People generally understand that crypto wallets are used to store cryptocurrencies and execute transactions on a blockchain network. But technically crypto wallets don’t store crypto per se. Instead, a digital wallet generates an address that locates the user’s digital assets on the blockchain.
There are different wallet types available in the market and every wallet has a corresponding public key and private key. A public key is like a bank account number, shareable with everyone. It is required for transferring money into a user’s wallet.
On the other hand, a private key is like a password with which users can access their funds or sign a crypto transaction. It is imperative to keep a private key safe.
Wallets are either custodial or non-custodial, depending on who controls or has access to private keys. But what else differentiates these two wallet types and how can one determine which is most suitable for their needs?
This article provides all the information you need to make an educated decision about the wallet type that's best for you.
What is a custodial wallet?
A custodial wallet is a wallet in which a third party (usually a central authority like a crypto exchange) is responsible for managing your private keys. Instead of having sovereign custodial access to your funds, a service provider gets complete control of your money.
Users rely on custodial wallets because managing private keys is not an easy task. Losing your private key means losing access to your funds forever. If you’re considering a custodial wallet, it’s important to choose a trusted and reliable service provider that will keep your private keys and funds safe.
Custodial crypto wallets compliant with existing regulatory regimes are usually safer than non-compliant wallets. Users can also opt for custodial wallets that offer insurance coverage for theft or misuse of funds.
What is a non-custodial wallet?
A non-custodial wallet is a wallet in which you are responsible for storing and managing your private keys. Instead of third parties like crypto exchanges having custodial access, you have full control over your digital assets.
Users with non-custodial wallets become their own banks with round-the-clock access to their funds. These non-custodial wallets are ideal for experienced traders ready to shoulder the great responsibility of storing their keys safely.
The crypto industry believes in the maxim: “not your keys, not your coins”. If investors and traders lose access to their private key, they lose all of their crypto assets. Since it's extremely difficult to retrieve a lost private key for non-custodial wallets, users need to be extra careful.
Although users are taking the risk of losing their funds into their own hands, non-custodial crypto wallets offer better protection against a data breach than custodial wallets. Some non-custodial wallets require internet connectivity to operate, however, so offline hardware wallets are usually the safest option in this regard.
Custodial vs non-custodial wallets
The main difference between custodial and non-custodial wallets is that custodial wallets give a third party the permission to hold your private keys, whereas non-custodial wallets give you sovereign control of your private keys.
Private key ownership
For custodial crypto wallets, the wallet provider is tasked with securely storing the user’s private key. Therefore, users do not have full control over their assets. Instead, the custodian directly handles the funds, and in some cases may misuse them.
For non-custodial crypto wallets, no third party is involved and users manage their own private keys. Thus, without interference from any kind of intermediaries, users alone can access the assets stored in their crypto wallets.
Users must consider security as the most important criterion when choosing a crypto wallet. Since a custodial wallet stores a user’s keys in centralized servers, they are more prone to attacks and hacks from malicious actors. The $90 million Liquid exchange hack, for example, demonstrated the vulnerability of exchange-hosted custodial wallets.
Since non-custodial wallet users store their keys (ideally off-chain), it's extremely difficult for hackers to steal their funds. Non-custodial crypto wallets therefore offer better security compared to custodial wallets. Using a hardware wallet that functions offline can further reduce security vulnerabilities.
Read our article How to spot and avoid crypto scams to learn all about the most common scams and how to spot them.
Transaction time and cost
With a custodial wallet, every transaction requires approval from the central exchange. Consequently, there is a delay in the transaction going through. The transaction history is also not recorded on the underlying blockchain in real-time, and transaction costs are typically higher due to the involvement of custodians and other intermediaries.
Non-custodial wallet users directly authenticate transactions without involving centralized entities, so they’re usually faster. Moreover, the transaction history appears on the blockchain in real-time. Transaction costs are also cheaper because there are few or no commission-seeking intermediaries.
Funds backup and recovery
Custodial wallet users can rely on the custodian to retrieve their password in the case of loss. The crypto exchange must recover a user’s funds since it holds custodial rights over the user’s private key. Thus, users need not worry as customer support can help get their assets back.
With non-custodial wallets, however, users need to be extra careful since losing one’s private key means losing all their assets. To protect their cryptocurrency, users need to safely store their recovery phrase (also called a seed phrase), a 12, 18, or 24 character mnemonic phrase used to regain access to one crypto wallet.
Creating a new account
Account creation for custodial wallets usually involves a lot of hassle. Users need to complete Know Your Customer (KYC) and Anti Money Laundering (AML) forms for security and regulatory compliance. This can be a lengthy and time-consuming process.
Non-custodial wallets, on the other hand, do not require KYC / AML. Thus, creating a non-custodial wallet is faster and easier, and users have the benefit of anonymity.
Custodial wallets require an internet connection to reach centralized servers and access blockchain data. Thus, custodial crypto wallets can only operate online, making them vulnerable to cyber attacks.
Non-custodial wallets are more flexible because they can usually operate both online and offline. A non-custodial crypto wallet can function from a web browser or a mobile application. A hardware wallet is the safest, however, because users can sign transactions offline, thereby protecting keys from malicious hackers.
Custodial pros and cons
Custodial wallet holders enjoy peace of mind because they don’t need to worry about losing their private key. If users lose any sensitive data, they can contact customer support and regain access to their funds. Thus, with custodial wallets, users can take advantage of backup facilities at any time and avoid financial loss.
Custodial wallets also usually have a very user-friendly interface so novices can navigate them quite easily.
With custodial wallets, users have to completely rely on a third party custodian for storing their private key. If the third party does not have strong security measures, the user is at risk of losing their funds. A liquidity crisis like the one at Celsius could also jeopardize investor funds.
Since custodial wallets cannot operate offline, they are more prone to hacks and online theft. Moreover, custodial wallets require KYC documents that infringe on user anonymity.
Non-custodial pros and cons
Non-custodial crypto wallet holders have sovereign control over their private keys, and therefore control their funds completely. They don’t need to trust a third party exchange to properly manage their assets. Moreover, offline non-custodial wallets, or “cold wallets”, are protected from online hackers.
Non-custodial wallets also usually process transactions immediately at negligible costs, and users don’t need to fill out KYC documents to obtain one.
Users need to be extra responsible with non-custodial wallets because losing one’s private keys means losing their funds forever. Apart from the seed phrase, there is no way to restore an account if a user loses their password. Sometimes the user interface of non-custodial wallets can also seem a bit overwhelming for new users.
Which wallet type is suitable for crypto users?
New users purchasing crypto may get lost in the weeds of the custodial vs non-custodial wallets debate.
As the aforementioned sections demonstrate, both custodial and non-custodial wallets have their own advantages and disadvantages. Each wallet type is suitable for different users with specific needs. Blockchain users can either delegate storage and private key management to a third party or become the sole custodian of their private keys.
Frequently Asked Questions
What is the main difference between custodial and non-custodial wallets?
With a custodial wallet, a third party stores and manages a user’s private keys. With a non-custodial wallet, the user must store and manage their private keys on their own.
What is a private key?
A private key is a cryptographically generated string of characters that acts as a password to manage user funds and create a backup wallet on a new device. The private key helps to prove asset ownership, create digital signatures, and execute transactions on the blockchain.
Are custodial wallets safe to use?
Yes, custodial wallets are safe to use but users need to do their own research before choosing one. It is better to select custodial wallets that comply with regulations and offer robust security and insurance coverage.
Are non-custodial wallets safe for users?
Yes, non-custodial wallets are safe for users, but it’s the user’s responsibility to keep their private keys safe and have a proper backup.
Is MoonPay custodial or non-custodial?
MoonPay is non-custodial. Blockchain users can buy crypto on MoonPay with their credit/debit cards, Apple Pay, Samsung Pay, and Google Pay. Be sure to check the network fees before making any payments to avoid paying extra gas.