Custodial Vs. Non-custodial wallets — which one should you choose?

ByteX
8 min readMar 10, 2023

When we invest in cryptocurrencies, we typically buy and sell assets. You can do this on a cryptocurrency exchange that lets you store your assets in digital crypto ‘wallets.’ There are two types of wallets — custodial and non-custodial wallets. How does one choose between a non-custodial wallet and a custodial crypto exchange wallet? Both help to buy and sell cryptocurrencies but function differently.

As opposed to a custodial wallet, safely storing investments is the primary objective of a non-custodial wallet. However, it’s mainly used for funds that are only actively traded. Before we look at the pros and cons of both types of wallets, let’s familiarize ourselves with the basics.

What is a cryptocurrency wallet?

A cryptocurrency wallet or crypto wallet is software or hardware used to securely store and transfer digital currency. Every cryptocurrency wallet has a wallet address tied to it. This public key is shared with different contacts, like an email address. The wallet address is unique to you and lets the blockchain identify your wallet.

Unlike traditional currencies like dollars or euros, cryptocurrency cannot be physically stored in a wallet or purse. There is no tangible form of cryptocurrency; instead, it exists only on the blockchain. However, there needs to be a way for users to keep track of how much cryptocurrency is being held or spent.

With a crypto wallet, users can verify their account balance and see how much cryptocurrency they own. As with a regular bank account, a crypto wallet lets you make and receive bitcoin transactions. A crypto wallet is a principal tool for storing and accessing bitcoin funds for all investors in the crypto space.

What is a cryptocurrency exchange?

The term “crypto exchange” refers to a trading platform specifically for digital currency. It is a marketplace for buying, selling, and exchanging digital currency. In addition to buying and selling, cryptocurrency exchanges also offer wallet services called custodial wallets. One way to look at an exchange is as a digital bank where users can deposit and withdraw cryptocurrency and use other banking features.

Some cryptocurrency exchanges, for instance, let customers borrow funds against their holdings. Some allow for more complex trades by including leverage and derivatives like options and futures contracts.

In legal terms, depositors lose ownership of their money once it is in a bank. Similarly, assets held in a custodial wallet on an exchange are not directly in the hands of the exchange’s users. This is because the users don’t own the private key of the wallet where their funds are stored.

So, what’s a custodial wallet?

A custodial wallet is one in which your private keys are managed by a trusted third party (often a crypto exchange). Instead of a sovereign custodian having access to your funds, a service provider gains total control of your assets.

Due to the complexity involved in keeping track of private keys, users often resort to custodial wallets. This is because the moment you lose your private key, you will no longer have access to your funds. If you use a custodial wallet, pick a service you know you can trust to protect your private keys and assets. Using a custodial wallet means a hassle-free experience for the consumer with an increased security risk. This is also great for those looking to trade regularly, as the funds are instantly accessible when you log into your preferred trading platform.

In general, compliant custodial cryptocurrency wallets, like those offered by ByteX, are more secure than non-compliant ones. Some custodial wallets also offer protection against loss, theft, and inappropriate use of funds.

What is a non-custodial wallet?

A non-custodial crypto wallet is one in which the private keys are held exclusively by the wallet owner. Non-custodial wallets are the best choice for consumers who want complete control over their funds. As no middlemen are involved, transactions between cryptocurrency wallets can be made instantly. It is the best option for tech-savvy traders and investors who understand the importance of securing their private keys and seed phrases. This is usually the preferred wallet for those looking to invest over longer periods.

Decentralized exchanges (DEXs) and decentralized applications (DApps) require users to use non-custodial wallets. Examples of decentralized exchanges that call for a non-custodial wallet are Uniswap, SushiSwap, PancakeSwap, and QuickSwap.

Some popular non-custodial wallet service providers include Trust Wallet and MetaMask. While most cryptocurrency exchanges offer only custodial wallets, ByteX allows users to store their funds in a non-custodial Metamask wallet, one of the most popular names in the list of non-custodial wallets.

However, when using non-custodial wallets, bear in mind that you are entirely responsible for safeguarding your seed phrase and private keys using these wallets.

What Is The Difference Between Custodial And Non-Custodial?

With the basics covered, it’s time we summarize the key differences between the two wallet types.

Private keys

When using a custodial crypto wallet, the user’s private key is safely stored by the wallet provider. In this way, consumers lose some measure of control over their assets. Instead, the custodian has direct access to the money and can potentially misappropriate some or all of it.

Users with non-custodial crypto wallets are in charge of safeguarding their private keys and never have to share them with anybody else. This means that users have sole access to the assets kept in their crypto wallets, unhindered by any other parties.

Security

When deciding on which crypto wallet to use, users should prioritize safety above all else. When a user uses a custodial wallet, their private keys are stored in a centralized server, making them more vulnerable to theft.

Since the keys to a non-custodial wallet are stored by the user (preferably off-chain), it is almost impossible for hackers to steal the user’s funds. In this regard, non-custodial crypto wallets provide superior protection than their custodial counterparts.

Time and Cost

If you use a custodial wallet, the exchange must approve your transactions. This causes the transaction to take longer than expected. Furthermore, transactions are not recorded on the blockchain in real time due to the involvement of intermediaries, which also increases transaction costs.

Users using non-custodial wallets authenticate transactions directly without needing third-party verification services. In addition, the blockchain records the transaction log in near-real-time. Due to the lack of profit-seeking intermediaries, transaction costs are also reduced significantly.

Backup/recovery of funds

If a user of a custodial wallet needs to reset their password, they can contact the custodian and ask them to help them recover it. Furthermore, since the cryptocurrency exchange has custody of the user’s private key, it is also responsible for recovering the user’s funds if they are lost or stolen. Therefore, consumers can rest easy since help is available via customer support.

However, users must exercise extreme caution while working with non-custodial wallets, as losing the private key results in the complete loss of all funds stored in the wallet. Users are also responsible for keeping their recovery phrase (or seed phrase) a secret. A seed phrase is a mnemonic phrase of 12, 18, or 24 characters that can be used to restore access to a cryptocurrency wallet if private keys are lost.

Account creation

The process of creating a custodial wallet account is typically time-consuming and confusing. Users must fill out Know Your Customer (KYC) and anti-money laundering (AML) paperwork to ensure security and compliance with laws and regulations. This can take a considerable amount of time.

On the other hand, KYC and AML procedures are not necessary while using a non-custodial wallet. Therefore, users can benefit from the speed and simplicity of creating a non-custodial wallet and the added privacy that comes with it.

Offline Availability

Internet access is necessary for custodial wallets to communicate with the blockchain network via the provider’s central servers. Because they rely on the internet, custodial cryptocurrency wallets are open targets for hacking.

Typically, non-custodial wallets can be used online or offline, giving them greater versatility. In most cases, if you have access to the internet or a mobile device, you can access your non-custodial wallet. However, a hardware wallet offers the greatest security since users can sign transactions offline, keeping private keys out of the hands of hackers.

Is Custodial Or Non-Custodial Wallet Better?

As discussed above, both custodial and non-custodial wallets have their benefits and drawbacks. Today, a wide variety of wallets are available, and each caters to a different type of user. As such, blockchain users can either outsource storage and private key management to a third party or become the sole custodian of their private keys.

Ultimately, a legally compliant custodial wallet is preferable to a non-custodial wallet if you are not confident in your technical abilities or prefer to avoid the hassle of operating a non-custodial wallet. However, if you want to remain faithful to decentralization and retain complete control over your funds, you can opt for a non-custodial software or hardware wallet.

Fortunately, ByteX provides both of these alternatives to its consumers and is quickly becoming the go-to provider for both day traders and long-term investors.

Important Disclosures:

Certain statements in this document might be forward-looking statements, including those identified by the expressions “anticipate”, “believe”, “plan”, “estimate”, “expect”, “intend”, “target”, “seek”, “will” and similar expressions to the extent they relate to the material produced by Bytex staff member. Forward-looking statements are not historical facts but reflect the current expectations regarding future results or events. Such forward-looking statements reflect current beliefs and are based on information currently available to them. Forward-looking statements are made with assumptions and involve significant risks and uncertainties. Although the forward-looking statements contained in this document are based upon assumptions the author of the material believes to be reasonable, none of Bytex’s staff can assure potential participants and investors that actual results will be consistent with these forward-looking statements. As a result, readers are cautioned not to place undue reliance on these statements as a number of factors could cause actual results or events to differ materially from current expectations

The commentaries contained herein are provided as a general source of information based on information available as of MMMM DD, 2022. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change investment decisions arising from the use or relevance of the information contained here. ByteX. makes no representation or warranty to any participant regarding the legality of any investment, the income or tax consequences, or the suitability of an investment for such investor. Prospective participants must not rely on this document as part of any assessment of any potential participation in buying and selling of virtual currency assets and should not treat the contents of this document as advice relating to legal, taxation, financial, or investment matters. Participants are strongly advised to make their own inquiries and consult their own professional advisers as to the legal, tax, accounting, and related matters concerning the acquisition, holding, or disposal of a virtual currency. All content is original and has been researched and produced by ByteX.

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