Custodial vs. Non-Custodial Wallets The Working and Difference Points

Custodial vs. Non-Custodial Wallets: The Working and Difference Points

By Chirag Bhardwaj
September 18, 2019 5 min read
Last update on: September 18, 2019

Cryptocurrencies and their underlying technology, Blockchain has been gaining a huge momentum since the past many days. 

Both developers and business founders have been taking a keen interest in determining how to incorporate the two into their processes and relish better opportunities compared to those offered by the traditional models. The one business model that has emerged as an ideal one is Cryptocurrency Wallets. But the entrepreneurs’ confusions doesn’t end at identifying the “right” business model which blends both Blockchain and Cryptocurrencies perfectly. 

While many are debating how to create a Blockchain wallet and which cryptocurrency will become the single global currency, many others are focusing on choosing the right wallet as per custody of private key: Custodial vs Non-Custodial Wallets. Something about which we will discuss in detail in this article.

But before we jump to the Custodial vs. Non-Custodial wallets part, let’s uncover the basics of both the blockchain wallet types, starting with Custodial Wallets first.

Custodial Wallets – Its Definition, Benefits, and Limitations

A Custodial Wallet is defined as a wallet in which the private keys are held by a third party. Meaning, the third party has a full control over your funds while you only have to give permission to send or receive payments. 

Here’s how the custodial wallets work: A (third party in this case) asks B (users in this case) to transfer their fund on a particular address/place, but A does not receive any private key to that storage address. The third party authority, manages all the funding, with the condition that users won’t be able to perform any transaction without their involvement.

Some of the popular examples of Custodial wallets are:-

Best Custodial Wallets to Consider

While this gives you a definitive information about what are Custodial wallets, let’s have a look at its advantages and disadvantages.

Pros of Considering Custodial Wallets

1. Free Transactions

One of the biggest benefits of a Custodial wallet is that it, unlike other wallets, do not demand a transaction fee. It enables customers to make transactions for free within the ecosystem. A perfect example of this is Freewallet – a custodial wallet that helped consumers save around $500,000 on network fees back in 2019.

2. No Major Effect of Lost Private Keys

A third party manages your custodial wallet. So, even if you lose your private key or forget the mnemonic phrase, it is easy to regain access into your wallet and your stored funds.

3. Higher Backup Possibility

Another advantage of custodial wallets is that the central authority managing your wallet offers backup facilities. This makes it easier to undo any transaction or restore a previous version.

Cons of Building a Custodial Wallets

1. Custodian’s Control Over Your Money

The biggest disadvantage of going with Custodial cryptocurrency services is that you do not have autonomy over your wallet.

The third party, i.e, the custodian, has complete control over your funds and associated processes. They have the freedom to take action on the funds, including freezing the stored amount.

2. Need for KYC

Another drawback of introducing Custodial wallet to your services is that this wallet type strictly recommends users to perform KYC (Know Your Customer, ID Verification). You cannot gain access to your funds or any of the related services without proving your identity. This necessity of identifying verification impede to the basic principle of Cryptocurrency, i.e, anonymity. 

3. Data Breach Threat

In the case of Custodial cryptocurrency exchanges, a huge amount of users’ funds is stored in cold and hot wallets. While these wallets may not be an easy target for hackers due to the involvement of various confirmations, they are still vulnerable to security breaches. 

One such incident is that of Japanese exchange Mt. Gox in 2014, where over 70% of the bitcoin transactions were hacked, which resulted in a loss of around $450M.  

4. No Offline Facility

Last but not least, the Internet connection is a must for logging in the Custodial wallets or to perform any transaction. 

With this covered, let’s dive into the concept of Non-Custodial wallets to get a crystal clear idea of both before we jump to the part where we look into the Custodial vs. Non-Custodial comparison.

Non-Custodial Wallets – Its Definition, Advantages, and Disadvantages

A simple answer to what is non-custodial wallet is that it is a type of Blockchain wallet that lets you be your own bank. This implies that you have full control over your funds and on the associated private key. 

These wallets serve users with two types of private keys to perform a transaction – 

1. Mnemonic Seed – It is usually a value of 12-24 word designed by encapsulating the real private key. This key, stored on the user devices, allows them to access multiple accounts simultaneously.

2. Raw Private Key – It is the actual private key in raw form (alphanumeric string), which is also stored on the user device.

Today, there are various non-custodial wallets available in the marketplace, while a number of others are getting added on an everyday basis, purely because of the benefits that non-custodial wallets carry over custodial wallets.

Best Non-Custodial Wallets to Consider

Advantages of Non-Custodial Wallets

1. Users’ Control Over Funds

The prime reason why Non-Custodial wallets are gaining a huge momentum is because they provide users an individual access to their funds. The users need not look up to any third party to manage their fundings or perform any related activity.

2. Safety in Funding

Since all the details associated with your Crypto wallet and its funds relies with you, the risk of data breach is much lower. This is one of the primal reasons why 66.5% of crypto holders are relying on non-custodial and mobile storage solutions these days.

3. Instant Withdrawals

Unlike Custodial wallets, these wallets do not need confirmation from a third party for performing every transaction. This streamlines the whole process and make it easier to enjoy instant withdrawals.

With this covered, let’s look into the limitations of non-custodial Wallets to take a neutral decision.

When it comes to the drawbacks of Non-Custodial wallets, there is nothing major that can be highlighted. The wallet type offers the best Blockchain facilities. 

However, to relish its benefits, it is necessary for users to store their key securely.

Losing their private key or mnemonic seed can make them lose access to their wallet, with no backup and recovery possibility.

Custodial vs Non-Custodial: How the Two Wallets Stack Up Against Each Other 

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1. Custodian of Private Key

The foremost factor to consider when comparing the two crypto wallets is who holds the private key.

In case of Custodial wallets, the third party manages the private key. Whereas, in the case of Non-Custodial wallets, all the blockchain custodian services reside with users.

So, in case you want to introduce a wallet where users can be their own bank, go with the idea of creating non-Custodial blockchain wallets.

2. Transaction Type

Another factor to consider during Custodial and Non-Custodial wallet comparison is the transaction type. 

The transaction is reflected on the chain in real-time in Non-Custodial wallets. But, it is not so in the case of Custodial wallet. 

This again shows that the former leads the show.

3. Security

In the case of custodial crypto wallets, all the sensitive user data is stored in hot and cold storage, which are often hacked by data intruders. Because of this, the security level is low in custodial wallets, unless the authoritative party implements strong security measures.

Whereas, in case of Non-Custodial blockchain wallets, the whole information remains with users. This reduces the risk of data being stolen, unless user shares the details with someone, or their device gets stolen.

So, here again, Non-Custodial wallets wins the Custodial vs Non-Custodial wallets battle.

4. Backup and Recovery Possibility

When it comes to backup and recovery possibilities, non-Custodial wallets lag behind the Custodial one.

The Custodial wallets keeps the private key with themselves. So, even if you lose the access to data, you can regain the access by requesting the third party. 

However, this is not possible in the case of Non-Custodial wallets where you are the sole authority.

5. Offline Accessibility

To access your funding and corresponding details, it is a must to login into your Custodial wallet and make a request to centralized authority. This makes it imperative to have internet connectivity.

But, there is no such requirement in Non-Custodial wallets. This, in return, signifies that Non-Custodial wallets is a better option to enjoy services in real-time.

6. Future Scope

As per the cryptocurrencies market trends, Non-custodial wallets will continue to get an edge over Custodial due to the growing data breach cases and users becoming more conscious about their data privacy and security. 

While the aforementioned ‘Custodial vs. Non-Custodial wallets’ comparative factors will help you in picking the right Blockchain wallet, we highly recommend Non-Custodial Wallets. For, these wallets offer ample opportunities and hold a better future in the marketplace – something which in turn establish itself as a profitable business decision.

Taking the thought forward, if you are planning to introduce a non-custodial wallet into your business offering, it can be a good start to consult the best Blockchain experts.

FREQUENTLY ASKED QUESTIONS

1. What is the Difference Between Custodial and Noncustodial Cryptocurrency Services?

The prime difference between custodial and non-custodial cryptocurrency services is that the private key is managed by third parties in the former case, whereas it is handled by users in the latter case.

2. How to create a non-custodial wallet?

Creating a non-Custodial wallet is an extensive and complicated process. So, it is advisable to consult with a reputed Blockchain development company for developing a non-custodial wallet.

Chirag Bhardwaj
Chirag Bhardwaj
ICO Consultant
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