Non-Custodial Vs Custodial Wallets: Pros & Cons, And Key Differences!

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Custodial Wallets

If you have made an investment in cryptocurrencies, then keeping your cryptocurrencies investments in your wallet is advantageous. 

But, what exactly are crypto wallets? And, what types of crypto wallets are available?

Let’s find out!

When not in use, a cryptocurrency wallet is where you can keep your digital currency. A large part of preventing your cryptocurrency from being stolen by hackers is knowing how to properly secure your valuables with a crypto wallet. Different configurations of cryptocurrency wallets exist. A blockchain network can be accessed with a crypto wallet. The three main categories of cryptocurrency wallets are paper, software, and hardware wallets.

They can be further divided into cold wallets and hot wallets depending on their work. While hardware-based wallets are the most secure, they are also more widely available and practical. Paper wallets, which are printed on paper, are no longer dependable and relevant.

Although various cryptocurrency wallets are available, they may be divided into two categories: custodial wallets and non-custodial wallets.

You have certainly used a crypto wallet before if you presently own any cryptocurrency. However, a cryptocurrency wallet differs from a traditional wallet in which you would keep your cash and credit cards. A prevalent misunderstanding is that users’ cryptocurrency assets are stored or contained in their crypto wallets. In reality, they are merely the means through which users can initiate cryptocurrency transactions and access their funds on the blockchain.

Continue reading our blog to know the key differences between non-custodial and custodial wallets.

Firstly, let’s start with,

A Custodial Wallet: What Is It?

Custodial crypto wallets, as the term implies, hold users’ private keys in trust. This indicates that users are giving third-party access to their cryptocurrency. Custodial exchange accounts function like banks, where you own the money but don’t have absolute control over it. On behalf of the owner of the wallet account, they execute transactions.

Benefits and Drawbacks of Custodial Wallets

Pros

  • If cybersecurity isn’t your strong suit, you could be better off having a third party secure your cryptocurrency. Ensuring you have access to funds can be made easier with the aid of a third-party custodian.
  • If you wish to trade on the most well-known cryptocurrency exchanges, custody wallets are frequently a prerequisite.
  • You may receive a return on your cryptocurrency-based investments from some custodians.

Cons

  • Your private keys are not your property, so a third party is in charge of maintaining security.
  • Since someone else is holding your money on your behalf, they can take it themselves.
  • Because they are centralized, custody wallets function similarly to the conventional financial system.
  • You are not permitted to use new coins resulting from forks of existing ones you already own.

A Non-Custodial Wallet: What Is It?

A decentralized crypto wallet called a non-custodial crypto wallet enables users to store their private keys independently. In other words, individuals ultimately control their cryptocurrency funds and can approve or reject any transaction.

Accessing the private keys, not your crypto or your keys. Who has access to the private keys is the primary consideration for users when contrasting a custody-based wallet with a non-custodial-based wallet. The custodian keeps your money in a custodial wallet. This implies that the private key to the wallet is entirely under the hands of the central authority.

A non-custodial wallet, however, uses a decentralized strategy. It gives users total control and wrests control away from any centralized authorities. So, consider choosing a non-custodial wallet if you do not want a third party to have access to your assets.

Benefits and Drawbacks of Non-Custodial Wallets

Pros

  • Since cryptocurrency is entirely under your control, stealing your funds is far more difficult.
  • You can carry out operations without anyone watching you.
  • You can receive access to cutting-edge capabilities like Lightning Network non-custodial access.
  • Depending on your security model, you can choose between various security levels.
  • Through the use of both hardware and paper wallets, you can access higher degrees of security.
  • Any dividends or staking incentives connected to your cryptocurrency assets will be fully accessible.

Cons

  • It will be more difficult to trade your cryptocurrency quickly, as it will first need to be sent to an exchange.
  • Being in charge of your security comes with great responsibility, and human error could lead to theft or accidental deletion.
  • You will usually be presented with user interfaces that are more difficult to understand.

Moving ahead, let’s discuss this,

Custodial vs Non-Custodial: what’s the difference?

The key differences are:

#1. Setting Accounts

The simplicity of opening accounts is another significant distinction between custody-based and non-custodial wallets. Custodial wallets require different KYC and AML processes before you can set up an account or use the wallet. The KYC and AML processes can be somewhat complex for various service providers. Even though these steps are crucial for security, some custodial wallets may require much more time to complete KYC authentication.

When comparing the simplicity of generating accounts between custodial and non-custodial wallets, non-custodial wallets come out on top. They also maintain user anonymity by not requiring any KYC or AML requirements.

#2. Backup and Recovery for Wallet

In most cases, you may get your money back if you lose access to your custodial account by contacting the exchange’s or service’s customer care team. Similar to a bank account, they can assist you in regaining access to your account by verifying your identity through a check of your identification documents.

However, with a non-custodial wallet, it is your responsibility to back up and retrieve your own money. You can achieve this by keeping your seed phrase in a safe place. There is no customer care staff you can contact to help you get your money back if you lose your private key.

#3. KYC

Financial organizations are required by the KYC (or “know your customer”) regulation to confirm the identities of their users and carry out extra checks. Simply put, it involves checking your identification paperwork to ensure you are who you claim you are.

Custodial wallets must comply with KYC regulations. This implies that you will typically need to present some sort of identity, such as your driver’s license or passport, when you log in for a custodial wallet.

Since non-custodial wallets are exempt from KYC regulations, no private data is necessary to establish the wallet.

#4. Transaction time and fee

With a custodial wallet, the central authority must approve each transaction. As a result, the transaction’s completion is delayed. Due to the presence of custodians and other intermediaries, transaction fees are often more significant, and the transaction history is not maintained on the underlying blockchain in real time.

Transactions using non-custodial wallets are typically quicker since users can instantly validate them without involving centralized bodies. Additionally, the blockchain displays the transaction history in real time. Because there are few or no commission-seeking authorities, transaction fees are also lower.

#5. Backup and restoration of funds

Users with custody wallets can rely on the custody holder to recover their passphrase in the event of a loss. Since it has custody of the user’s private key, the cryptocurrency exchange must retrieve the user’s funds. Therefore, people should not fear because customer assistance can assist in recovering their valuables.

However, users of non-custodial wallets must exercise extra caution because missing one’s private key results in the loss of all holdings. Users must securely save their recovery key (also known as a seed phrase), a 12, 18, or 24-character mnemonic phrase required to obtain access to one cryptocurrency wallet in order to preserve their cryptocurrency.

#6. Security

The security offered by each wallet should be taken into account when comparing custodial and non-custodial wallets. All of the private information is kept in a custody wallet and is held in cold and hot storage, both of which are frequently vulnerable to hacking. Typically, this is based on the security measures adopted by the relevant central authority.

Although the security level in non-custodial crypto wallets is relatively strong, overall, the user protects sensitive data, reducing the likelihood of data theft. The data is secure unless the users disclose it to another person or the gadget is stolen.

#7. Friendliness to Users

The user-friendliness of custody-based and non-custodial wallets differs, with custody-based wallets being more user-friendly. The most popular option is web-based custodial wallets, mainly due to their user-friendly UI. Custodial wallets also enable customers to transact without problems on various well-known platforms.

Owners of non-custodial wallets must manually transfer their funds across several platforms. Additionally, some non-custodial wallets may not have the ability to connect to the internet. Therefore, doing transactions with non-custodial wallets may require you to go through difficult steps.

Conclusion

The characteristics of a wallet that are most essential to you will help you decide between a non-custodial and a custodial type. Beginners and individuals who appreciate the set-and-forget simplicity of maintaining their cryptocurrency through a centralized wallet provider typically choose custody wallets. Users who want to exert more control over who has access to their funds should use non-custodial wallets. Both types of wallets have advantages and disadvantages, so consider your ease with the aspects that matter to you the most before making a choice.

Regardless of the wallet you use, make sure it works in the manner you intend to use your cryptocurrency funds.