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There are several different types of crypto wallets to choose from, but the two main varieties can be broken out as custodial wallets and non-custodial wallets.
If you currently hold any cryptocurrency, you’ve probably already interacted with a crypto wallet before. But a crypto wallet isn’t like a regular wallet in which you’d hold your credit cards and cash. It’s a common misconception that crypto wallets store or contain a user’s cryptocurrency holdings. In fact, they are simply the tool through which a user can access their funds on the blockchain and initiate crypto transactions.
Non-custodial and custodial: who owns your keys?
When we’re talking about whether a wallet is custodial or non-custodial, what’s actually being taken custody of isn’t the funds in a crypto user’s account, it’s the private key needed to gain access to their crypto assets.
A custodial wallet service (like Coinbase or Kraken) holds on to the private key, so it is responsible for safeguarding a user’s funds. A non-custodial wallet, on the other hand, gives users complete control over their private key, with it sole responsibility for protecting their holdings.
Custodial wallets are nearly always web-based, and are usually provided by centralized crypto exchanges like Coinbase. Most exchanges’ interfaces are designed so users never even have to directly interact with their wallets. This user-friendliness means custodial wallets are generally preferred by newcomers, to whom the convenience factor of not having to manage their private key themselves is a big benefit.
Custodial wallets also give users peace of mind that a lost or forgotten password doesn’t mean they lose access to their funds. Most of the time providers or exchanges can simply reset your password with a few security questions. If a non-custodial wallet holder loses their private key, their funds could be unrecoverable.
With a custodial wallet, a user initiates a transaction through their platform of choice and selects a wallet address to which they’d like to send funds. The custodian of the private key, in this case a crypto exchange, is tasked with “signing” transactions using the private key to ensure they’re completed correctly. Custodial wallets are generally easy to connect to decentralized apps (dApps) and financial opportunities like staking or yield farming.
Another concern around custodial wallets is theft. Exchanges are known to be the holders of private keys, and their services are interacted with online, which makes them a continuous target for hackers. As a result, billions of dollars are lost to cybercriminals every year. You could even lose your funds to government seizure in the event an exchange that holds your private key <a href="https://fortune.com/2022/05/11/coinbase-bankruptcy-crypto-assets-safe-private-key-earnings-stock/" rel="noopener noreferrer nofollow">goes bankrupt</a>.
Using a custodial wallet requires a great deal of trust in the institution, which highlights the importance of doing your homework and only using a trusted and reliable exchange. Part of that process should involve inquiring whether they’re regulated, how they keep your private keys secure and whether they offer any insurance coverage. As a best-of-both-worlds solution, users can connect their Coinbase account in the <a href="https://bitpay.com/wallet/" rel="noopener noreferrer nofollow">BitPay app</a> to retain all of the spending and crypto management perks of a non-custodial wallet but without the responsibility of self-securing their private keys.
What is a non-custodial wallet?
With non-custodial wallets, a crypto user has complete control over their private key, along with their funds. Non-custodial wallets tend to be a bit more technically complex than custodial wallets, so they’re generally more favored by experienced crypto users.
Some non-custodial wallets are browser-based, but there are a few other types available. Software wallets store and encrypt private keys on a computer hard drive. But the most secure type of all is a hardware wallet. Hardware wallets resemble a USB thumb drive, and are only online when connected to a computer or mobile device. The signing of transactions using the private key happens within the device itself and is only sent to be confirmed by the blockchain once it’s back online. This makes non-custodial hardware wallets virtually impervious to hackers.
Non-custodial wallets give users the freedom to be their own bankers, but that freedom comes with more responsibility. If you forget your account password at a custodial wallet provider, it can be reset with a few emails and maybe some identity verification. But losing your hardware wallet or your private key could leave you with no way to access your funds.
Fortunately, many non-custodial wallet providers give users a recovery phrase or “seed phrase”. This phrase consists of 12–24 random words, serving as a sort of backup password recovery method, even if a wallet is lost, deleted or destroyed. But this phrase should be guarded just as carefully as your private key, because anyone with the seed phrase will be able to access the account. What this all boils down to is the biggest downside of non-custodial wallets. If you somehow lose your private key, your wallet and your seed phrase, there will be no way to recover your funds.

Non-Custodial Wallets vs Custodial Wallets: Know the Difference

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