Custodial vs. Non-Custodial Wallets
While a custodial wallet may be considered less secure than a non-custodial wallet, many prefer them because they don’t require as much responsibility and are usually more convenient.
Updated May 6, 2021 • 4 min read
With a non-custodial wallet, you have sole control of your private keys, which in turn control your cryptocurrency and prove the funds are yours. With a custodial wallet, another party controls your private keys. Most custodial wallets these days are web-based exchange wallets.
Once you’ve purchased cryptocurrency, you must decide whether to use a custodial vs. non-custodial wallet to store your funds.
With a non-custodial wallet, you have sole control of your private keys, which in turn control your cryptocurrency and prove the funds are yours. While there is no need to trust a third party when using a non-custodial wallet, this also means that you are solely responsible for not losing your keys and requires that you take your own precautions to protect your funds.
With a custodial wallet, another party controls your private keys. In other words, you’re trusting a third party to secure your funds and return them if you want to trade or send them somewhere else. While a custodial wallet lessens personal responsibility, it requires trust in the custodian that holds your funds, which is usually a cryptocurrency exchange.
Most custodial wallets these days are web-based exchange wallets. The following information can help you decide which is right for you.
Custodial Crypto Wallets: Pro and Cons
Most — but not all — web-based crypto wallets are custodial wallets, and it’s very likely that the first time you purchase crypto, it will end up in a custodial exchange crypto wallet. In this case, the exchange is your custodian, which holds your keys and is tasked with securely storing your funds. It is crucial that you use a reputable custodial wallet such as those offered by major U.S. crypto exchanges, where the majority of customer funds are held in cold storage hardware wallets and highly secure.
While a custodial wallet may be considered less secure than a non-custodial wallet, many prefer them because they don’t require as much responsibility and are usually more convenient. Losing your password to a non-custodial wallet could be financially devastating if you do not take sufficient precautions. However, if you forget your exchange account password you’ll likely be able to reset it. Be sure to follow the exchange’s recommended security measures to best protect the digital assets within your crypto wallet.
Other custodial wallet solutions include investing in crypto ETFs and ETPs. These newer options are gaining popularity, especially with institutional investors seeking more investment exposure to cryptocurrency and tokens. They offer an option to invest in cryptocurrency that doesn’t require managing keys or transacting on the blockchain. They do, however, charge higher fees and only provide exposure to a fraction of the cryptocurrencies and trading pairs offered on exchanges.
Non-Custodial Crypto Wallets: Taking Personal Responsibility for Your Assets
Non-custodial crypto wallets give you complete control of your keys and therefore your funds. While some people store large amounts of crypto on exchange accounts, many feel more comfortable with a non-custodial wallet, which eliminates a third-party between you and your crypto.
Non-custodial wallets can be browser-based, they can come in the form of software installed on mobile devices or on desktops, or they can be hardware devices, among other options. Although they can take many forms, the most secure way to hold your cryptocurrency is using hardware wallets. These crypto wallets usually look like a USB storage device with a screen and analog buttons.
Turned off when not in use, these hardware, non-custodial crypto wallets must be connected to a computer or mobile device via USB ports or bluetooth to transact. Although they are technically connected to the internet during a transaction, the signing of the transaction by the private keys is done offline within the hardware wallet itself before being sent online to the blockchain to be confirmed. For this reason, even a malware-infected computer or phone can’t access your funds when you’re using a non-custodial hardware wallet.
While non-custodial wallets don’t require you to trust a third party, they require you to trust yourself to keep your keys and your wallet secure. If you were to lose your wallet, destroy your wallet, or forget your password, and you haven’t taken precautions to be able to regenerate your wallet, you could lose access to your funds. Any non-custodial wallet with significant funds should be password protected, and that password should be kept in written form in a location only you know. In addition, you should not allow anyone physical access to your non-custodial crypto wallet. Were someone to discover the PIN or password, they could drain your funds without your knowledge.
However, if you do end up losing access to your crypto wallet or forget your password, there is a back-up procedure. Typically, you will have generated a sequential string of 12, 18 or 24 words that is displayed upon setting up your crypto wallet.
Like your password, this should remain completely private and safely stored. This recovery phrase, also known as a “seed phrase,” would allow anyone to “regenerate” your crypto wallet on another device, giving them access to all crypto balances associated with your private keys. With your seed phrase someone could regenerate your crypto wallet even without physical access to your original hardware wallet.
It Comes Down to How You Want to Secure Your Crypto
Choosing between a custodial wallet and non-custodial wallet is a key decision when it comes to securing your cryptocurrency holdings. Some prefer a custodial exchange account, while others prefer non-custodial wallets, and some end up using a combination of the two. You’ll also have to decide if you want a hot or cold wallet, and whether to spread your cryptocurrency holdings between various crypto wallets. Regardless of your choice, be sure to always follow best security practices.
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