Custodial vs non-custodial wallets: Who holds your crypto?

Investing in cryptocurrency involves making tough decisions. After deciding which type of cryptocurrency you want to buy and how much you’ll spend, you’ll also need to think about how you will be using those assets and keeping them safe.

While everyone knows security is paramount in the digital asset industry, even the most seasoned experts and industry leaders have failed to adequately protect funds from theft, fraud or accidental loss.

Crypto wallets play a critical and fundamental role in crypto security. The decision of which wallet you choose can be the difference between keeping or losing funds in certain situations.

Broadly speaking, there are two main types of crypto wallet you’ll need to consider:

• Custodial
• Non-custodial

Each option has its own advantages and disadvantages and suits different needs depending on your investment goals, technical experience and risk tolerance.

With custodial wallets, you place trust in a third party to manage your private keys and keep your crypto safe on your behalf.

A private key is the critical piece of information needed to prove who owns the wallet and, most importantly, the funds inside.

Whoever holds the private key controls the wallet. You can think of them as the password to your email. If someone else ever got hold of your email password, they could access your messages and online account details, so protecting them is vital.

The main advantage of surrendering control of your private keys to a third party is convenience. For crypto users who aren’t especially tech-savvy or confident in securing their own digital assets, entrusting a security focused company like Kraken to keep their funds safe can help to relieve a technical burden.

This can make custodial wallets a convenient option for beginners or those who prefer a hands-off approach to security. Custodial wallets are typically easier to use, set up and access than non-custodial wallets — as teams of people are dedicated to delivering the best possible user experience. However, relying on a third party, even one with the reputation and proven security track record like Kraken, also comes with trade-offs in terms of certain risks that may be out of your direct control. 

The obvious drawbacks of relying on a third party to custody your assets is that it undermines the most fundamental idea that cryptocurrencies were founded on — decentralization. 

Cryptocurrencies allow you to take full control of your financial freedom, and introducing a centralized intermediary into that process opens you to some of the same limitations and risks of the traditional financial system.

Custodial wallets can potentially expose users to external security breaches, crypto scams or fraud, insolvency, censorship, government regulation, and service changes (removing support for certain assets) that are not under their control.

Ultimately, when it comes to choosing between custodial and non-custodial wallets, you’ll need to weigh what’s most important to you: convenience or security. 

With that in mind, we surveyed U.S. crypto holders in late 2024 and found nearly half (48%) of respondents expressed a desire for stronger "security and fraud protections" when it comes to crypto policy.  

This crypto trend could suggest a growing concern for enhanced security measures in the DeFi space.

Custodial wallets typically include all centralized exchange-based wallets, including wallets used to secure the funds you keep in your Kraken account. They also include wallets used by other fintech and payment platforms that offer support for cryptocurrencies. 

With non-custodial wallets, you as the wallet owner are solely responsible for properly storing and protecting your private key against cyber and physical threats.

With non-custodial wallets there is no hotline to call or branch to walk into if you lose access. Whether you make a mistake entirely on your own or lose your funds in a sophisticated attack, non-custodial wallets place the responsibility entirely on you to keep your funds secure.

As a backup measure, a non-custodial wallet will typically prompt you to copy down sensitive information such as the private key and recovery phrase — a series of random words that you can use to migrate your crypto wallet and any funds it contains to the new device.

Safely storing this information is crucial in case the device storing your non-custodial crypto wallet gets lost, compromised or damaged. You will need these phrases or your private key again if you ever want to restore your wallet or log in from a new device. 

Maintaining exclusive control of your wallet’s private keys means you won’t have to worry about losing access to your funds due to third-party errors.

For added peace of mind, you can use cold wallets, which store your crypto completely offline — so long as you don't move funds from the device to a laptop or computer. This mitigates any chance of an online hacker accessing your crypto assets and means you only need to worry about physically securing the device.

The main drawback of self-custodying your crypto assets is that you're solely responsible for copying down and securing sensitive information. Any input errors, misplaced passwords or lost devices can cause you to lose access to your funds.

If you opt to use non-custodial wallet services or devices, it's vital to make duplicate copies of your sensitive information either on paper or etched into metal plates and spread those across multiple locations. 

That way, you have a backup option should one copy go missing or the storage location is compromised (house fire, flooding, etc.). If you hold substantial amounts of crypto, consider splitting the amount across multiple hardware devices to further spread your risk.

Non-custodial wallets include any type of cold wallet solution, including a crypto hardware wallet. These physical crypto wallet devices store your private keys offline and are widely regarded as the safest solution for storing cryptocurrency assets. 

When owning hardware wallets, consider placing them in secure locations such as a safe or a lock box to maximize security. Hardware wallet examples include: 

• Ledger
• KeepKey
• Trezor 

While hardware wallets may be considered the safest for holding crypto over the long term, they can be inconvenient to use. This is because every time you want to connect to a decentralized application or blockchain protocol, you will need to physically connect and authorize your hardware wallet.

Because of that, there are also non-custodial software wallets that offer the self-custody freedom of crypto with a more convenient user experience.

Also known as a Web3 wallet, non-custodial software wallets like Kraken Wallet allow users to take full custody of their private keys while also offering an intuitive user experience when using DeFi.

As mentioned, the main difference between a custodial and non-custodial wallet is who holds the private key. 

When choosing between a custodial and non-custodial wallet, it ultimately depends on how much control and responsibility you're comfortable with. 

If you want full control, and all the responsibilities that entails, a non-custodial wallet may be your best option. 

If you want to offset the risk that you may make a mistake with your private keys, and are ok with a centralized intermediary managing them on your behalf, a custodial wallet may be the best option.

It’s crucial to understand who controls your crypto — and how much control they have. For instance, custodial wallets are subject to regulations like KYC (Know Your Customer) and AML (Anti-Money Laundering), meaning your assets could be frozen or seized under certain conditions. Custodial wallet operators are often legally obligated to follow regulations and the requests of law enforcement or government organizations.

Non-custodial wallets, on the other hand, give you full control. You get greater privacy and censorship resistance, plus no one can restrict your access. This makes them a preferred choice for those prioritizing financial sovereignty and privacy. But once again, that prioritization is entirely your responsibility, rather than a dedicated, professional security team.

Custodial wallets offer built-in security measures like two-factor authentication and account recovery options, but you risk exchange hacks or platform bankruptcy. If a provider is compromised, your assets could be at risk. 

Non-custodial wallets eliminate third-party vulnerabilities, but there’s a tradeoff. If you lose your private key or recovery phrase, there’s no way to regain access to your crypto. Security is in your hands, so proper backup and storage are essential.

For beginners, custodial wallets could provide a smooth experience, allowing users to reset passwords, access customer support and execute crypto trades quickly.

Non-custodial wallets require more technical knowledge, as users must manage their own keys and navigate blockchain transactions. While they offer more freedom, they also demand more responsibility, making them better suited for those comfortable with self-custody.

Custodial wallets often enable instant, low-cost transfers within their platform, as transactions don’t always need to be broadcast to the blockchain. However, withdrawals to an external wallet may come with fees and require a time to be confirmed on the chain.

Non-custodial wallets process transactions directly on the blockchain, ensuring full transparency, but they sometimes lead to higher fees and longer processing times, especially during periods of network congestion.

A private key in crypto is a code that grants full control over your assets, acting like a password to authorize transactions. It’s mathematically linked to your public key, which is used to receive funds, but only the private key can sign transactions and prove ownership. If someone gains access to your private key, they can steal your crypto. Protecting your private key is crucial. 

A non-custodial wallet is generally safer from hacks than a custodial wallet because you control your private keys, eliminating the risk of exchange breaches or account freezes.

Its security depends entirely on how well you protect your keys. If you lose your private key or recovery phrase, you lose access forever, and if someone else gets hold of it, they can steal your assets.

The main risk associated with custodial wallets is the reliance on a third party to safeguard your assets. You would not possess control over your private keys. 

This dependency can lead to potential security threats, like hacking, account freezing, withdrawal limitations or even platform closure, which could result in the loss of access to your cryptocurrency.

While assets held on the Kraken exchange itself are kept in a custodial wallet, we also offer a non-custodial wallet that is completely separate from the Kraken exchange.

Kraken Wallet is a non-custodial software wallet. Kraken Wallet allows users to take full custody of their private keys — which are never known to or under the control of Kraken.

We believe the future of DeFi is linked to on-chain innovations. Kraken Wallet provides full control over your crypto assets. 

With Kraken Wallet, you can seamlessly track your tokens, NFTs or DeFi positions, connect with major blockchains and securely access the most popular dApps through WalletConnect integration. 

See what you can do with Kraken Wallet today.