Elrond Wiki - Custodial & Non-Custodial Wallets
  Custodial & Non-Custodial Wallets
Published by Elrond Wiki | the 06/23/2022  |  Category: Elrond Library > Introduction to Elrond
Custodial & Non-Custodial Wallets | Key points, Pros & Cons for each + Hardware & software wallets and something special in the end

Here you are. You decided to invest in cryptocurrencies, you already purchased some coins, and now you need to store them in a wallet. But what kind of storage should you choose? A custodial exchange wallet or a non-custodial decentralized wallet? Let’s talk about their key points, benefits & drawbacks, and you’ll know by the end of this article which one suits you better.

What is a Custodial Wallet?

The custodial wallet is a digital wallet in which the Private Key is held by a third party, called the custodian. This should be the most important thing you need to remember. You are handing over the responsibility of holding and securing the funds to a third party, rather than taking care of them fully on your own. This way, someone else has control over your funds, while you only need to give permission to send or receive payments. The custodian secures the funds on your behalf and provides backup and security for your assets. The custodian is usually represented by an exchange platform.

What is a Non-Custodial Wallet?

A Non-Custodial Wallet is a cryptocurrency wallet that only you have control over. A Non-Custodial wallet it’s a decentralized type of wallet that puts you in full control of your funds. Therefore, it also comes with great responsibility. You hold your private key, this time, so no one else can access your funds. This is the greatest thing when it comes to non-custodial wallets.

Custodial vs non-custodial wallets

Each of the two types of wallets has Pros and Cons. It’s up to you to decide which one is best for you taking into account their features.

PROs for Custodial Wallets

When you start purchasing cryptocurrencies at the beginning of the road, you will most likely store your funds in an exchange custodial wallet. It’s somewhat easier because all you have to do is to set up an account and remember a password. On one hand, having a custodial wallet means a stress-free and very convenient way to store your funds at a click away.

One great advantage of custodial wallets is that if you forget your account password and lose access to the wallet, it’s quite easy to request the platform to reset it and restore access to it. Having the wallet backed up by the exchange platform, you don’t need to worry about losing the backup phrase or passwords.

Another important thing to mention is that, usually, the custodians offer their customers the chance of having zero fees for the transactions within their ecosystem.

If you decide to store your funds in a custodial wallet, you should take into account choosing a very known and trusted exchange platform which will most likely store your funds in hot/cold wallets, therefore your assets are safe. The provider’s main concern should be to ensure the maximum safety of your wallet — from hackers or any other data intruders.

CONs for Custodial Wallets

There are also downsides to the Custodial Wallets. They come with risks. :) It’s really important for you to understand that your Private Key is held by a third party. The worst thing that can happen — and, unfortunately, did happen in the past — is to lose your holdings if the exchange platform breaks, gets hacked, or just decides to run with your money. And even if this is most unlikely to happen, they could lock you out of your funds without you knowing about it. This is the reason why Custodial Wallets are considered less secure and less safe than the Non-Custodial ones.

It’s also about decentralization. You are supposed to have full autonomy over your money, so keeping them in a Custodial Wallet it’s somehow against the greatest goal of holding digital assets that should allow you to be your own bank.

If you store your funds in a Custodial Wallet on an exchange platform, there is also the risk that the platform can’t process the transaction due to the high demand of withdrawing because it lacks liquidity.

Another drawback of the Custodial Wallet might be the necessity to perform a KYC. Therefore, you will have to make an ID verification in order to prove your identity. So we cannot talk about anonymity.

Even with all of the above, the greatest risk of the Custodial Wallets is represented by the data breach. Having your funds kept by someone else comes with vulnerabilities and security breaches.

Thus, the Custodial Wallets are centralized. They operate on centralized exchanges (CEX) because most of the exchanges offer Custodial Wallets.

PROs for Non-Custodial Wallets

Let’s move to the Non-Custodial’s PRO’s arguments, now. As we already mentioned, Non-Custodial wallets are great because you have complete control over your wallet, and therefore, your funds. This is the greatest advantage the Non-Custodial Wallet has, thus you can freely make transactions without someone watching every step you take.

A lot of crypto holders rely on this type of storage because the security is higher and the data breach is very low.

You don’t have to trust a third party to secure your funds on your behalf. Whereas, the whole data will remain only with the wallet holder. You also don’t need to wait for approval from a third party if you want to make a transaction, so you can make instant withdrawals. Of course, every transaction that you make is going to be marked on the chain in real-time, which means that you have direct access to public blockchains.

If you opt for Non-Custodial wallets, you will have full access to the staking rewards associated with your funds.

You can even check the last status of your wallet without an Internet connection. But, in order to see your assets in real-time or to make transactions, you have to query the blockchain in real-time, therefore you will need an internet connection.

Another major advantage of Non-Custodial wallets is the fact that you can keep your anonymity if you would like to. That means that you are not bound to go through a KYC process in order to associate the wallet with your identity.

Depending on your threat model, you can opt for a higher level of security by using at the same time a hot and a paper wallet. A piece of paper that contains keys and QR codes which you can use to facilitate cryptocurrency transactions, is called a paper wallet. It is a cold wallet because it’s not connected to the internet, which makes it more secure than a hot wallet. Another very well-known type of hardware ‘cold’ wallet is Ledger.

Peer-to-peer (P2P) transactions: if you have a non-custodial wallet, it means that you can join a decentralized exchange (DEX). This comes with plenty of advantages, such as purchasing unlisted coins. You could even participate in lotteries that are held on platforms.

The decentralized exchanges work with these types of Non-Custodial wallets. You can trade your assets by swapping, lending, and farming them. And you are able to do that instantaneously. Sometimes, but depending on the platform, you can do that at insignificant costs. You can deepen the subject by reading more about the Maiar Exchange decentralized investment platform, which was launched last autumn. On the platform, there are a lot of opportunities if you are a crypto investor or have some holdings in your Non-Custodial wallet.

To sum up, Centralized Exchanges (CEX) work with custodial wallets, and Decentralized Exchanges, such as Maiar Exchange, work with Non-Custodial wallets. Thus, if you want to trade in a CEX, you will have to keep your holdings in a Custodial wallet. But if you want to trade on a DEX, you’ll always be the only owner of your holdings with your Non-Custodial wallet. Even if the exchange platform might encounter problems, you won’t.

CONs for Non-Custodial Wallets

If you choose to hold your funds in a Non-Custodial Wallet, you take full personal responsibility for your assets. This can be seen as a pro or con, depending on how you look at it. We think that this is one of the strongest pro points about Non-Custodial wallets, but some might not want to assume this responsibility.

What is really important to note: the Private Key of your Non-Custodial wallet is the greatest duty that you have. That means that you must not lose it! Because if you do, you will lose your financial assets for good. You don’t have the possibility to reset the password of your account without the Private Key. So be sure you take sufficient precautions and keep well your Private Key and the Password of your wallet.

Another risk of the Non-Custodial Wallet is that someone else can access your Private Key. But this will only happen if YOU give it away. So, make sure you don’t.

— — —

Having such an immersive talk about wallets, it’s time to mention a few things about software and hardware wallets, as well. But before we take a deeper look into each one’s characteristics, we must mention that no wallet, no matter the type of it, actually holds your crypto, but it only holds the key for access to the funds you own in the blockchain.

A software wallet is a software program or app, and it gives you access to the blockchain. It’s also called a hot wallet. It’s like a digital storage for your cryptocurrencies (holds your private key) that you can easily access with your phone or computer, through a connection to the Internet. It’s the most popular type of wallet because it’s very convenient for crypto holders. It’s like a bank account through which you can see your holdings and make transactions. However, hot software wallets are not as secure as the hardware cold wallets, due to the Internet connection it requires. Software wallets can be divided into 3 types: desktop, mobile, and web wallets.

Also, there could be custodial hot wallets and non-custodial hot wallets. Take, for example, Binance or Coinbase. These are custodial hot wallets. On the other hand, Maiar App is a non-custodial hot wallet.

However, a hardware wallet is an offline, portable device on which you can store your Private Key. The hardware wallets are also called cold wallets because they don’t need an Internet connection in order to operate. You will only connect the hardware wallet via USB and Bluetooth to internet-connected devices, such as your computer.

There are plenty of hardware wallets for you to choose from, but the most popular ones are the Nano X and Nano S ledgers, which look like sticks. Note: You only store the Private Key on the ledger, NOT your cryptocurrencies. You don’t put any funds on the ledger, you only keep the Private Key that allows you to access your cryptocurrencies.

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