Custodial vs. Noncustodial Wallets: Main Difference

Crypto owners require wallets to keep their cryptocurrencies in a secure and private environment. Wallets are digital storage devices designed specifically for storing and transferring cryptocurrencies.

Crypto wallets come in two main varieties: custodial vs non custodial wallets. While both offer the ability to store digital assets, they are designed for different purposes. Let's look at these types to understand when you should use one or the other. This article describes how crypto wallets work, the advantages of noncustodial and custodial wallet, and why it is best to use either in different contexts.

How do crypto wallets work?

A crypto wallet is a software program for storing cryptocurrencies and certain digital assets such as NFTs. There are different types of crypto wallets, ranging from software that works on mobile devices and computers to hardware devices that use cold storage technology. As you buy, sell, or mine cryptocurrencies, you need a place to store them safely and securely and for easy access. You might also require a way to store cryptocurrencies that integrate with online platforms for transactions.

All crypto wallets are connected to the blockchain where cryptocurrencies and digital assets exist. Each wallet has a unique identity and is secured by wallet keys which could be several phrases, passwords, or other security measures. You can either have a custodial or non custodial wallet based on who holds the private keys to your wallet. The best online crypto wallet should provide the strongest security measures and allow users full control of their assets.

What is a custodial crypto wallet?

All crypto wallets are either custodial or non custodial. So, what is a custodial wallet? How does it work? How safe is it? How do you create one?

A custodial wallet is 'hosted' on a third-party platform. Because a third party is involved, the user does not have full control of the private keys. Instead, the third party keeps the private keys and allows users to access the wallets through passwords, fingerprints, codes, or other security features. Custodial wallets are popular on crypto platforms such as exchanges, gaming platforms, and interactive websites. For example, when you register on popular crypto trading exchanges such as Binance, you get wallets through which you can send or receive cryptocurrencies. But the exchange retains the private keys to the wallets and only permits you to log in to the wallet when you enter a password to your account. A custodial wallet is sometimes called a crypto custodial account because it is most suited for trading on centralized crypto exchanges, receiving cryptocurrencies for short-term storage and use, and navigating privacy. Creating a custodial wallet is simple; once you register on a crypto trading exchange, you get a custodial wallet. Some other non-trading platforms also offer custodial wallets. In both cases, you only need to create a password to access the platform, and then you can access the custodial wallet without private keys. Custodial wallets have unique advantages and are best suited to users who do not want the responsibility of storing their private keys.

Pros and cons of custodial wallets

Here's what to know to choose the best crypto wallet:

Pros

• Free transactions: most custodial wallet platforms don't charge transaction fees. Although the number of transactions is sometimes limited, you can make large transactions on your private wallet without paying a fee.
• Less user responsibility for managing private keys: the responsibility of storing private keys could become a burden on users. But using non custodial wallet removes that burden. There's no responsibility on you to keep your private wallet keys safe, as the platform takes that responsibility.
• No serious consequences of losing private keys: even if you lose the password to your non custodial wallet platform, you can easily recover the password and regain access to your wallet. There are no serious issues with losing private keys or passwords.
• Higher backup capability: users can easily request a third party to provide the private keys for quick and easy backup or restoration. That's possible because the third party keeps the private keys safe and provides alternative access such as passwords.

Cons

• Need for KYC: most noncustodial wallets request users to complete KYC before creating wallets. KYC is necessary to verify user identity.
• The threat of data leakage: although providers of custodial accounts keep private keys safe, there's always the threat of data leaks if such platforms are compromised. Hackers may gain access to a custodial wallet if they hack the platform.

Which custodial wallets are the best?

Some of the popular custodial wallets are:

• BitGo
• BitMex
• KuCoin
• Binance
• Freewallet
• Blockchain.com

What is a noncustodial crypto wallet?

Beginners in crypto often ask what is a non custodial wallet. A non custodial wallet allows users to store the private keys themselves. So if you create a custodial wallet, you get to manage the private keys and password to access the account. Non custodial wallets are also called private crypto banks or private wallets.

How to create a non custodial wallet?

There are different platforms offering crypto storage with a non custodial protocol. If you want to create such wallets, find one you trust and register on the platform. Next, you would be asked to create passwords and verify your email address. Once you complete that verification, you can create as many new non custodial wallets as you want on that platform. Each wallet has a private key that you can store elsewhere. Most non custodial wallets will ask you to re-enter the private keys, either in sequence or randomly, to verify that you have safely stored them.

The best non custodial wallet should prioritize safety and allow you to recover your passwords to access your account. Non custodial wallets are safe as users retain full control of their wallets. You can send, receive, exchange, or store cryptocurrencies without third-party interference. You can also connect your non custodial wallet to websites and other platforms where you need to integrate crypto payment systems.

Your non custodial wallet works best for decentralized crypto exchanges such as PancakeSwap, where you can connect or disconnect your wallet to secure your funds. The true power of non custodial wallets is that you retain full control of your funds without third-party interference. Furthermore, since KYC is not required, users remain private without the risk of identity breaches. The full privacy feature is the main attraction to non custodial wallets.

Pros and cons of noncustodial wallets

Here's what to consider when using a non custodial wallet:

Pros

• User control over funds: non custodial wallets give users full control over their funds without limits. You always retain private keys and passwords without sharing them with the wallet provider. There's no third-party interference when you send, receive, or store crypto.
• Instant withdrawal: once you access your non custodial wallet, you don't need further checks before making transactions. Most custodial wallets require a transaction code, but your non custodial wallet won't require it. Withdrawals are thus instant and fast.
• Security in financing: all your financial transactions on any non custodial wallet are secure. You only have to store your private keys to prevent unauthorized access safely. It's your responsibility to secure the wallet at all times. You can do that through security features such as 2-Factor Authorization.
• Full privacy: your non custodial wallet brings the fullness of privacy to your transactions. You don't have to do KYC or meet other requirements that expose your identity to the public. That's why non custodial wallets are best for decentralized finance (DeFi).

Cons

• Lost keys: non custodial wallet translates to an increased risk of losing funds forever if you lose your private keys.
• Trade Delay: transactions on non custodial wallets are queued in a 'nonce.' Sometimes trades are delayed before completion because of network congestion. It is more common in non custodial wallets than in custodial wallets.

What are the best noncustodial wallets?

If you want to create a non custodial crypto wallet, here are some to consider:

• Trust Wallet
• Metamask
• Electric;
• Trezon One
• Coinomi
• Wasabi
• Exodus
• Coinbase

Comparison Table

This table compares custodial wallets vs non custodial wallets.

Bottom line: what type of wallet should you use?

If you own or trade cryptocurrencies, you need a software or physical device where you can store your assets. Choosing between a custodial wallet vs non custodial wallet depends on certain factors such as storing private keys and what you use the wallet for. Custodial wallets remove the responsibility of storing private keys and are best for centralized trading. On the other hand, non custodial wallets allow users to store private keys and are best for decentralized finance trading and long-term storage. Consequently, depending on your specific needs, you can use either of the two. For example, you can earn bitcoin through the best bitcoin hosting and store it on custodial or non custodial wallets.