Starting a journey into the world of cryptocurrencies most often involves choosing your first cryptocurrency wallet. It is this software that will be used by us to “collect” funds, as well as perform operations on our cryptocurrencies. In 2020, the market offers an extremely wide range of solutions for each type of user. Less advanced people, but also experts, will find something for themselves without any problems.
Beginning cryptocurrency traders know that there are hardware wallets (Trezor, Ledger), there are also mobile wallets (COINS, JAXX), as well as wallets assigned to an account on the exchange. However, this list includes one more element that is not always remembered – the choice between a custodial and a non-custodial wallet. In this article, we will focus on presenting the main differences, advantages and disadvantages of both solutions. You will learn why it is so important to understand the differences between the two types of wallets.
What is a custodial wallet?
The Custodial wallet is a tool by which we entrust the care of the private key to an external entity. This means that we can personally control our funds, but apart from us, the wallet provider also has access to cryptocurrencies. How does it work in practice?
Most often this means that the user is creating their account in the third party application. This is often similar to registering on typical social networks. The platform creates a cryptocurrency wallet on our behalf and undertakes to store our private key and execute transactions on our behalf. When making a transaction, we log in to our wallet, usually with a login and password, and order the transaction.
This solution has several obvious advantages:
- Custodial wallets are the easiest way to function in the cryptocurrency space;
- They function like typical platforms that we log into every day;
- We are not obligated to remember our addresses and private keys;
- If the password is lost, we can always recover it thanks to the fact that an external entity always keeps a copy of the access to our wallet.
The advantages of custodial wallets are mainly based on availability. Unfortunately, due to this utility, there are also a few risks that we must remember:
- By using the custodial wallet, we give control over the portfolio and funds to another entity – so there is a risk of losing funds if the entity collecting the keys is hacked or if it had bad intentions towards its users and decided to steal the funds;
- In the case of a fork of a specific cryptocurrency, there is a risk of not receiving additional coins;
- The funds kept in the custodial wallet may be seized by a court judgment – the entity running our wallet may be required to block such a block.
Custodial wallets are quite popular in the cryptocurrency market. Users use them, often unaware that the wallet is a custodial wallet. To put it simply, each cryptocurrency exchange we use creates a custodial wallet on its platform, from which we conduct operations. It is a simple and convenient solution as traders can trade directly from the wallet built into the application. Nowadays, such large entities as Binance, Bitfinex or Coinbase enjoy such a great reputation that storing money on their wallets is perceived as relatively safe. History, however, remembers the example of the Mt.Gox exchange, when hundreds of users lost funds worth several million dollars. In our Polish market, the Bitmarket scandal was quite a famous example from last year. To this day, hundreds of Polish investors have not recovered their money after the mysterious disappearance of the stock exchange from the market. Therefore, before registering on any custodial platform, it is worth checking whether it is safe and has a good reputation.
What are non-custodial wallets
Non-custodial wallets are all cryptocurrency wallets that do not hold users’ private keys. In this case, you are solely responsible for your funds. It is worth noting that custodial wallets function in various forms.
A good example of such a non-custodial wallet is the Polish COINS mobile wallet. The application makes it easier for us to access funds by using security measures used by a smartphone (e.g. biometric security), but COINS itself does not store information about users’ private keys. Thanks to this, we can easily use the application on a daily basis, and in the event of an emergency situation of losing access to the wallet, we can still regain access to funds if we have our special phrases saved.
In addition to mobile solutions, we also find many other non-custodial wallets operating on various platforms. Non-custodial wallets can be both mobile and desktop wallets, but also hardware wallets. The multitude of these choices is so large because all these groups of wallets share the same feature – the owner of the wallet is also the sole owner of the private key.
When to choose which wallet?
A non-custodial and custodial wallet are two solutions that are useful in completely different situations. We should remember that the use of any of these wallets is not good or bad in itself. The most important thing is to remember which of these solutions works best in certain situations.
We should use non-custodial wallets primarily to store funds that we do not use on a daily basis. With this type of wallet, our cryptocurrencies will be safe, and we can decide on the best version of the wallet for us. Mobile and desktop applications will be useful if we want to have fairly easy and pleasant access to the contents of our wallet. Very often, these tools are equipped with many additional functionalities that will help us monitor the status of our portfolio. In the case of the aforementioned COINS, these are, for example, news and trackers informing about the cryptocurrencies that interest us, as well as a full register of market data. However, if we are looking for a safe solution that has only one goal – safe storage of our funds, choose a hardware wallet.
Custodial wallets are mainly used on exchanges. They allow investors and traders to trade smoothly and quickly. Thanks to the facilitated access integrated with the exchange, they do not have to remember about private keys. In addition to stock exchange custodial wallets, there are also internet wallets that operate on a similar principle. The Custodial wallet is therefore a useful solution when the dynamics of changes in our portfolio are high, and when we do not plan to keep funds on our “account” for a long time.
Regardless of the type of wallet you choose, it is always worth remembering to verify service providers and applications for cryptocurrencies. If we want to entrust money to the stock exchange – let’s make sure that it is a large and transparent entity in its activities. If we use a mobile custodial wallet, do not be afraid to check if the creators enjoy a good reputation. As is often the case in the world of cryptocurrencies, caution and security are paramount.