The rise of crypto wallets represents a significant innovation in fintech. Those wallets can be very useful for businesses because, with them, many people can have access to funds depending on roles and permissions.
Depending on the type, cryptocurrency wallets also help in managing digital assets and allow businesses or individuals to control funds without banking, as they retain the full autonomy of funds, or even trade assets without manual transfers. In this article, we are going to see what is the difference between a custodial and non-custodial wallet.
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The custodial wallet requires identity verification, breaching the user’s anonymity, while the non-custodial wallet is pseudonymous.
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Since non-custodial wallets operate independently of centralized exchanges (CEXs), transaction speed depends on blockchain network conditions, leading to delays in crypto operations.
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Although the custodial wallet relies on the Know Your Customer policy, the risks of cyber security attacks arise because of the required identity verification.
Foreword: The Essence of Private Keys
Hold on! Why is it important to discuss the private key and how it comes with the custodial and non-custodial wallets? Let’s define this cryptographic element and analyze its functions and importance for crypto wallets.
The crypto wallet generates a private key, which represents an alphanumeric code consisting of a large string of letters and numbers. The primary functions of a private key include enabling the users to authorize transactions and prove ownership of their assets.
This alphanumeric cipher matters to any crypto wallet type as it generates a digital signature. A private key is used to sign the transaction, which is transmitted to the blockchain, but prior to being added to the block, it requires verification. The computers operating the blockchain check the user’s public key to verify the digital signature, and if it is correct the transaction is approved and recorded permanently on the blockchain.
The private and public keys are paired, which ensures the transaction’s security due to the resistance to tampering and the impossibility of making any changes on the block. Hence, private keys are central elements of a crypto wallet, so let’s discuss their essence in custodial and non-custodial wallets.
What Is a Custodial Wallet?
The custodial wallet meaning can be defined as a wallet in which a third party, such as an exchange or bank, holds the private keys of the users. This means that the client is not in full control of their funds, as they rely on the custodian who secures and manages their transactions.
There are the following features of the custodial wallets:
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Simplified Usability
The custodial wallets represent an opportunity for beginners to trade their crypto assets without managing private keys.
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Options for Account Recovery
If users lose access to their accounts, they will be able to recover their funds as the custodian holds their private keys on the centralized server. The users will only have to verify their identity.
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Support Opportunities
A central unity manages the client’s wallet, providing them with support like undoing the transaction.
Some of the best custodial wallets to consider are: Coinbase, Gemini, BitMex, BitGo, Binance, and Bitfinex.
What Is a Non-Custodial Wallet?
When analyzing the non-custodial vs custodial wallet, the first one provides clients with full ownership of their private keys and funds, respectively. This autonomy defines the non-custodial wallet meaning that no third party will handle the user’s funds and operations. This excludes issues like account freezing and withdrawal restrictions. There are the following distinctive features of the non-custodial wallets:
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User’s Full Ownership
The non-custodial wallets function within the decentralized ecosystem, meaning that no centralized unity will manage the wallet.
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Direct Blockchain Interaction
A non-custodial wallet does not require an intermediary; transactions occur directly on the blockchain.
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Increased Privacy
The users don’t have to abide by the Know Your Customer policy and verify their identity in the non-custodial wallet. This crypto wallet type preserves pseudoanonimity.
Gain insights into the essence of e-wallets, their benefits, and examples.
Difference Between Custodial and Non-Custodial Wallet
Based on the aforementioned analysis of two crypto wallet types, their meaning, advantages, and disadvantages, it would be essential to provide a short summative recap, as well as additional details on the differences between the custodial wallet vs non-custodial wallet, focusing on the following metrics.
Security
Custodial Wallet
The custodial wallet is less secure than its non-custodial counterpart, considering its vulnerability to cyberattacks. Hackers can attack the centralized servers and obtain access to multiple accounts.
Credential harvesting is a phishing type of cyberattack which aims to steal a user’s login and password so that the attacker can access their account. The attackers send the falsified site links, almost identical to the real ones, via SMS or email, so by entering their credentials, the victim provides them with access to their funds.
Non-Custodial Wallet
The non-custodial wallets depend on the private keys owned by the users, which decreases the risks of theft. Nevertheless, attackers can obtain the key due to malware attacks, which can infect the computer or smartphone as in the case of clipboard hijacking malware attack.
The malware functions, so to say, silently in the device, monitoring the clipboard. When the user copies the wallet address, the malware substitutes it with the attacker’s one, so the victim sends them their funds unintentionally.
Ownership of Private Keys
Custodial Wallet
In the custodial wallet, it’s the custodian’s responsibility to hold the user’s private keys, which limits the latter’s control over their funds. This is one of the most significant disadvantages of the custodial wallets for the following reasons:
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Lack of Client’s Full Ownership Over Their Finances.
The client has access to accounts but relies heavily on the custodian’s controls over the transaction’s approval.
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Withdrawal and Transaction Restrictions
The custodian can delay or block the transaction based on governmental policies, which can limit the fund movement.
Non-Custodial Wallet
In the non-custodial wallet, the user holds the private keys by themselves, which is simultaneously convenient and requires a decent level of responsibility not to lose them.
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No KYC Compliance
The non-custodial wallet does not rely on the KYC policy, so the user doesn’t have to verify their identity to proceed with the transactions, showing their full ownership over their funds.
Ease of Use
Custodial Wallet
Custodial wallets are easier to use as the client does not have to know the precise details of the exchange work. If the user wants to undo the operation, customer support can help with that.
Non-Custodial Wallet
Non-custodial wallets require decent knowledge about the work of blockchain and smart contracts, as minor mistakes can lead to the loss of funds with no refund option, representing one of the core challenges of this wallet type.
Check out 7 potential crypto wallets you might use.
Choosing the Right Wallet for Your Business Needs
You might be interested in how to choose the right wallet type per business needs. It's time to discuss the most suitable cases to use custodial and non-custodial cryptocurrency wallets.
Custodial Wallets
The custodial wallets are a valuable option for businesses that need an insured and regulated service. For instance, Greyscale, a leading crypto asset manager, utilizes Coinbase Custody, which improves its scalability and contributes to success due to alignment with NYC banking laws as the wallet is regulated by NYDFS, one of the most prominent financial regulators in the world.
Non-Custodial Wallets
The non-custodial wallets are best suited for businesses that manage crypto without third-party integration, and those companies with DeFi projects and NFT platforms. For instance, Open Sea, a web3 marketplace for NFTs, applies Meta Mask, which improves its scalability and success by integrating Layer 2 support like Polygon network for lower fees and faster transactions.
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Conclusion
The article analyzed the features, advantages, disadvantages, and differences of custodial vs non-custodial crypto wallet types. Both introduce unique approaches to handling finances, such as the client’s full ownership of the private keys versus the custodian’s. Nevertheless, when choosing a wallet type, you have to take into account the elements of security, anonymity, and tech knowledge to make your trade or transactions secure and minimize risks.
Are you eager to craft a personalized crypto wallet? Then contact us to get a consultation!
