When you enter the world of cryptocurrency, your first step should be to create a crypto wallet. This wallet is where you store, send, and receive your cryptocurrencies. However, not all wallets are the same, and they come in different forms. One crucial difference is whether the wallet is custodial or non-custodial. It is important to understand the difference because each type has its advantages and disadvantages. Depending on your needs, one type might be suitable for you while the other might not. Therefore, we will explain the differences between custodial and non-custodial wallets for beginners.

Crypto wallets

To understand the differences between custodial and non-custodial wallets, we need first to understand what crypto wallets are. When you hear the term “crypto wallet,” you might assume it’s a place to store your cryptocurrencies. However, this is only partially accurate. In reality, a crypto wallet doesn’t store your cryptocurrencies, as they exist on the blockchain. Instead, it stores a “private key” that allows you to access your tokens on the blockchain, which serves as proof of ownership. Only the person with access to the private key can access the associated cryptocurrencies. This private key is what distinguishes custodial and non-custodial wallets, and it’s important to understand how they impact your cryptocurrency ownership.

Custodial Wallets

Custodial wallets are the most commonly used wallets in the world of cryptocurrency. Almost everyone who is involved in crypto will have a custodial wallet. A custodial wallet is a wallet that is controlled by someone else, and you don’t have access to the private key. If you have opened an account on a crypto exchange, the likelihood of you having a custodial wallet is very high. When you create an exchange account, it automatically creates a custodial wallet for you, but it doesn’t give you access to the private key. You can send and receive cryptocurrencies easily when using a custodial wallet, as you still have access to the public key used for transferring funds in and out of the wallet. However, you don’t have full control over your crypto, which means that you are relying on someone else to keep your digital assets safe.

Non-Custodial Wallets

Non-custodial wallets are cryptocurrency wallets where you, and only you, have access to the private key, ensuring full control of your funds. Popular examples of non-custodial wallets include MetaMask and Ledger. When creating a non-custodial wallet, you will receive a security phrase that grants access to your wallet and private key. It is crucial to keep this security phrase in a secure location and never lose it, as losing access to the phrase means losing control of your wallet. Non-custodial wallets are commonly used for storing large amounts of tokens or for long-term token storage. On the other hand, custodial wallets are managed by exchanges. Following the collapse of FTX, the second-largest crypto exchange during the last bear market, user funds were lost along with the exchange.

Which wallet should you use?

Many people need help determining which wallet to use and why. The answer depends on what you plan to do with your cryptocurrencies. At first glance, owning a non-custodial wallet is the best option, but there are situations where you would be better off using a custodial wallet instead.

When trading with cryptocurrencies, instead of holding them long-term, it is necessary to own a custodial wallet. Most exchanges only support their custodial wallets, so you cannot connect your wallet to the exchange and trade that way. Whenever you trade with crypto, your tokens will be on the market, and you will need to store them in these custodial wallets. Custodial wallets are also a safer option, as the exchanges keep them. From a security perspective, these exchanges likely have better security measures in place than an individual user. This is especially true for big players such as Binance. If someone gains access to your private key, they can do anything they like with your cryptocurrencies. Private keys are the only proof of ownership, and if they were stolen from your non-custodial wallet, you would never be able to prove that someone else stole them. If someone saw your security phrase and accessed your wallet, even the police would not be able to do anything about it. However, in the case of custodial wallets, exchanges have high-security measures in place, and they even store funds in cold wallets. While it is unlikely that someone will steal your private key from a custodial wallet, there are still possibilities, and there have been cases when this has happened to well-known exchanges.

If you don’t trade frequently or have a large amount of cryptocurrency that you only trade in small amounts, then having a non-custodial wallet is probably a better option. You can use a non-custodial wallet on most websites that involve cryptocurrencies. For instance, if you visit a website like OpenSea, the largest NFT website in the world, you can connect your wallet directly to the website and use it to buy or sell NFTs. 

While exchanges generally have better security than you, they are also a prime target for attacks. However, as long as you follow basic security measures, such as not sharing your security phrase anywhere and not downloading suspicious programs, you should be able to keep your crypto safe with a non-custodial wallet. 

If your funds are in custodial wallets and something happens to the exchange, you won’t be able to access them because the exchange will never provide you with the private key, and they won’t be able to give you withdrawal rights. Therefore, your choice between custodial and non-custodial wallets should depend on how you use cryptocurrencies.

Pros and cons of custodial and non-custodial wallets

It’s important to understand that both types of wallets, hot and cold, serve a specific purpose and that one may be more beneficial than the other, depending on the situation. Each wallet has its own advantages and disadvantages. In order to make an informed decision, it’s important to have a clear understanding of these. Let’s take a closer look at both types of wallets.

Custodial Wallet

The advantages and disadvantages of a custodial wallet can be summarized as follows:

Advantages:

  • Easier to use when trading
  • It is secured using security measures implemented by world-leading crypto exchanges.
  • to be more user-friendly, making it easier for beginners to use

Disadvantages:

  • You don’t have full control over your funds.
  • If the exchange were to go bankrupt, you wouldn’t be able to withdraw your funds.
  • Crypto exchange hacking is not uncommon. Numerous cases have been reported of exchanges being hacked and users’ funds stolen.

Non-Custodial Wallet

The advantages and disadvantages of a non-custodial wallet can be summarized as follows:

Advantages:

  • You are the only person who has access to your funds
  • If you follow basic security measures, the likelihood of someone stealing your funds is very low
  • It can be used across different websites

Disadvantages:

  • It might not be very clear for newcomers
  • If you lose your security phrase, you will never be able to access your wallet again

FAQs on the difference between custodial and non-custodial wallets

Is MetaMask a custodial or non-custodial wallet?

MetaMask is a type of wallet that does not hold your funds. When you create a MetaMask wallet, you’ll receive a security phrase that will enable you to access your wallet and its private key. This makes MetaMask a non-custodial wallet, and it is currently one of the best free non-custodial wallets available in the market.

Can non-custodial wallets be hacked?

Non-custodial wallets are considered highly secure as they are difficult to hack. However, there are still ways for hackers to gain access to your wallet. One possible way is through hacking the entire blockchain, although this is highly unlikely. The other way is if hackers manage to hack into your computer and locate your security phrase in case you have stored it on your computer. This is why it is recommended that you write down your security phrase on a piece of paper and keep it in a secure place inside your home. This will ensure that your wallet remains safe and secure.