What The Difference Between Custodial vs. Non-Custodial Wallets?

by Jessy Rayder Marketing Expert

In this article, we'll look at the differences between custodial and non-custodial cryptocurrency wallets.

You have sole control of your private keys, which control your cryptocurrency and prove the funds are yours, when you use a non-custodial wallet. With a custodial wallet, you hand over control of your private keys to someone else. Nowadays, the majority of custodial wallets are web-based exchange wallets.

After you've purchased cryptocurrency, you'll need to decide whether you want to store your funds in a Custodial Vs Non-Custodial Wallet.
You have sole control of your private keys, which control your cryptocurrency and prove the funds are yours, when you use a non-custodial wallet. While using a non-custodial wallet eliminates the need to trust a third party, it also means that you are solely responsible for not losing your keys and must take your own precautions to protect your funds.
With a custodial wallet, you hand over control of your private keys to someone else. In other words, you're putting your trust in a third party to keep your money safe and return it to you if you want to trade or send it somewhere else. While a custodial wallet reduces personal liability, it necessitates faith in the custodian who holds your funds, which is usually a cryptocurrency exchange.

Nowadays, the majority of custodial wallets are web-based exchange wallets. The following information can assist you in determining which option is best for you.

What is a Custodial Wallet, and how does it work?

A Custodial Wallet is one in which the private keys are controlled by a third party. That is, the third party has complete control over your funds, and all you have to do is give permission to send and receive payments.

Advantages and disadvantages

Most — but not all — web-based crypto wallets are custodial wallets, and the first time you buy crypto, it'll almost certainly end up in a custodial exchange crypto wallet. In this case, the exchange acts as your custodian, holding your keys and entrusted with the safekeeping of your funds. It's critical to use a reputable custodial wallet, such as those provided by major U.S. crypto exchanges, where the majority of customer funds are held in cold storage hardware wallets and are extremely secure.

While a custodial wallet is less secure than a non-custodial wallet, many people prefer it because it requires less responsibility and is generally more convenient. If you do not take adequate precautions, losing your password to a non-custodial wallet could be financially disastrous. You should be able to reset your exchange account password if you forget it. To best protect the digital assets in your crypto wallet, follow the exchange's recommended security measures.

Investing in crypto ETFs and ETPs is another option for a custodial wallet. These newer options are gaining traction, particularly among institutional investors looking to diversify their cryptocurrency and token investments. They provide a way to invest in cryptocurrency without having to manage keys or transact on the blockchain. They do, however, charge higher fees and offer access to a smaller number of cryptocurrencies and trading pairs than exchanges.

Advantages of Using Custodial Wallets

Transactions are free:

One of the most significant advantages of a Custodial wallet is that it does not charge a transaction fee, unlike other wallets. It allows customers to conduct transactions within the ecosystem for free. Freewallet, a custodial wallet that helped consumers save around $500,000 on network fees in 2019, is a great example of this.

The loss of private keys has had no significant impact:

Your custodial wallet is managed by a third party. Even if you misplace your private key or forget the mnemonic phrase, regaining access to your wallet and stored funds is simple.

Increased backup potential:

Another benefit of custodial wallets is that the central authority that manages them provides backup services. This makes undoing a transaction or reverting to a previous version much easier.

Custodial Wallets' Drawbacks

Control of your funds by the custodian:

The most significant disadvantage of using Custodial cryptocurrency services is that you lose control of your wallet.

The custodian, or third party, has complete control over your funds and related processes. They have complete control over the funds, including the ability to freeze the amount held.

KYC is required:

Another disadvantage of introducing Custodial wallet to your services is that it strongly encourages users to complete KYC (Know Your Customer, ID Verification). You won't be able to access your funds or any of the associated services unless you can prove your identity. The requirement for identifying verification obstructs the fundamental principle of cryptocurrency, namely anonymity.

Threat of a data breach:

When it comes to custodial vs. non-custodial exchange, it's more likely that the first time you buy crypto, it'll end up in a custodial exchange online crypto wallet.

Custodial cryptocurrency exchanges keep a large portion of their users' funds in cold and hot wallets. While the involvement of various conformations makes these wallets less appealing to hackers, they are still vulnerable to security breaches.

One such incident occurred in 2014 at the Japanese exchange Mt. Gox, when over 70% of bitcoin transactions were hacked, resulting in a $450 million loss.

There is no offline capability:

Last but not least, an Internet connection is required to access the Custodial wallets or conduct any transactions.

Now that we've covered that, let's look at the concept of Non-Custodial wallets to get a better understanding of both before moving on to the Custodial vs. Non-Custodial comparison.