Our partner, XM, lets you access a free demo account to apply your knowledge.
No hidden costs, no tricks.
As time goes on, more and more people are joining the crypto world. Even after this massive crypto crash that we saw at the start of 2022, the number of crypto users is still growing at a rapid pace, and it is speculated that there are around 1 billion people around the world who own or have owned cryptocurrencies.
But owning cryptocurrencies, or any other digital asset that is integrated into the blockchain, is not as straightforward as owning traditional money, a car, or any other physical asset. Whenever something is part of a blockchain, it needs to be stored inside a digital wallet, also called a crypto wallet. These wallets can come in different shapes and forms, each designed for different purposes and fitted for different people.
There is one difference that is very important to consider when acquiring a crypto wallet, and that is whether the wallet is custodial or non-custodial. If you don't know the difference between these two wallets, you came to the right place. Here we are going to discuss the differences between custodial and non-custodial wallets, and which one you should use.
Before we discuss the differences between custodial and non-custodial wallets, let's take a look at what crypto wallets are in general.
The simple explanation of crypto wallets is that they are digital wallets where we can store our cryptocurrencies, NFTs, or any other digital asset that is on the blockchain. But if we dive deeper, things are not as simple as they seem. First of all, crypto wallets and their keys are also proof of ownership, meaning that whoever has access to the crypto wallet also has ownership of assets. This means that, if someone were to hack your wallet, there is practically no chance to kick that person out of your wallet or return the funds he stole. This is why, whenever we are creating a crypto wallet we will be advised multiple times to store our security seed in the safest place possible.
Another thing we need to mention is that crypto wallets, besides custodial and non-custodial, can be classified into two other styles, hot and cold wallets. Hot wallets are software wallets that we have installed on our computers or smartphones. Generally, these wallets are safe and without the security seed, no one will be able to access our funds. But for further protection, people started to use cold wallets which are hardware-type wallets, like USB wallets that come in a physical form. These are considered to be the safest crypto wallets because they are disconnected from the internet and are impossible to access without having both a security seed and a physical wallet.
Another important thing that we need to understand before discussing custodial and non-custodial wallets is the public and private keys of crypto wallets. These wallets are what we use for transactions, verifications, and everything else. Public keys are simple, they are also known as crypto wallet addresses. There are combinations of letters and numbers we input when selecting which wallet we want to send the crypto to. They can also be used to look up transfer history, assets, and other information regarding a crypto wallet.
On the other hand, private keys are what we use to confirm transactions and prove the ownership status of an asset. You never want someone accessing your private key as this is what controls your whole wallet. If someone were to get their hands on it, they can send your cryptocurrencies to their wallet, and unlike traditional finances where you can request a chargeback, here you can not do such a thing and there is no way to return your funds.
These two keys are used to complete any cryptocurrency transaction. The public key is used to indicate which address should receive these tokens, and the private key is then used to confirm and finalize this transaction.
Custodial wallets are wallets offered by third-party providers who retain ownership of the wallet. What we mean by that is that you don't have access to the private key and these providers keep them themselves. These types of wallets are really common, as almost every centralized crypto exchange only offers custodial wallets.
It has its advantages and disadvantage. In some cases, traders might benefit from these wallets, while some might prefer to have control over their wallets. The biggest advantage of these wallets is the lack of responsibility. Whenever you own a custodial wallet the protection of the private key is the responsibility of the provider. This is good for beginner traders and crypto investors as they don't have to worry about these private keys and security seeds. It also makes trading easier as traders don't need to confirm every transaction they make and they avoid a somewhat complex system of crypto wallets. Protection is generally also higher as crypto exchanges will most likely have a higher level of security in place than regular traders.
But there are also downsides to these wallets. One of these disadvantages is a lack of control. Exchanges are mostly secure, but if something were to go wrong this lack of control is a big problem. Say for instance that a mass cyber attack was launched against the custodial website, it is likely that these exchanges will prioritize the protection of wallets with high-value assets in them, and your funds will be left unprotected. Another problem is that crypto is a risky business and if the exchange was to go down, they can simply close your account and keep the funds that were in the wallet.
Non-custodial wallets on the other hand are wallets that we have full control over. These wallets are all cold wallets that we purchase and hot wallets such as MetaMask and other similar wallets. Whenever you are creating a crypto wallet and you are given a security seed phrase, that usually contains 12 random words, it means that you are creating a non-custodial wallet.
If we are joining the crypto world, it is crucial to have a non-custodial wallet, even if you are using a wallet provided by the exchange. When using a non-custodial wallet only you have access to the private key and you are in full control of everything. But it comes with a bit of complexity as, unlike custodial wallets, here you have to make sure that the private key is always secured, and every time you make a transaction you will need to use the private key to complete these transactions. Another risk associated with non-custodial wallets is the loss of private keys. This key is what gives you access to your funds and you are the only person who knows this key, even the wallet provider does not know this key. So if you were to lose it, you will lose every crypto you had in that wallet and will have absolutely no chance of recovering these funds.
If someone owns a large number of cryptocurrencies, it is better to keep them in a non-custodial wallet rather than a custodial one. It is also better to keep tokens that you plan on holding for an extended period of time on these wallets, as this will be the most secure place to store them. Another thing that traders do is keep the majority of funds in non-custodial wallets and only transfer funds that they plan on trading with to the wallets provided by exchanges.
Now that we know what these wallets are and in what cases they are used, let's take a look at the pros and cons of each wallet.
|If you are not sure that you can protect your private key, it's better to let a third party do it for you, as they probably know what they are doing||Not owning a private key means that your fund's security is in the hands of third-party providers, which can be bad for some traders|
|They are easier to manage and use||They are centralized, which removes the main goal of cryptocurrencies|
|Custodial wallets are better for trading on big crypto exchanges||You might have a limited selection of cryptocurrencies that you can hold in this wallet|
|You have complete control over the wallet and the funds kept in it||This will slow down the trading speed, as you will need to send crypto to the exchange first|
|Your transaction history is not sent to someone automatically||Losing your private key will result in a loss of funds, as recovering it is impossible|
|Can gain access to more advanced features||Requires a bit of knowledge to operate a non-custodial wallet|
It comes down to personal preferences. If you are not going to hold high-value crypto and want to have a fast trading experience, then a custodial wallet should be your choice. On the other hand, if you want more control and safety over your assets then a non-custodial wallet is a must.
MetaMask is a non-custodial wallet. When we are creating a MetaMask wallet, we are given a security seed phrase as well as a private key, which means that this is a non-custodial wallet.