Custodial vs. Non-Custodial Wallets — What’s The Difference?

TL;DR:

The key difference between custodial and non-custodial wallets is who has custody of the wallet's private keys — and, therefore, control of the funds.

Custodial wallet services hold onto the private keys of the user, storing and securing them on the user’s behalf. Non-custody wallets give private key access only to the owner, allowing them full authority and autonomy over their assets.

Cryptocurrency wallets come in many shapes and sizes. Software, hardware devices, hot and cold wallets, mobile apps, paper wallets, and many more.

Even though each of them functions differently, all of them are designed with one inherent purpose: to provide you with a secure way to store and manage your digital assets.

All crypto wallets use a pair of cryptographic “keys” to guarantee storage and security. One public key and one private key. These “keys” are essentially long sequences of letters and numbers, most commonly around 25-36 characters long.

One crucial component of finding the perfect wallet for your crypto journey will be deciding who you will trust to safeguard your wallet’s private keys.

Will you entrust them to a custodial wallet by handing responsibility to a popular cryptocurrency exchange, or will you take the path of autonomy and hold your funds safe in a non-custodial wallet?

Before you decide which type of wallet you’re going to choose, you have to understand the pros and cons of both “custodial” and “non-custodial” wallets. In this article, we’ll explore the benefits and drawbacks of both wallet types so you can better choose which one is right for you.

Remind me, what is a non-custodial wallet again?

A non-custodial crypto wallet is a crypto wallet that lets you, the user, store and manage your own private keys without needing any third-party intermediary. It’s also called a self-custody wallet or a non-custodial crypto wallet. They mean the same and we use these terms interchangeably in our articles. 

By giving you the ability to safeguard your own private keys, self-custody wallets provide you with greater autonomy, more control, and more flexibility when it comes to your digital assets.

Self-custody wallets are a suitable option for users who prefer long-term holding and who want full responsibility for their private keys.

Because non-custodial options do not require intermediaries, users can trade assets directly. Taking on this extra responsibility has its benefits and drawbacks, and it’s up to you to make the choice of whether self-custody is a good fit for you. 

To learn more about what is a self-custody wallet and why you need one, read this article or visit Valora Learn.

Benefits of a Self-Custody Crypto Wallet

1. Security

The extra security of non-custodial wallets stems from the fact that no third party has access to your private keys. This eliminates the risks of most third-party vulnerabilities, breaches, or mismanagement. If you want to have complete ownership and responsibility over your private keys, and therefore, all your crypto assets, non-custodial options are the best choice for you.

2. Privacy

Most non-custodial wallets do not require you to provide any personal information in order to create an account. For example, you can create your Valora wallet today with just a phone number — and even that phone number is only to make it easier to send money between friends. Additionally, self-custody options do not require users to hand over any information via a KYC or AML process.

3. More advanced features

Many self-custody wallets are now providing a variety of advanced features and new opportunities for people who wish to make better use of their assets. These wallets seamlessly integrate with decentralized applications (dapps) on different blockchain networks, provide you with the ability to safeguard your private keys in additional ways, and provide you with extra flexibility features like customizable crypto transaction fees.

4. Your Keys, Your Money

By giving you full control over your private keys, self-custody options ensure you’re the only one with access to your assets on the blockchain. This means they provide complete financial self-custody and self-sovereignty.

Drawbacks of a Non-custodial Wallet

Increased responsibility 

If you lose your recovery phrase (also known as a seed phrase) and/or your private keys, it will be impossible to access and use your funds. You must safeguard your recovery phrase from being destroyed or lost.

More technical for a beginner in crypto

While non-custodial options allow you to take advantage of advanced features, this will require some technical know-how that beginner holders may not have. Part of the reason why custodial options have become so popular is that they simplify the experience of buying cryptocurrency and offer a very similar experience to other Internet-native apps.

What Is A Custodial Wallet?

Custodial wallets remove the responsibility of maintaining your private keys, by encrypting and managing their users' private keys — much like an ordinary bank. Platforms like centralized cryptocurrency exchanges offer custodial wallets and are a popular choice among many crypto users.

Why are custodial wallets popular?

In Bitcoin’s early days, all wallets were self-custodied. Users had to create and manage their own private keys. And with these early versions, self-custody was often slower, less convenient, and a riskier experience for new users. People weren’t familiar with the new concept of managing private keys. Many people learned the hard way that if you lost your keys, you lost access to your assets, forever. 

As a result, centralized wallet providers and exchanges grew into some of the most famous names in the space. They onboarded millions of people by providing a faster, simpler way to get started — and importantly, a way for people to easily discover, buy, and trade new crypto assets. In the early days of Bitcoin and Ethereum, decentralized exchanges simply didn’t exist. If you wanted to quickly buy or trade, an exchange (or another person!) was the only way to do it.

Now, nearly a decade later, many non-custodial wallets offer similar, or even better experiences for people who want to get started quickly. With built-in access to decentralized exchanges and “dapps” (decentralized applications), self-custody wallets often provide a faster way to get started, as well as, access to a wider variety of cryptocurrencies — all without the trade-offs of relying on a centralized entity.

Benefits of a Custodial Wallet

1. Less responsibility

Custodians usually only require you to care after a username and password instead of your private keys or seed phrases. The responsibility of safeguarding your private keys will be in their hands. Because they're similar to other applications native on the Internet that only require a username and password, they've been able to onboard hundreds of millions of users into the world of crypto.

2. Additional recovery options

In a situation where you lose or forget your password, you can request a new password from your custodian since they’re the party that ultimately has access to your private keys. This means you don't have to personally store and protect your recovery phrase.

3. More user-friendly for beginners

Most custodial options are very easy to use, featuring intuitive user interfaces created to make managing and trading assets safe and effortless for beginners. In the case of popular crypto exchanges that act as custodians, they offer a user-friendly way for users to fund their accounts and start trading their crypto.

Downsides of a Custodial Wallet

Target of hackers

Giving away complete responsibility over your private keys is both a benefit and a drawback. Some custodians, such as major centralized exchanges, may be vulnerable to security breaches and exploits, so giving away responsibility to a custodian will not guarantee you total security.

You don’t own your private keys

The third party is responsible for managing your private keys — so you’ll likely require permission to withdraw, send, or sometimes even receive funds. If you don’t own the private keys to your wallet, that’s like leaving all your assets in a vault and giving the key to someone else. If you want complete control over your wallet and your funds, you can’t have it without access to your private keys. Always remember: not your keys, not your crypto.

Less privacy, KYC requirements

To comply with regulations, most custodial platforms will require you to complete a know-your-customer (KYC) or anti-money laundering (AML) verification. Like every other financial platform, they are required to collect personal data to verify your identity, monitor your transactions, and report any suspicious activity.

Custodial Vs. Non-Custodial Wallet – Do We Have a Winner?

When it comes to safeguarding your cryptocurrency holdings and digital assets, making a choice between custodial or non-custodial wallet providers is one of the most crucial decisions you have to make.

Ultimately, choosing the right crypto wallet will depend on how you plan to use your crypto, how you want to secure it, how much responsibility you want to take on, as well as your personal investing preferences.

While some people prefer non-custodial options because they value autonomy and privacy, others prefer custodial exchange accounts where they can easily trade. Most experienced traders, investors, and enthusiasts use a combination of the two.

Additionally, you must choose between a hot and cold wallet, depending on whether you want it to be connected to the Internet or not. Moreover, you have to choose whether or not to distribute your cryptocurrency holdings among different cryptocurrency wallets.

No matter what decision you make, make sure to always adhere to the best security measures, as this is the ultimate goal of any digital wallet.