Wallets 101: Custodial vs Non-Custodial

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A handy guide to understanding the basics of crypto wallets, and what the differences between custodial & non custodial mean for you. Op-ed by Danielle Davis
bitcoin wallet

Op-Ed by Danielle Davis

Not your keys, not your coins.

If you invest in cryptocurrency it is important to know who has custody of your tokens, it might not be you. We have all heard the phrase “not your keys, not your coins”, but what does it really mean? 

Wallets 101: custodial v. non-custodial

Custodial Wallet or “hot” wallet, is a digital centralized service, like an account on an exchange, owned by a third party that owes you assets (tokens or currencies), while a Non-Custodial Wallet or “cold” is decentralized, nobody other than you has access to it.

 

When making a new non-custodial wallet you will generate a unique Seed Phrase & Private Key  associated with your wallet. Nobody else has these, and you shouldn’t share them to keep them safe, thus if you lose them you won’t be able to access your money.

 

Your private key is alphanumeric and allows you to access your wallet.

A seed phrase is a string of 12-24 random words to your wallet, that can be used as a backup in case you lose or forget your password, to restore all of your tokens and information.

There are pros & cons to both custodial and non-custodial wallets, it is important to understand which one is right for what purpose.

Custodial Wallets: Pros

  1. Spendability
  2. Cheaper Fees
  3. No Keys to Lose
  4. Customer Support

Is the key reason why hot wallets exist. Tokens in custodial wallets are immediately available for use and/or trade.

Custodial wallets are digital wallets offered by centralized third parties, like exchanges, which means they typically run on services and will require no gas or other costs.

Keeping your keys safe is a major concern. With most of them you can even get your passwords reset or confirm your identity to regain access to your account should you lose it.

3. Customer Service

Being a service provided to you, custodial wallets typically come with added customer support to help with whatever trouble you may run into.

Custodial Wallets: Cons

  1. Others Can Control
  2. KYC Needed
  3. Data Breach/Hack
  4. Internet Reliant

Similar to a bank holding your money, or a casino changing your cash for chips, a custodial wallet owes you tokens that it holds and can use for its own purposes in the meantime – such as providing liquidity for trading.

Compliance with Know Your Customer (KYC) and Anti-Money Laundering (AML) regulation is required in many cases depending on jurisdictions and legislations applicable. For you, this means you have to submit ID to use it, and that your transaction history are subject to tax oversight.

3. Data Breach/Hack

Hot custodial wallets of exchanges hold a lot of tokens and Personal Private Information (PPI), which makes them prime targets for malicious actors such as hackers or other attackers.

4. Internet Dependency

In order to view or transfer your tokens, you need internet access. Being cut from accessing the internet implies being cut from your capital.

Non-Custodial Wallets: Pros

  1. Full Control – Unique Keys/Seed Phrase
  2. Lower Risk of Data Breach/Hack
  3. Instant Withdrawals
  4. Always Accessible

No one else has access to your credentials. No one can spend your money without your unique keys. Not the wallet provider, not the authorities, not the banks. You must authorize every transaction and fee you spend.

2. Lower Risk of Data Breech/Hack

Everyone is a potential target for hackers, just like everyone is a potential target of theft. But being a single wallet with a relatively small amount of tokens compared to what an exchange would hold, reduces your risk of being targeted by attackers.

3. Instant Withdrawals

Having full control means you can move your tokens whenever you want, without any preset delay period imposed by third parties, which are a common practices with exchanges.

4. Non-Internet Reliant

Local cold wallets can be accessed without any internet access, you may not be able to transact buy you can at least see how many tokens you hold and that they are safe.

Non-Custodial Wallets: Cons

  1. No Customer Service
  2. Keys Lost = Money Lost 
  3. Higher Fees
  4. More Complicated To Use

If you make a mistake, you are stuck with the consequences. One typo can mean a loss, and there’s no way of undoing mistakes.

If you lose your password & seed phrase, there is no one who can help you restore your wallet or information. Be very careful ! 

3. Higher Fees

Fees are based on ETH gas costs, which depends on the price of ETH and the congestion of the network. These fees fluctuate wildly, and get pretty high at times.

4. More Responsibility

If it is your first crypto purchase, you may not be comfortable sending funds to a cold wallet, or setting one up. Althought, it is not technically difficult, it can be emotionally overwhelming.

"Which one is better ?"

Many people use a combination of both wallet types.

You shouldn’t place all your eggs in one basket, just as you shouldn’t store all your tokens in one wallet. Distributing assets between multiple wallets is much more safe. Just remember, this means more credentials to remember and keep safe.  Find out more about best practices to keep your crypto safe.

Fundamentally, it is a trade-off between convenience & security

Custodial wallets are easier to deal with, and more convenient if you’re looking to move assets or participate in the markets. But the fear of major problems like attacks should be enough to make want a second, non-custodial cold wallet to store what you want to keep for a long term.

And as always, DYOR !

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Lorenzo Ferrari

Lorenzo Ferrari is the Founder & CEO of CryptoArena.org, a fintech startup aiming to launch the first “Self-Decentralizing Exchange” – a secondary market intermediary using a custom blockchain solution to transition its own holding entity into a fully non-profit Foundation. 

CryptoArena distributes platform-generated revenue to its (active) Users through a game-like, social-competitive, points scoring system. Incrementally, over time, 

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