What are custodial and non-custodial crypto wallets?

📚  The beginner’s guide to crypto security

Investing in cryptocurrency involves making a number of tough decisions. After deciding which asset you want to buy and how much you’re going to spend, you’ll finally need to think about how you’re going to store those funds.

Security is paramount in the digital asset industry, and even the most seemingly proficient platforms and people have failed in the past to adequately protect funds from theft, fraud or accidental loss.

Wallets play a foundational role in crypto security and, depending on which option you choose, can often 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.

Kraken Learn Center custodial and non-custodial wallets image

🗝️  Custodial wallets

The key defining characteristic between a custodial and non-custodial crypto wallet is who ultimately controls the private keys to it. 

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 keys to your front door. If someone else ever got hold of your house keys they could potentially access your home and the contents inside, so it’s vitally important they’re protected.

You can find out more about private keys in our article, How do cryptocurrencies use cryptography?

With custodial wallets, the private keys are managed by a third party. This involves placing trust in an intermediary to safely secure your funds on your behalf.

Pros and cons of custodial wallets

The main advantage of surrendering control of your private keys to a third party is convenience. For crypto users that aren’t especially tech savvy or confident in securing their own digital assets, entrusting a company to do it instead helps to relieve that pressure.

The obvious drawbacks of relying on a third party to custody your assets is exposure to potential external security breaches, fraud, insolvency, censorship and service changes (removing support for certain assets.)

👜  Examples of custodial wallet services

Custodial wallets typically include all centralized exchange-based wallets, including wallets used to secure funds on Kraken, as well as other fintech and payment platforms that offer support for cryptocurrencies.

In these instances, the company itself holds your private keys for you and is solely responsible for their security.

⚔️  Non-custodial wallets

With non-custodial wallets, the responsibility of storing and securing the private keys lies solely with the wallet owner. That means, if you opt to secure your own assets, you must shoulder the burden of ensuring they’re properly stored and protected against cyber and physical threats alone.

When using a non-custodial wallet, you’ll be prompted to copy down sensitive information such as the private key and recovery phrases. The latter refers to a series of random words which, when entered into a new device in the correct order, automatically migrates your crypto wallet and any funds it contains to the new device.

This is a backup measure in case the device storing your non-custodial crypto wallet gets lost, compromised or damaged.

Pros and cons of non-custodial wallets

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

Hardware wallets have the added benefit of giving you peace of mind that your funds are completely offline so long as the devices are not connected to a laptop or computer. This mitigates any chance of an online hacker accessing your cryptoassets and means you only need to worry about physically securing the device.

The main drawback of self custodying your own assets is being solely responsible for copying down and securing your own sensitive information. Any input errors, misplaced passwords or lost devices means you’ll lose access to your funds.

This is why it’s vitally important that people who use non-custodial wallet services or devices make duplicate copies of their sensitive information either on paper or etched into metal plates and spread those across multiple locations. That way, should one copy go missing or the location is compromised (house fire, flooding, etc) you have a backup option.

If you hold substantial amounts of crypto, it can sometimes be beneficial to split the amount across multiple hardware devices to further spread your risk.

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

If the former, then custodial options like holding crypto on Kraken are perhaps better suited to your needs. If the latter is more important, then a hardware wallet device or web-based non-custodial solution is likely a better option.

📋  Examples of non-custodial wallet services

Non-custodial wallets include any type of cold wallet solution, or “hardware wallet,” such as Ledger, KeepKey or Trezor devices. These are physical crypto wallet devices that store your private keys offline and are widely regarded as the safest solution for storing cryptocurrency assets. When owning hardware wallets, it’s advisable to place them in secure locations such as a safe or a lock box to maximize security.

There are also web-based non-custodial wallets such as Coinbase Wallet, MetaMask and Trust Wallet. In these examples, users retain control of their private keys while their assets are held in third-party cold wallets. 

🥇  Start buying crypto

Now that you know all of the differences between custodial and non-custodial wallets, you are ready to buy some crypto and keep it safe in the wallet of your choice. Click the button below to buy crypto on Kraken today!

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