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Custodial vs. Non-Custodial Wallets
General Wallet Use
The two main types of Bitcoin wallets can be described as custodial and non-custodial. A custodial wallet is managed by a third-party service provider, which is likely to be a crypto exchange (i.e. Coinbase, Gemini, etc.), while a non-custodial wallet is fully managed by the user.
What is a Custodial Wallet?
A custodial Bitcoin wallet is managed by a third-party entity, which is responsible for the safekeeping of your private keys and, therefore, your Bitcoin. This third-party usually takes the form of a crypto exchange like Coinbase, Gemini, or others.
You can think about it along the same lines as you would a traditional finance brokerage account: your Bitcoin is in an account that belongs to you, but that account is at the mercy of your brokerage’s whims and vulnerabilities.
What is a Non-Custodial Wallet?
A non-custodial wallet puts the power of control over your Bitcoin entirely in your hands. This great power, though, comes with great responsibility. The secure storage and management of your private keys is completely up to you.
This type of wallet is often preferred by more experienced Bitcoin users due to its greater trading flexibility, and third-party independence. Some Bitcoin veterans even prefer non-custodial hardware wallets, which do not require internet access to operate and store private keys, further isolating the Bitcoin inside from a potential attack vector.
It is extremely difficult to retrieve lost private keys for a non-custodial wallet, but depending on who you are and what you want out of your Bitcoin journey, it might be the right option for you.
Pros and Cons of Custodial and Non-Custodial Wallets
Both categories of Bitcoin wallet have advantages and disadvantages, and what’s right for one user will not necessarily be right for another.
Custodial wallet pros
Custodial wallets require less user responsibility. A user can outsource the management of their private keys to the third-party provider managing the wallet.
Custodial wallet service providers, which primarily take the form of a crypto exchange, can provide support and advice regarding asset management, security, and more.
The professionalism and infrastructural muscle of crypto exchanges has greatly increased over the years. These improvements have helped the Bitcoin community grow exponentially and have ushered in widespread adoption of custodial wallets.
Custodial wallet cons
Custodial wallets carry third-party security risks.
No matter how much care a custodial wallet provider may take to try to ensure the security of their users’ assets, trusting these providers means opening yourself up to the possibility that your assets can be stolen.
Bitcoin transactions on crypto exchanges are constantly in the crosshairs of malicious actors, and have lost billions of dollars worth of their users’ assets over the years.
Security issues and risk of breaches remain possible despite the industry’s growth.
Non-Custodial Wallet Pros
Non-custodial Bitcoin wallets are not subject to the same third-party security risk as custodial wallets.
With a non-custodial wallet, your private keys are exactly as secure as you want them to be. Solutions like hardware wallets can help increase security by bringing your Bitcoin completely offline and out of the reach of hackers.
Non-custodial wallets are not subject to the censorship or asset restrictions that a custodial wallet managed by a third party, such as a crypto exchange, may be subject to.
Non-Custodial Wallet cons
It is extremely difficult to retrieve lost private keys for a non-custodial wallet.
Non-custodial wallets lack the support that the holder of a custodial wallet may be given by a third-party manager of a custodial wallet.
Holders of non-custodial wallets take on complete and total responsibility for their assets, which may be overly time-consuming for some users.