Crypto Wallets: Custodial vs Non-Custodial
You may hear folks talk about crypto wallets. What are these and how do you choose which kind to use?
What Is a Crypto Wallet?
A wallet is used to hold your crypto.
Associated with your wallet is a unique set of keys:
🔑 a public key (your wallet’s address)
🔐 a private key (your “password” to access the contents of your wallet)
The public key is what will enable you to receive crypto payments directly to your wallet.
The private key will allow you to manage your crypto. The private key is a long series of numbers and letters, making it hard for humans to remember.
Example private key:
With this set of public and private keys, you can integrate with other apps for seamless transactions.
Custodial vs Non-Custodial Wallets
There are essentially two categories of wallets: custodial and non-custodial.
Custodial wallets are managed by third party companies who take care of a lot of the responsibility that goes along with managing a crypto wallet. This makes custodial wallets really convenient to use. However, you’d need to find a reputable custodian company and trust them with your assets.
The most reputable custodial service providers are centralized. Well, a major idea behind crypto is to make it easier for people to make payments to each other without the involvement of a centralized third party.
And because these custodial service providers are managing tons of wallets, that makes them a very lucrative target for hackers – and unfortunately, there’s been several instances where hackers have been successful.
Also, because your wallet is managed by a centralized entity, withdrawals can be delayed at the custodian’s discretion, just like with banks. Also, your funds can be seized by the government.
Alternatively, there’s non-custodial wallets. There’s a saying that with great power comes great responsibility. That is surely applicable to non-custodial wallets. Non-custodial wallets are managed by you. You’re in complete control of your assets, however, you also have more responsibility to keep your keys safe and integrate with apps to accept payments.
Non-custodial wallets can be digital (prone to hacking) or they can be physical (most secure).
With digital non-custodial wallets, you’re responsible for keeping your assets secure. If you lose or forget the access key to your wallet, there is no one who can help you. You will no longer be able to access your crypto.
Physical non-custodial wallets are known as Hardware Wallets (or Cold Wallets). These are small plug-in physical devices that store your private key offline so that it can’t be accessed by anyone, including hackers.
With hardware wallets, you don’t have to worry about remembering your long private key. Instead it’s stored within the hardware wallet which you can access with a PIN. Also most hardware wallets will provide a recovery phrase (also known as seed phrase) which is a string of unrelated words. Keep this phrase somewhere very secure as it will allow you to regenerate your wallet should you ever lose this device. Likewise in the hands of a bad actor, they can also generate your wallet – so be extremely careful with your seed phrase.
To use your hardware wallet to transact, you connect the wallet to a computer but to keep your private key safe, the transaction is “approved” offline within the wallet, and then goes online to send it to the blockchain for confirmation.
Which Crypto Wallet Should I Choose?
The type of wallet you use is up to you and is really a preference of the level of security and convenience you desire. You can also get a few different ones and put a little in each to try out the various types. The key points to remember are:
- Custodial wallets are managed by centralized entities so offer less control and security. However, they are more convenient to use.
- Non-custodial wallets are solely controlled by you, the owner. With this complete control comes more security and freedom, but less convenience. Losing or forgetting your password could mean the loss of your funds if precautions were not taken in advance.