Custodial vs. Non-Custodial Crypto Wallets
Cryptocurrency is an exciting and innovative space. I don’t know about you, but when I first got involved I felt like I’d uncovered the world’s best-kept secret. And let’s face it – if you’re here in the crypto space, you’re in on it too. That said, one of the first things that caught my attention was how to store cryptocurrencies. Namely, the differences between a custodial vs. a non-custodial crypto wallet.
Being new to the crypto space I had absolutely no idea what custodial or non-custodial meant. While surely there are many resources out there, being new to the scene, understanding the different terms proved to be challenging at first.
This brings me to the purpose of this article, which is to break down the differences between custodial and non-custodial wallets. Having spent some time immersing myself in the crypto space, I hope to highlight the main ideas in a straight and simple way that anyone new could understand.
We’ll be taking a closer look at what each type of crypto wallet does, along with their features, benefits, drawbacks, and use cases. So, let’s jump right in.
What is a custodial crypto wallet?
To put it simply, a custodial wallet is essentially a crypto wallet where the keys are controlled by a third party. It is comparable to how banks custody your fiat currency held in their bank account. A custodial wallet is in essence the same idea but applied to digital assets, namely cryptocurrency.
Some of the more popular custodial wallets are those operated by exchanges and DeFi service providers.
Some of the most common exchanges people hold their crypto-assets on are: Binance, Coinbase, Kucoin, Gemini, Okex, Bitstamp, and Crypto.com. Some of the more recent custodial wallets to pop up have been provided by DeFi service providers such as Celsius, Nexo, and BlockFi.
These services are more akin to traditional banking services where they custody your cryptocurrency, but also use it to allow them to provide crypto-loan services to those seeking them, completely controlled by smart contracts. You earn a fluctuating APR % based on your assets being loaned out, and those loans being paid back.
This may sound all well and good, but a custodial crypto wallet does come with some caveats.
I’m sure you’ve heard it many times before but I’ll repeat it here for good measure:
“Not your keys, not your crypto”.
A custodial wallet essentially means that the third party controls the private keys to your wallet – and by extension, the crypto assets stored in those wallets. As you can imagine, this can be concerning.
Since the keys are controlled by the exchange, should anything happen to them, your assets have the potential to be at risk along with it.
It’s happened in the past, most notably with Bithumb, Coincheck, Bitgrail, and Coinrail. Coincheck tops that group with an estimated $534million in NEM coins stolen.
This isn’t the only risk with custodial wallets though. If for some reason the exchange goes down, exit scams, or believes you to be caught up in nefarious activities, they can lock your access to the wallet, run off with your assets, disable withdrawals, or close your account. You get the idea.
Building on these risks, the same can be said with DeFi providers. Because your assets are being loaned out to others who use the service, there is a risk that your assets are not paid back (even though those taking these loans would have to provide collateral to be able to take the loan, the risk is still present).
If you have a look at the terms and conditions of these providers, this will be outlined within those terms. Celsius has recently updated their terms of service which you can read here.
The updates are concerning, to say the least. Always consider every possible outcome when engaging with a custodial wallet service.
Custodial wallet use cases
So, if you’re aware of the above, why would someone use a custodial wallet? To put it simply, it’s easy. In fact, it’s perhaps the easiest way to go about crypto storage.
This makes it the most popular type of wallet for beginners to use in the crypto space. The ease-of-use, accessibility, and seamless crypto buying experience all check the right boxes. In fact, if you own any crypto in the exchanges listed above, chances are you’re using their custodial wallet services.
With a custodial wallet, generally you only need a password (plus any 2FA you have enabled) to access your exchange or DeFi provider account. Also, depending on your custodial wallet provider, withdrawal fees to other wallets or providers can usually be a lot lower (depending on the asset and current market prices).
Having your assets on an exchange platform also means you can easily buy, sell, or swap into other assets without the rigmarole of sending from your wallet to the exchange.
Other minor benefits will include pretty aesthetics and usually options to stake, loan, or purchase other financial services like Crypto ETF’s and ETP’s.
This boils down to your personal preferences. If accessibility ranks high on your list, then a custodial wallet may not be such a bad idea. But if you want more control over your private keys, and perhaps more security, consider the non-custodial variant.
Pros and cons of custodial wallets
With that said, here are some pros and cons of using custodial crypto wallets outlined for you:
- Quick and easy access.
- Easy to navigate interface.
- All (or most) assets in one place.
- Can quickly buy, sell and swap between the range of assets provided by the exchange/provider.
- Low cost sending fees (not all exchanges).
- Pretty user interface, with easy to read information.
- Options to borrow, stake, or loan assets out.
- Options to purchase things like Crypto ETFs and ETFs using your assets.
- “Not your keys, not your crypto”. Wallet is controlled by a third party.
- Less secure than an offline cold storage wallet.
- Susceptible to hacks, resulting in loss of funds.
- At the complete mercy of the exchange or provider.
- Some providers have shady terms of service, with lack of transparency for their fees.
- Some providers loan your assets out to other users to enable the payment of interest, but this comes with risk of asset loss if the user doesn’t pay their loan back.
- Exit scams are always a possibility.
- Accounts can be closed or locked if exchanges think you are engaged in shady activities.
As you can see there are a lot of things to unpack before handing your assets over to a third party.
Now that you’ve got some background on custodial wallets, next we are going to take a closer look at non-custodial crypto wallets.
Learn the fundamentals: How do crypto wallets work?
What is a non-custodial crypto wallet?
In an ideal crypto space, a non-custodial wallet is something everyone should have. It is a wallet that you own the private keys to – meaning any cryptocurrency assigned to the wallet is completely within your possession and cannot be controlled, manipulated, or stolen without control of the private key.
A non-custodial wallet comes with a range of security-based benefits and comes in both hot and cold wallets. Some even offer a hybrid of the two, such as Exodus and Trezor – where you can have the best of both worlds.
Deciding which non-custodial wallet is right for you is something you will have to figure out for yourself, but we’ll touch on some of the benefits these types of wallets provide.
Non-custodial hot wallets
A non-custodial hot wallet is a wallet that is connected to the internet 100% of the time. This is one of the more common non-custodial wallets used for crypto storage.
You will see most of your peers and people online using one of these as their interim (and sometimes full-time) wallets.
Below are some examples of popular non-custodial hot wallets:
- Exodus Crypto Wallet
- Trust Wallet
- Atomic Wallet
These wallets allow you to hold the private keys yourself, meaning you are in control of and own your crypto outright. However, because they are still connected to the internet there is still a risk of the wallet providers servers being attacked.
This is something to be wary of, as even though you hold the keys, there is a chance attackers can get into these types of wallets as they are always online.
Crypto OG’s and seasoned users will usually use these types of wallets for interim transacting and holding smaller amounts of crypto.
Non-custodial cold wallets
A non-custodial cold wallet is arguably the most secure type of crypto storage. You have full ownership of your private keys, and you also secure them in an offline environment away from malicious threats online.
Being a cold wallet, they are secured by physical devices which unless interacted with, remain offline, making it harder for attackers to access. And since they are non-custodial no one can tamper with your private keys, and no one can authorize any transactions without your consent.
Below are some notable examples of non-custodial crypto cold wallets:
As mentioned above, non-custodial cold wallets are perhaps the most secure method for crypto storage. Trezor and Ledger especially are very user-friendly to be easy to set up and begin using, but also safe enough to give peace of mind that your assets won’t be going anywhere without your consent.
As with anything, there are still risks involved and I highly recommend you research which cold wallet best suits your needs before buying.
Cold storage wallets can sometimes be costly and are still prone to becoming lost or damaged. Remember to always back up your secret phrases and keep them somewhere safe and secure.
Custodial vs. non-custodial crypto wallets
The differences between Custodial and Non-Custodial wallets are minor in terms of functionality, but when it comes to security and peace of mind the differences are quite significant.
Custodial wallets entrust your private keys and security of your assets with a third party while offering the benefits of accessibility and ease of use.
Non-custodial wallets provide you the full ownership of your keys and an arguably safer crypto storage solution. With only the initial purchase price being a deterrent for some.
So, as I prefaced early on – it comes down to your personal preferences, how much control you are willing to exert over your assets, and what features you seek for your crypto investment purposes.
Someone with a large capital wanting to dive into cryptocurrencies as a way to diversify their assets may want to opt for a non-custodial crypto cold wallet for the utmost security.
While newcomers in the crypto space who want to get to know and familiarize themselves with digital crypto assets may find the custodial wallet option perfectly tailored to their needs.
Need some wallet suggestions? Narrow down your choices with our guide on crypto wallets.
When it comes to crypto storage, the most commonly discussed topic is often around hot or cold wallets. I feel like knowing and understanding the differences between custodial and non-custodial is just as important for anyone wanting to get into the crypto space.
Cryptocurrency has opened up a world for people to regain this responsibility essentially freeing you from reliance on a third-party entity.
As always remember to take responsibility for your wealth and investments.
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