The Difference Between Custodial & Non-Custodial Wallets?
Definitions of Custodial & Non-Custodial
A Custodial Wallet is a type of wallet in which the private keys of the wallet are held by a third party. In this type of wallet, you only have permission to send or receive payments, while the third party has full control over your funds. The third party performs the role of a bank. It provides you with a wallet in which you can safely hold your funds.
On the other hand, a non-custodial wallet is a wallet that provides you with far more control and independence. A non-custodial wallet allows you to be completely responsible for your funds and do with it whatever you please. You have full control over your funds, and most importantly, you possess your private key.
Compared to non-custodial wallets, custodial wallets require more transactions and multiple confirmations to confirm a transaction. Because of this, custodian wallets might be easier to hack compared to non-custodial wallets, as they require fewer transactions and confirmations.
To open an account with a custodian, it is often necessary to identify yourself with KYC. This partly disrupts the goal of cryptocurrency, its anonymity. With a non-custodial wallet, the user does not have to do it.
Another worry is that the custodial wallet is linked to a third party. This means that the data of its clients is centralized and may become a potential target for a data breach. The non-custodial wallet, on the other hand, presents much lower risks, because it is separate from other clients.
However, complete control over non-custodial wallets might come with some perks. If you lose your password to your custodian account, you don’t have to worry too much because the custodian can easily reclaim the details of your wallet. If the same thing happens with your non-custodial wallet, for instance, if you lose your private key or mnemonic phrase, then you permanently lose access to your funds as well.
But let us tip the scales once more. The custodial wallet has another liability. You are susceptible to having your wallet frozen, whether on purpose or by accident. Such a thing could never happen if you owned a non-custodial wallet.
Two Kinds of Non-Custodial Wallets
A hardware wallet or ‘cold wallet’ is completely isolated; it is 100% airtight. Meaning, that there is a literal physical space between your private key and the device you are trading on. This isolation ensures that a hardware wallet is not vulnerable to spyware, viruses, or hackers. In addition, a hardware wallet offers not only virtual but also physical protection of your cryptocurrency tokens. Someone who gets hold of your Ledger Nano S or X, for example, cannot simply read your private keys. You first need to enter the physical wallet passcode, then you can use your private key.
A software wallet is a program on your computer or smartphone. A wallet on a smartphone is also called a mobile wallet. A wallet on your personal computer or laptop is called a software wallet. This software only stores the private key to your crypto coins. As your crypto stays in the blockchain and remains stored in a vault. This means that your bitcoins will never leave the blockchain.
Whatever type of non-custodial wallet you choose, it will generate a seed phrase. This phrase is a string of 12 to 24 random words. These words are your access to the vault in blockchain that contains your crypto coins.