What’s the Difference Between Custodial and Non-Custodial Crypto Wallets?
We understand that getting started in the cryptocurrency space can be a little intimidating, especially when you realize that there seem to be so many kinds of wallets to choose from.
There are many different kinds of wallets like web, mobile, desktop, hardware, and paper wallets. However, to simplify things, they all fall into two main categories: custodial wallets and non-custodial wallets.
What are custodial and non-custodial wallets?
By its very definition, custodial wallets mean that a third-party is holding onto your Bitcoin private keys for you—in most cases, it’s the exchange or platform you bought the crypto from. On the other hand, non-custodial wallets allow you to hold your own private keys, giving you complete control over your funds.
Both types of wallets provide their own unique sets of pros and cons. Each will appeal to different traders, so to give you a better idea of which one to pick, let’s delve deeper into each kind of wallet.
The pros and cons of each wallet type
The first advantage of using this type of wallet is accessibility. All you need to do is input your login details to access your funds and they’re immediately available for you to spend or trade.
Because you’re using services offered by centralized third parties (like exchanges), transaction fees are often cheaper when you use custodial wallets.
Additionally, since you’re most likely going to be trading on an exchange, customer support services will be available to you if anything goes wrong with your transactions.
Lastly, and arguably most importantly, there’s an advantage to having no keys to lose. Your private keys are the only way to access funds, and if you trust an exchange more than you trust yourself to hold them, custodial wallets are the way to go. If you lose your password for your wallet, you’ll just have to confirm your identity to regain access to your account.
Now, let’s talk about some of the disadvantages.
Since you don’t control your private keys, you don’t technically ‘own’ the coins inside your wallet. Instead, you own a debt. You can compare this situation to banks holding your money or a casino exchanging your cash for chips. The wallet owes you the tokens that it holds and they can use them for their own purpose in the meantime.
Secondly, because money is stored in centralized third parties like exchanges, everyone’s funds are somewhat susceptible to data breaches or hacks. Because many platforms hold personal and private information, they are prime targets for malicious actors such as hackers. Of course, it all depends on which specific crypto exchange you choose—some will have better security measures than others. Still, overall, the crypto space has evolved enough for platforms to be aware of these problems and take the necessary precautions.
The last disadvantage of using this type of wallet is that it’s dependent on the Internet. Simply put, if you don’t have access to the internet, then you can’t access your funds.
The first advantage of using a non-custodial wallet is that you have your own unique key, meaning that only you have access to your money. For a transaction to go through, you have to authorize it using your private keys.
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Secondly, there’s a lower risk of data breaches and hacks. Although everyone can be considered a target for malicious attacks, the amount of money in your wallet is relatively small compared to the amounts held in centralized exchanges—making your funds less likely to be targeted.
Because you have complete control over your money and your private keys, instant withdrawals are possible since it eliminates the possible delay periods imposed by third parties.
Lastly, you don’t need an Internet connection to access your funds. Some non-custodial wallets can be accessed without an Internet connection, allowing you to manage your funds anywhere and at any time.
Now, let’s talk about some of the disadvantages that come alongside using this type of wallet.
The first is that you won’t have customer service to back you up. Since you’re managing everything yourself, you’re pretty much stuck with the consequences if something goes wrong. A single typo could mean a loss in funds, and there’s no way of undoing that mistake.
Even if complete control over your money seems appealing, it means that you alone are responsible for your funds. This is especially true if you’re just starting out. You might not be comfortable setting up a non-custodial wallet or even sending money to one. While it isn’t technically difficult, the process can be overwhelming.
The last disadvantage is that if you lose your keys, you lose your money. These types of wallets are susceptible to human error, meaning that if you lose or damage the physical wallet holding all your money, there’s really no way of getting it back.
Not your keys, not your coins: Explained
“Not your keys, not your coins” is a common phrase that describes the difference between custodial and non-custodial wallets: if you don’t hold your private keys, then they’re technically not your coins.
Let’s say you buy Bitcoin on Robinhood. Technically, you don’t own the coins you purchased. Instead, the platform owes you a certain amount of money depending on how much BTC you bought. The same is true with Bitcoin on PayPal.
However, a common misconception is that that’s the worst thing in the world—just because someone else holds your keys doesn’t mean that your money is in danger. Recent custodial wallets have upgraded their security and user interfaces to be easier to use and much safer.
Take the Paxful Wallet as an example. Technically, BitGo, our wallet service provider, holds your private keys—you can’t download them, but at least you know they’re in good hands with BitGo being one of the best in the business. Additionally, we put systems in place that keep your money safe—high-security escrow services, two-factor authentication, and state-of-the-art blockchain analysis tools that can identify suspicious activity. Plus, you can receive and send out cryptocurrency to any non-Paxful crypto wallets.
It’s hard to stay away from custodial wallets simply because they’re more beginner-friendly. Understanding the different aspects of cryptocurrencies is hard enough for beginners to wrap their heads around. Custodial wallets make it just a little easier for them. Plus, most custodial wallets now look like banking applications, making the UI seem more familiar than non-custodial wallets.
Custodial vs. non-custodial
Choosing between a custodial and non-custodial wallet is one of the critical decisions you must make before you start trading cryptocurrency. People out there will prefer a custodial exchange account, others will choose a non-custodial wallet, and some others will use a combination of both. Ultimately, the choice is yours.