Summary:
  • A non-custodial wallet allows absolute control over your private keys, allowing you to manage your cryptocurrencies and provide proof of fund ownership 
  • A custodial wallet gives someone else access to your private keys. These days, web-based exchange wallets make up the majority of custodial wallets.
  • This article aims to explain the distinction between custodial and non-custodial wallets

The dramatic FTX cryptocurrency exchange collapse has sent shockwaves through the sector. It has also brought up several crucial issues, such as the fundamental definition of speculative investments.

An army of angry clients was left without access to their hard-earned coins when FTX temporarily banned withdrawals of user cash, citing liquidity difficulties, just before declaring bankruptcy.

Since the vast majority of centralized cryptocurrency exchanges use non-custodial wallets, clients entrust the exchange to hold and manage their funds.

After buying cryptocurrency, you must choose between a custodial wallet and a non-custodial wallet to manage your funds. This blog aims to explain the distinction between custodial and non-custodial wallets.

What is a Non-custodial Wallet?

There’s a cliche in the crypto community that goes, “Not your keys, not your crypto,” which effectively implies the only real and verifiable owner of the money in a wallet is the person who owns the private key. It is generally agreed in the crypto community that users who opt for custodial wallets don’t genuinely own their cryptocurrency because they don’t have access to the private key.

When using a non-custodial wallet, you have complete control over your private keys, allowing you to manage your cryptocurrencies and provide proof of fund ownership. However, while utilizing a non-custodial wallet eliminates the need to rely on a third party, it also means that you are entirely responsible for keeping your keys safe and must take security measures to safeguard your funds. 

What is a Custodial Wallet?

A custodial wallet gives an external party access to your private keys. In other words, you’re putting your faith in a third party to look after your funds and give them back to you if you decide to trade or transfer them someplace else. A custodial wallet reduces personal accountability but necessitates faith in the custodian, typically a cryptocurrency exchange, that holds your investment.

Users of custody wallets can rest easy knowing they will still have access to their money even if they forget or lose their password. Most of the time, your password can be reset by providers or exchanges with the help of a few security questions. A non-custodial wallet owner may lose access to their money if they misplace their private key. 

Custodial Wallets vs Non-custodial Wallets

These days, web-based exchange wallets make up the majority of custodial wallets. You may choose which is best for you with the following information.

Custody wallets have a low entrance barrier for people new to the cryptocurrency industry since they are easy to use and available from any device with an internet connection. However, security is a major concern. 

Custodial wallet users don’t truly control their crypto assets since a third entity, such as a cryptocurrency exchange or wallet provider, holds their private keys. Instead, users must rely on the third-party custodian to safeguard their coins.

In contrast, non-custodial wallets, sometimes called self-custody wallets, are intended to offer users complete control over their private keys. However, the freedom to be your own banker comes with the risk of safeguarding your assets. 

Hardware wallets, often known as cold wallets, are one of the most widely used non-custodial wallet types. These wallets save private keys offline on a separate device that frequently resembles a USB drive in appearance and feel. Only when you wish to conduct a  transaction may a hardware wallet connect to the internet.

Security Aspects

You must choose the wallet type that offers the best balance of ease of use and security for your funds because each wallet has advantages and disadvantages. A mix of the two is sometimes used by those who favor a custodial exchange account over non-custodial wallets. You must also decide whether you want a hot or cold wallet and whether you want to divide your cryptocurrency holdings among several crypto wallets. Whatever decision you make, always adhere to proper security procedures.

Self-custody crypto wallets are generally safe since neither the network’s transactions nor currency can be stolen using a public address. However, non-custodial wallets can also be a clear alternative for someone wishing to be financially independent, as we saw with the FTX incident.

Your funds are only as safe as the private key you require for transactions. When you work with cryptocurrencies, your investment is probably gone for good because there is no central authority you can turn to if you misplace it.

Which wallet should you use?

The qualities of a wallet that are most essential to you will help you decide between a non-custodial and a custodial wallet. Newcomers and individuals who appreciate the set-and-forget simplicity of managing their cryptocurrency through an exchange or other centralized wallet provider would typically choose custody wallets. On the other hand, users who want to exert more control over who has access to their funds should use non-custodial wallets. Both wallets have advantages and disadvantages, so consider your comfort level with the most important features before making a choice. You should also consider the benefits each wallet provides, such as the range of supported coins, staking opportunities, cashback rewards, and crypto debit or credit cards.