A deep dive into the key differences that separate custodial vs non-custodial wallets.
However, losing your private keys means that you also lose access to your crypto holdings. Therefore, it is imperative that you understand how crypto wallets work, and how to keep your keys secure. Read on to find out more.
Types of Wallets
There are two main umbrellas of wallets:
Furthermore, each crypto wallet includes two important components.
- Public key
- Private key
Public and Private Crypto Wallet Keys
In crypto terms, the keys serve the purpose of receiving inbound cryptocurrencies and handle the encryption of outbound transaction data. While depositing cryptocurrency to a wallet, a public key is required to be entered as the deposit address.
Meanwhile, a private key is akin to the password used to access your digital assets. It also proves ownership over those assets stored in the wallet, and is used to transfer cryptocurrencies out of the wallet.
Custodial Crypto Wallets
Outsourcing your wallet custody means that you are giving away access to your own set of private keys. In short, the user is not responsible for protecting their private key to their wallet, as they already have placed their trust in a business into keeping their assets safe. However, many CEXs also offer non-custodial wallet solutions, such as Binance Chain Wallet, Coinbase Wallet and Crypto.com DeFi Wallet.
How Do Custodial Wallets Work?
In order to make a successful transaction through a custodial wallet, the user is required to log in to the platform with their username and password and then enter the public key of the location where they wish to make the transfer.
After that, the business takes over and is directly responsible for making the transaction on their own as the funds are stored on the wallets that they own.
Pros of Custodial Wallets
As mentioned, the private access keys are not your responsibility. You do not need to worry about forgetting your key, and even if you misplace your password, you can always request that the CEX or wallet provider recovers your account.
Some businesses that offer these custodial wallet services also offer a backup option. Backups enable users to undo transactions or restore a previous version as every step is recorded and backed up to the company’s server.
Cons of Custodial Wallets
While it may be a simpler option, users need to note that they are exposed to the risk of exploitation or hacks that the wallet provider might suffer. There have been several hacking cases, including loss of funds held in custody.
Furthermore, certain governments have completely banned the use of custodial wallets for completing transactions for users in certain areas. In times of political unrest, this means that governments have more power to restrict movement of funds in custodial wallets. For example, during the Canadian trucker protest in early 2022, the government ordered a freeze on the crypto assets of the protestors held in custodial wallets.
As most of you have already guessed, non-custodial wallets do not require any sort of third-party involvement like custodial wallets do. They don't outsource to any institution, so as a result, no institution can refuse to complete transactions.
A user has total control over their own private keys: none of their transactions have to go through centralized third-parties.
Pros of Non-Custodial Wallets
Non-custodial wallets serve the purpose of ensuring the confidentiality of a user's assets. However, that comes with the responsibility of storing your private keys, which are the sole way of accessing your account.
Unlike custodial wallets, users can easily access their stored funds in any situation and without KYC, as there is no need for a confirmation notice from any third party. Instant withdrawals are available in non-custodial wallets, while some CEXs require a certain time to process transactions.
Cons of a Non-Custodial Wallet
Unlike custodial wallets, non-custodial wallets aren't often particularly user-friendly. Beginners may have a steeper learning curve and require some time before getting to know how to use these wallets.
When it comes to non-custodial wallets, the recovery of funds is a bit more complicated and in some extreme cases even impossible, which is why it is important to be extra careful when using them.
In the event that you do lose access to your non-custodial wallet, the first thing you should do is reach out to the wallet's support team. If the wallet's support team is unable to help you, you can try reaching out to the blockchain's support team. And if all else fails, you can try contacting the exchanges where you purchased your cryptocurrency.