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Self-custodianship is the fine line that divides the world of decentralized finance (DeFi) and traditional finance (TradFi)
It refers to the act of storing, managing and safeguarding your financial assets using a crypto wallet that gives you complete control over your assets.
Many are unfamiliar with the concept of self-custodianship because the world is used to relying on third-party commercial banks to custody their cash. Therefore, this article will help you understand the difference between custodial wallets vs. non-custodial wallets.
Find out which crypto wallet suits you best.
Key Takeaways
- Non-custodial wallets give owners full control over the cryptocurrencies they hold.
- Custodial wallets refer to third-party controlled accounts that store cryptocurrencies on your behalf.
- History has shown us that centralized custodians, such as banks and exchanges, can fail, leading to customers losing access to their funds.
- Non-custodial wallet users may find it tedious to secure private keys and SRPs.
- Show Full Guide
Custodial Wallets vs. Non-custodial Wallets: How Do They Work?
A non-custodial wallet is a cryptocurrency wallet that gives the owner full control over cryptocurrencies held in it.
Instead of relying on a crypto exchange or a bank to custody crypto assets, a non-custodial wallet relies on the owner to be the custodian of their own crypto assets. Therefore, non-custodial wallets are also known as “self-custodial” or “self-custody” wallets.
This means that the owner of a non-custodial wallet is responsible for safeguarding its assets.
Owners of non-custodial wallets must protect private keys and secret recovery phrases (SRP) required to access the wallets and their contents.
Non-custodial wallets champion decentralization and privacy, as they prevent third parties from censoring user transactions, seizing their assets, and tracking their crypto spending habits.
Custodial wallets refer to third-party controlled accounts that store cryptocurrencies on your behalf.
These wallets are provided by third-party service providers such as centralized crypto exchanges (CEX) and centralized lending platforms for their customers.
You can think of custodial wallets as your bank account. The service provider protects your assets against misuse and theft for you. However, the service provider has the power to impose withdrawal restrictions and other limitations on your account.
Different Types of Non-custodial Wallets
Let’s briefly go through the different types of non-custodial wallets to better understand the concept of self-custodianship.
Why Are Non-custodial Wallets Important?
History has shown us that centralized custodians such as banks and exchanges can fail, resulting in customers losing access to their funds.
The crypto community has a popular expression called “Not your keys, not your coins” which refers to the fact that the holder of private keys has complete control over the cryptocurrencies used to access them.
In the case of a custodial wallet, the third-party service provider is the holder of the private keys that can access your crypto tokens, not you.
In 2022, thousands of custodial wallet account holders at now-defunct crypto firms such as BlockFi, Voyager, Celsius, and Vauld lost access to their crypto assets after their service providers suspended token withdrawals before filing for bankruptcy.
Similarly, in November 2022, 9 million account holders at the FTX crypto exchange lost billions of dollars in crypto assets after the company filed for bankruptcy. It took over 18 months for a US court to approve a liquidation plan that would fund the repayment to customers.
However, according to Reuters, FTX customers are set to receive their crypto refunds in cash based on much lower cryptocurrency prices from November 2022 (Bitcoin price of ~$16,500) compared to elevated prices as seen in July 2024 (Bitcoin price of ~$55,000).
Even the TradFi world has seen its share of bank failures. In March 2023, two prominent US-based banks, Silicon Valley Bank and Signature Bank, collapsed after anxious customers withdrew their funds due to fears of the bank’s solvency.
Custodial vs. Non-custodial Wallets: Side-by-Side Comparison
Despite the importance of self-custodianship, custodial wallets still have their advantages.
Let’s dive deeper to understand what is the difference between non-custodial wallets vs. custodial wallets with the help of the following table:
| Custodial Wallets | Non-custodial Wallets | |
| Cost | Creating accounts with service providers is usually free | Hot wallets are free-to-download, while cold hardware wallets are expensive |
| User-Friendliness | Easy to set up and use | Newcomers may face technical difficulties setting up non-custodial wallets |
| Experience Level | Suitable for beginners and advanced users | Not suitable for beginners |
| Risks | Exchange failure, bankruptcy, hacks, token withdrawal suspension, account suspension | Hacks and loss of private keys and SRP |
| Privacy | Users must complete KYC processes when setting up accounts. | No personal information needed to set up non-custodial wallets. |
| Security | Password protection and two-factor authentication | Password protection and two-factor authentication |
| Private Key Ownership | Secured by the third-party custodian | Secured by the wallet owner |
| Transaction Cost | Third-party custodians may charge fees and commissions to use their platform | Users pay gas fees to transact using non-custodial wallets. The fees will depend on the underlying blockchain |
| Transaction Time | Token swaps using CEX accounts are swift | Transaction time will depend on the underlying blockchain used |
| Recovery | Accounts can be easily recovered in the event of password loss | Recovering non-custodial wallets due to lost passwords and SRPs is difficult |
| Features | Crypto exchange accounts have token swaps, options trading, staking, and other features | Mobile crypto wallets come with in-built browsers, token swap tools and more. Cold wallets mainly specialize in storing crypto |
| Example | Binance, Coinbase, Kraken | MetaMask, Rainbow, Ledger |
Non-custodial Wallets: Advantages, Pitfalls & Examples
Non-custodial Wallets Pros & Cons
- Users have complete control over their cryptocurrencies
- No censorship
- Privacy-preserving technology
- Mobile and desktop wallets are free-to-download
- Cold wallets are considered the safest method to store cryptocurrencies
- Mobile wallets are well-suited to explore the web3 world as they allow users to easily use their tokens online via the in-built browser and token swap features.
- Beginners may find it difficult to set up non-custodial wallets
- Users are responsible for securing private keys and SRPs
- Recovering non-custodial wallets due to lost passwords and SRPs is difficult
- Cold hardware wallets are expensive
Example of Non-custodial Wallets
MetaMask is arguably the most popular non-custodial crypto wallet in the world. Users can download the wallet on their smartphones or install its wallet extension on their laptop browsers.
At the time of writing, the following browsers supported MetaMask: Google Chrome, Mozilla Firefox, Brave, Edge, and Opera.
When setting up a MetaMask wallet, users will be prompted to write down their 12-word SRP on paper and store it in a secure place.
SRP allows users to recover their crypto wallets in the event of loss of password or loss of devices. This also means that anyone with knowledge of your SRP can access your crypto wallet and the tokens in it.
Users can use their cryptocurrencies across multiple blockchain networks from a single non-custodial crypto wallet.
Non-custodial wallets like MetaMask are the gateway into the world of DeFi. Note that users must ensure that they have gas fee tokens to pay for transactions.
If you are not sure which non-custodial wallet to use, this guide reviews the 20 best non-custodial wallets for 2024.
Custodial Wallets: Advantages, Pitfalls & Examples
Custodial Wallets: Pros & Cons
- Easy to use and set up
- Best suited for beginners
- Most service providers do not charge users to create accounts
- Account recovery is easy in the event of lost passwords
- CEX accounts offer token swaps, options trading, peer-to-peer trading, staking, and more
- CEX accounts allow crypto-to-fiat conversion and vice versa
- Users do not need to worry about private keys and SRPs
- Third-party custodians can censor transactions, suspend user accounts, and prevent users from withdrawing their crypto tokens
- Custodial wallet users are vulnerable to exchange risks, hacks, and bankruptcies
- Third-party custodians may ask users to submit their personal and financial information when setting up accounts
- Third-party custodians have full control over user’s cryptos
- Third-party custodians may use custody funds to earn yield
- Users may incur costs when conducting token swaps
Examples of Custodial Wallets
All user accounts on CEXs are considered as custodial wallets, since the CEX is the custodian of user funds.
Binance is the biggest CEX in the world in terms of trade volume. The platform is available in over 100 countries around the world and has over 600 cryptocurrencies listed on its exchange.
Creating a custodial account at Binance is free-of-cost, however Binance charges users a commission on spot crypto trading and debit card purchases, among others.
Custodial account holders at Binance have access to peer-to-peer trading platforms, NFT marketplaces, staking tools, and futures trading. CEXs like Binance also provide crypto traders with deep liquidity, enabling faster transactions at narrower spreads.
Most crypto users tend to buy their cryptocurrencies using custodial wallets on CEXs. They later withdraw their tokens to non-custodial wallets, where they can be used on DeFi websites and Web3 platforms.
Note that CEXs like Binance, Coinbase and Kraken also have non-custodial wallets available to download as standalone apps on the Apple App Store and Google Play Store. These non-custodial wallets should not be mistaken for user accounts.
The Bottom Line: Which Wallet Type Should You Choose?
Both custodial wallets and non-custodial wallets are essential tools that crypto users need. The former is required for easy conversion of fiat-to-crypto while the latter is needed to safeguard cryptocurrencies against exchange risk and censorship.
If you are a beginner, it is best to start your crypto journey by setting up a custodial wallet account at a CEX. Once you gain experience and learn technical details about crypto blockchains you can choose to practice self-custodianship by sending your tokens over to your personal crypto wallet.
