When you own digital assets, like cryptocurrencies and NFTs, you need a blockchain wallet to store them.
Most digital wallets that have the technological capability to store crypto assets fall into two categories — custodial and non-custodial. Understanding the difference between these types of wallets is crucial, as it can greatly affect your ability to control the future of your digital assets.
In this article, we will define what custodial and non-custodial are, and compare the two on several important factors. Keep reading to learn how you can keep your digital assets safe with whichever wallet you choose.
Defining Custodial and Non-Custodial Wallets
Although there are many different types of blockchain-based wallets, they can generally all be categorized into one of two groups: custodial wallets and non-custodial wallets.
A custodial wallet is a type of wallet that involves a third-party helping you manage your assets and private keys. For first-time investors in blockchain-based assets, many of the initial wallets you encounter will likely be custodial wallets (like Coinbase custodial).
Comparatively, a non-custodial wallet places all control into the investor’s hands. There will be no third-party helping to manage your wallet, meaning you have full authority over your funds and your account accessibility. Contrary to popular belief, the assets aren’t actually inside the non-custodial wallet; they are still on the blockchain, but access to the wallet is purely in your control.
How Do Custodial and Non-Custodial Wallets Compare?
Before you choose between a custodial or a non-custodial wallet, it is important to consider the advantages of both. Some of the most important considerations to keep in mind include ease of use, security, yield, sidechain benefits, and simplicity.
Here is a breakdown of how custodial vs. non-custodial wallets compare on these 5 key factors:
Ease of Use
In terms of ease of use, custodial wallets tend to offer more intuitive user interfaces than non-custodial wallets. For instance, with a custodial wallet, your keys are stored by the custodian, meaning you only need to log into your account with a traditional username and password (in most cases) to access your wallet.
Comparatively, non-custodial wallets require you to have a strong foundational understanding of how blockchains work, how blockchain wallets work, what type of wallet you have, and how to properly store your keys.
One important consideration with this, however, is that owning a custodial wallet can inhibit your ability to interact with decentralized exchanges, like Uniswap. This can result in non-custodial wallets actually offering a higher level of ease of use when you get into more of the technical aspects of blockchain – like being able to exchange your assets for other tokens without dealing with a centralized party (like a centralized exchange).
Security & Safety
When you have a custodial wallet, the security of your assets and keys are supported by a third-party company or platform. This helps to ensure you always have safe access to your wallet. Plus, the centralized nature of custodial wallets makes it possible to use better fraud protection methods as well.
Additionally, having a custodial wallet means you have to share access to, and control over, your digital assets. For many blockchain investors, this goes against the belief that blockchain technology should be a decentralized system where individuals have full control over their own funds and assets.
Comparatively, non-custodial wallets embrace the concept of decentralization and place full control of a wallet’s security into the individual investor’s hands. While this gives you better overall authority over your own wallet and how your assets can be used, this also means you must be extra cautious with your keys so as not to leak your private wallet access information to bad characters and cybercriminals. There is also no backup plan if you lose these keys; unless you use a smart contract protection solution like Webacy.
With custodial and centralized services, you have the potential to participate in various investing, lending, and borrowing activities facilitated by a third party. This can be a great way to increase the value of your assets while also achieving a high yield.
However, this also opens you up to greater risks, especially if the custodial company you work with is untrustworthy or unreliable.
Take the recent controversy with Celsius as an example — after extreme fluctuations in the crypto market, the centralized lending platform Celsius announced it would no longer allow its users to withdraw, swap, or transfer their account balances. In order to honor their obligations with creditors they eventually filed for chapter 11 bankruptcy and their users have no guaranteed timeline on whether or not they will even get their assets back.
If these users had a non-custodial wallet or decentralized lending account, Celsius would not have been able to block users in this way. Yet, since Celsius is centralized and custodial, users are left with very little control over their own assets in such instances.
A sidechain is a blockchain network that is separate from the main blockchain you are operating from, but still has a connection to that parent blockchain (called a mainnet).
Sidechains offer many key benefits, such as improved security and privacy protocols, as well as the ability to enable smoother and more efficient asset exchanges. Since a sidechain is separate but still connected, it can also contain its own smart contracts.
To access a sidechain, you will typically need to have a non-custodial wallet that allows you to interact with sidechains connected to the main blockchains. Most custodial wallets are located on the main blockchains and do not provide access to these sidechains.
A good real-life example of a sidechain is the xDai sidechain that is connected to Ethereum. On the xDai sidechain, you can access and mint a specific type of NFT called a POAP (Proof of Attendance Protocol). What’s great about owning a POAP is that it gives the holder the ability to prove their experience record at both virtual and IRL events via a cryptographic record.
Another useful real-life example to look at is Bitcoin’s Liquid Network. This sidechain offers inherent features that allow for much more efficient block discovery times (aka, the amount of time it takes for a transaction to be verified).
Overall, custodial wallets will almost always offer a greater level of simplicity than non-custodial wallets.
For instance, with a custodial wallet, you are alleviated of the need to securely store your access keys. This allows you to keep your crypto and NFTs safe without having to enter your keys every time. Instead, the custodian bears the responsibility of keeping your assets safe.
Moreover, having a custodian watching over your assets can help you safely store them without your own dedicated non-custodial wallet. A great example of this is MakersPlace, which acts as a custodian for NFTs and other crypto assets. With MakersPlace, your assets are managed for you until you are ready to pull them out and use, trade, or move them.
Final Thoughts: How to Protect Yourself & Your Crypto Assets
After several major controversies hit the blockchain industry — such as the Celsius incident discussed above — more blockchain investors are making the switch to non-custodial wallets.
While there are many advantages to having a non-custodial wallet, it is crucial to know how to protect your assets without the help of a third-party investment platform.
Three of the most important security measures to take include:
- Using a Hardware Wallet: A hardware wallet is a non-custodial wallet stored on an external piece of hardware, such as an external hard drive or flash drive specifically designed for blockchain use.
- Enabling Multi-Sig: A multi-sig-enabled wallet is a type of wallet that is accessed using more than one private key. This is an especially helpful protection to have if your wallet is used for business purposes and is accessible to more than one person.
- Smart Contract Protection: Having a wallet that supports smart contracts is essential, especially if you plan on using a non-custodial wallet. This will help you set key security protocols that determine when and how your assets can be transferred to and from your wallet, like Webacy.
If you are ready to begin improving the security of your non-custodial wallet now, there are options out there and basic tools to set up, including Webacy. Easy things to consider are safety trigger products like a panic button, or things like a backup wallet for peace of mind.