What Is The Difference Between Custodial and Non-Custodial Wallets

Whenever you are joining a crypto market, the first thing you will need to do is to create a crypto wallet. A crypto wallet is where you store your cryptocurrencies, send and receive them, and pretty much do everything in the blockchain ecosystem. But not every crypto wallet is the same and they come in different forms and shapes. One of the differences between them is whether the wallet is custodial or non-custodial. It is crucial to understand the difference between these two wallet types, because each wallet has its own advantages and disadvantages, and depending on your needs, one might be good for you and another not. Because of this, we will be explaining custodial and non-custodial wallets for beginners and what the differences are.

Crypto wallets

Before we take a look at the differences between custodial and non-custodial wallets, we need to understand what crypto wallets are in general. When hearing the term “crypto wallet”, you might be thinking that this is a place where you store your cryptocurrencies, and looking at it from a simple point of view, it can be considered a correct statement. But if we go into detail, a crypto wallet does not store your cryptocurrencies, as these currencies are on the blockchain and remain there. Crypto wallets in fact store something called a “Private Key”, and this key is used to access your tokens on the blockchain. It is a kind of proof of ownership, meaning that only the person who has access to the private key has access to cryptocurrencies associated with this key. This private key is what differentiates custodial and non-custodial wallets, and you should know how custodial and non-custodial wallets impact your cryptocurrency ownership.

Custodial Wallets

Custodial wallets are the most commonly used wallets, as almost everyone who is involved in crypto will have a custodial wallet. If you have opened an account on a crypto exchange the likelihood of you having a custodial wallet is very high. So in essence, custodial wallets are wallets that are controlled by someone else, and you yourself don’t have access to the private key. Whenever you create an exchange account, it automatically creates a custodial wallet for you and doesn’t give you access to the private key. You can send and receive cryptocurrencies easily when using a custodial wallet, as you still have access to the public key used for transferring funds in and out of the wallet, but you don’t have full control over your crypto.

Non-Custodial Wallets

You might be able to guess what non-custodial wallets are based on the information provided above. Non-custodial wallets are cryptocurrency wallets where you are the only person that has access to the private key and as such hold full control of your funds. Crypto wallets such as MetaMask and Ledger are all non-custodial wallets, and you can tell this by the fact that when creating these wallets you are given a security phrase that gives you access to the wallet and the private key. This is why, whenever you are creating a non-custodial wallet you are told to keep the security phrase in a secure location and never lose it, as losing it means losing access to your wallet. These non-custodial wallets are primarily used for storing large amounts of tokens or for keeping tokens long-term. With custodial ones, they are in the hands of an exchange, and as we saw with what happened following the collapse of the second largest crypto exchange in the world, FTX, during the last bear market, if the exchange goes up in smoke, user funds tend to go the same route.

Which wallet should you use?

Now, the question that most people will have is “which wallet should I use and why?” The answer to this question comes down to what you are planning to do with your cryptocurrencies. Just looking at this from the surface, you might think that owning a non-custodial wallet is a go-to, but there are some cases where you might be better off using these custodial wallets instead.

If you plan on trading with cryptocurrencies instead of investing in them long-term, owning a custodial wallet is a must. First of all, most exchanges only support their own custodial wallets, meaning that you can not connect your wallet to the exchange and trade that way. Whenever you are trading with crypto, you will have your tokens on the market, and for that, you will need to store them in these custodial wallets. In some ways, custodial wallets can also be considered a safer option, as they are kept by the exchanges. Talking from a pure security perspective, the likelihood that these exchanges will have better security in place than you do is pretty high, especially if we are dealing with a big player such as Binance. If someone was to gain access to your private key, they can do pretty much anything they like with your cryptocurrencies, as it is the only proof of ownership and if it were to be stolen from your non-custodial wallet, you will never be able to prove that someone else stole it. If someone were to simply see your security phrase and accessed your wallet, even the police won’t be able to do anything about it. But in the case of custodial wallets, these exchanges have high-security measures in place, and they even store these funds in cold wallets. So, someone stealing your private key from the custodial wallet is unlikely, but of course, possibilities are there and there are cases when this actually has happened to some well-known exchanges.

If you are someone who does not trade a lot, or has a very large amount of crypto and trades only with a small amount, owning a non-custodial is probably a better option. Whenever you have a non-custodial wallet and you have crypto on it, you can use this wallet on most websites that have some usage of cryptocurrencies. For example, if you visit a website like OpenSea, the world’s largest NFT website, you can connect your wallet to the website directly and use your wallet to purchase or sell NFTs. Also, we mentioned that exchanges most likely have better security than you, but they also have a very large target on their backs. Unless someone knows that you have a very large sum of crypto, following simple security measures, such as not sharing your security phrase anywhere, not downloading suspicious programs, and stuff like that, will give you good enough security to keep your own crypto safe. When you have your funds in custodial wallets, if something were to happen to the exchange, you will not be able to access your funds, as an exchange will never provide you with the private key, and if they have problems they won’t be able to give you withdrawal rights. This is the role of custodial and non-custodial wallets in crypto security and the one you choose should depend on your usage of cryptocurrencies.

Pros and cons of custodial and non-custodial wallets

As we can see both of these wallet types have a purpose, all depending on the situation. There are cases when one is better than the other and vice versa. Therefore, each wallet has its own pros and cons, and understanding them is very important. Let’s see what these are.

Custodial Wallet

The pros and cons of a custodial wallet are as follows:

Pros

• Easier to use when trading
• Is secured using security measures implemented by world-leading crypto exchanges
• Is more beginner friendly and easier to use

Cons

• You don’t have full control over your funds
• If the exchange where to go bankrupt, you won’t be able to withdraw your funds
• Hackings of crypto exchanges are not a very uncommon occurrence and there have been numerous cases of exchanges being hacked and users funds stolen

Non-Custodial Wallet

The pros and cons of a non-custodial wallet are as follows:

Pros

• You are the only person who has access to your funds
• If you follow basic security measures, the likelihood of someone stealing your funds is very low
• Can be used across different websites

Cons

• Might be confusing for newcomers
• If you lose your security phrase, you will never be able to access your wallet again

FAQs on difference between custodial and non-custodial wallets

Is MetaMask a custodial or non-custodial wallet?

MetaMask is a non-custodial wallet. When you are creating a MetaMask wallet, you are given a security phrase that gives you access to your wallet and the private key associated with it, this makes MetaMask a non-custodial wallet, and currently, it is one of the best free non-custodial wallets on the market.

Can non-custodial wallets be hacked?

Non-custodial wallets are pretty much impossible to hack, but there are still ways for hackers to gain access to your wallet. One way is that hackers can hack the whole blockchain, but the likelihood of that is close to zero. The only other way that hackers can gain access to your wallet is if they hack into your computer and are able to find your security phrase if you stored it on your computer. This is why most people suggest that you write your security phrase on a piece of paper and store it somewhere safe inside your home.