is your wallet type. Here, the ‘wallet’ refers to the hardware or software that holds crypto coins, and it’s generally a consideration between custodial versus non-custodial wallets. They allow cryptocurrency enthusiasts to store and transact their digital assets by connecting to and interacting with specific blockchain networks.
Read on for a detailed insight into the difference between custodial and non-custodial wallet options.
A custodial wallet is a type of wallet where your private keys remain with a third party. They are services provided by centralized entities such as cryptocurrency exchanges or crypto custodians. Those providers handle the security of the assets on behalf of their clients with most of the time regulated and audited cryptographic security softwares.
On the other hand, non-custodial wallets do not require a third-party service. It is a type of wallet where you own and exercise complete control over the private keys and your crypto assets. A non-custodial wallet allows you to be your own bank in the simplest terms. In other words, a non-custodial wallet is also known as a self-custody wallet.
Custodial Vs. Non-Custodial Wallets Differences
If you purchased cryptocurrency recently, the chances are high that you’ve used a custodial wallet. Most cryptocurrency exchanges like Coinbase and Gemini offer them, and typically, they are the easiest to use. But how do you differentiate a custodial wallet from a self-custody wallet?
Private Keys Custody
One of the critical differences between custodial and non-custodial wallets is the private key custody. For the custodial wallet, the private key belongs (or shared in case of Multi-Party computation technology) to the third-party provider who manages and secures them. They relieve the user of the responsibility of securing their private keys.
With non-custodial wallets, users retain their private keys and take the responsibility of protecting them. They must hold their private keys securely since the loss of private keys could mean losing access to their wallet and their crypto assets forever.
Possibility of Wallet Recovery
Custodial wallet users do not take part in managing and storing their private keys. Their data is held securely by the wallet service provider. Therefore, even if they lose their log-in details, they can always recover their wallet by requesting the assistance of a third-party provider.
For self-custody wallet users, recovering a lost wallet is much more complex and can even be impossible. Besides the private key, users must remember a series of 12-24 words known as the seed phrase. It’s also known as the recovery phrase, and they must keep track of it to be able to recover their wallet if they lose access. If they lose the private keys and the seed phrase, it becomes impossible to recover the wallet.
Custodial wallet and custodians in general must undergo a security audit and other security certifications like ISO and SOC 2 Type 2. As their number one priority is security they manage cryptocurrencies through complexe cryptography softwares to make sure that the funds from their customers are safe.
With a non-custodial wallet, users are responsible for their own security. The basics requires the use of a hardware wallet and that their seed phrase is stored in a safe or a very secure non-digital location. Please refer to our article: How to keep your crypto safe for crypto security 101.
Choosing a cryptocurrency wallet comes down to a few critical issues like ease of access and use, security, and recovery. Non-custodial wallets undoubtedly provide a higher level of anonymity than custodial wallets. But then, they tend to be a significant risk as they could even lock you out—to your disadvantage if you lost your private key and seed phrase.
On the other hand, custodial wallets seem to be the future of cryptocurrency storage and management due to the ease of access, use, and recovery if lost. For the past 2 years we have seen the amount of crypto assets secured by custodians rising with institutions and corporates entering the crypto market.
Non custodial wallets will still be at the root of the crypto general idea of becoming your own bank, but handling their security is not made for the general public.