Custodial vs. Non-Custodial wallets: What are the differences?
Tags: crypto, blockchain, beginners, cryptowallet
Published: 2023-04-12 18:14:05

_Choosing the best type of wallet for storing and safeguarding digital assets is critical for crypto ownership. There are many different types of wallets on the market, and deciding which one to choose can be difficult. This article delves deeper into the differences between custodial and non-custodial wallets. Continue reading for a quick guide on whether you should keep your own crypto key or delegate responsibility._

_**Important Takeaways:**_

- With a custodial wallet, a third party manages your private key rather than you, the crypto owner.

- With a non-custodial wallet, you control your own private key and thus your funds.  

- One disadvantage of non-custodial wallets is the lack of recovery options if you forget your passwords.  

- Non-custodial wallets, on the other hand, give you complete ownership of your cryptocurrency, making you responsible for the security of your own private keys and funds.

**Custodial Wallets**
To understand how a custodial wallet works, you must first understand how crypto wallets work. A cryptocurrency wallet is a software or hardware device that allows you to store, access, and interact with cryptocurrencies such as Bitcoin and Ethereum. A user's funds are not stored in a crypto wallet. Instead, they contain the public key, which allows you to set up transactions as the user, and the private key, which is used to authorize transactions. Software wallets are installed on a user's device, whereas hardware wallets are standalone physical devices used to store digital assets. (desktop or mobile). 

Private keys—strings of letters and numbers that act as a highly sensitive password—are stored in both hardware and software wallets. Possession of a private key allows you to send crypto assets from a specific public address, making private key management critical.

A custodial wallet, as the name implies, is one in which a third party stores private keys on behalf of users. The third-party has complete control over the crypto assets, managing the user's wallet key, signing transactions, and protecting the user's crypto assets. Custodial wallets are available from custodial wallet providers or cryptocurrency exchanges as mobile or web applications. You use the wallet provider's interface to manage your funds and make transactions once you log in to your wallet account. 

This implies that you must have trust in the service provider's ability to securely store your tokens and implement strong security measures to prevent unauthorized access. Two-factor authentication (2FA), email confirmation, and biometric authentication, such as facial recognition or fingerprint verification, are examples of such measures.

Custodial wallets are a low-entry barrier if you are a newbie in the crypto space as they are simple to use and can be accessed from any device with an internet connection. Security, on the other hand, is a major concern because centralized exchanges have previously been victims of cyberattacks, compromising users' keys and cryptocurrency assets.

Custodial wallets however have some advantages, such as requiring less user involvement in private key management. When you outsource wallet custody to a company, you effectively outsource your private information to that company. You are not responsible for keeping the private key to the wallet safe, so you rely on the company to do so. Binance and Coinbase are some examples of custodial wallets. Only after identity verification are you able to hold crypto assets on these custodial exchanges.

**Non-Custodial Wallets**
A non-custodial wallet, also known as a "self-custody wallet," is one in which you are entirely responsible for managing your own funds as a cryptocurrency owner. You have complete control over your crypto assets, as well as the ability to manage your own private key and handle transactions on your own. Non-custodial wallets are preferred by crypto experts, security advocates, and the larger decentralized community because they do not require trust to be outsourced to an institution, and no institution can refuse to complete transactions.

Non-custodial wallets come in various forms. Browser-based wallets, which are browser extensions that allow you to enter your private key and initiate transactions, or mobile wallets, which are downloadable mobile apps, are two options. It could also take the form of hardware wallets, which are physical devices. Many people believe that hardware wallets are the most secure option because they can be accessed and managed while not connected to the internet. 

A seed phrase is provided by non-custodial wallets. When you create the wallet, you will be asked to write down and save a sequence of 12 randomly generated words known as a 'recovery, ‘seed,' or 'mnemonic' phrase. The public and private keys can be generated from this phrase. It also functions as a backup or recovery mechanism if users lose access to the original device. Anyone who knows the seed phrase will have complete control over the funds in your wallet.

If the seed phrase is lost, you will no longer have access to your funds. Each transaction is your responsibility to manage and complete. To send money and complete other transactions, you'll need your private keys. The transaction can be reflected in real-time on-chain depending on the non-custodial wallet used, or it can be signed offline and uploaded to the blockchain for confirmation later. 

Hardware, or "cold" wallets, which store private keys offline on a standalone device that looks and feels similar to a USB drive, are one of the most popular types of non-custodial wallets. When you want to send a cryptocurrency transaction, hardware wallets connect to the internet. A non-custodial wallet, particularly a hardware wallet, may be the best option if you need to store a large amount of crypto assets. 

Furthermore, in order to interact with decentralized applications, you will need a non-custodial wallet if you want to invest in DeFi. Keep in mind that having complete control over your assets entails greater responsibility. You must backup your wallet and keep your private keys in a secure location. Non-custodial wallets, such as Bitpay, Electrum, Trust Wallet, and MetaMask, are examples of software that you install on your computer or mobile device.

**How Can I Tell What Kind of Wallet I'm Using?**
In contrast to custodial wallets, non-custodial wallets provide users with complete control over their private keys associated with the wallet's public address. You have a custodial wallet if you can only access it with a login and password and do not have your own private key. Otherwise, you have a non-custodial wallet.

**Conclusion — Choosing between a Custodial or Non-Custodial Wallet**
Custodial and non-custodial wallets both have benefits and disadvantages. If you value convenience as well as backup and recovery options, custodial wallets are a good choice. Non-custodial wallets, on the other hand, may be exactly what you're looking for if you want complete control and ownership over your private keys. 

**Do Your Own Research and Due Diligence**
This article's examples are provided solely for informational purposes. Any of this information or other material should not be construed as legal, tax, investment, financial, cyber-security, or other advice. Past results do not assure or predict future outcomes. The value of crypto assets can fluctuate, and you could lose all or a portion of your investment. You must conduct thorough research and due diligence when evaluating a crypto asset in order to make the best possible decision, as any decision you make is solely your responsibility.

_Cover Photo by Regularguy-eth from Unsplash_