Easy Crypto: Custodial vs. Non-Custodial Crypto Wallets

Being new to the crypto space can be challenging. While there are many online resources, understanding the many different terms can be overwhelming.

In this article, we aim to break down the differences between custodial and non-custodial wallets. We take a close look at what each type of crypto wallet does, along with its 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’s comparable to how banks custody their customers’ funds.

Some of the more popular custodial wallets are those operated by exchanges and DeFi service providers, such as:

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. They custody your cryptocurrency, but also use it 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 then 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 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.

It’s happened in the past, most notably with Bithumb, Coincheck, Bitgrail, and Coinrail. Coincheck tops that group with an estimated $534million in stolen NEM coins.

This isn’t the only risk with custodial wallets. 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 will not get paid back. Even though those taking out such loans have to provide collateral, the risk is still present, as evinced by the recent Celsius bankruptcy.

So 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 them from your wallet to the exchange.

Other minor benefits include pretty aesthetics and usually options to stake, loan, or purchase other financial services like crypto ETFs and ETPs.

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:

Pros

• 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

Cons

• “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 some background on custodial wallets, we’re going to take a closer look at non-custodial crypto wallets.

What is a non-custodial crypto wallet?

In an ideal crypto space, a non-custodial wallet is something everyone should have. It’s 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 in both hot and cold formats. Some are a hybrid of the two, such as Exodus and Trezor, which offer 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:

These wallets allow you to hold the private keys yourself, meaning you own and control 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 OGs 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 your crypto is secured in an offline environment away from malicious online threats.

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. They are easy to set up and use, plus safe enough to provide peace of mind that your assets won’t be going anywhere without your consent.

But as with anything crypto, there are still risks involved, and I highly recommend you research which cold wallet best suits your needs before buying one.

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 to 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. However, the initial purchase price can be 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 amount of 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 familiarise themselves with digital crypto assets, and perhaps aren’t dealing with significant capital, may find the custodial wallet option perfectly tailored to their needs.

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