In this episode of BeInCrypto’s Video News show, host Juliet Lima explains the difference between custodial and non-custodial crypto wallets.
When people buy their first cryptocurrency, they often have immediate questions. What type of crypto wallet should I use? Am I storing it correctly? Will someone hack me? Can other people hold the crypto for me so I don’t have to take all the responsibility? All of these are valid questions that can be answered with an understanding of custodial and non-custodial portfolios.
Custodian or non-custodian
Cryptocurrencies are stored in something called a wallet, which is actually where the public and private keys are stored. A public key is an address associated with your wallet that may be publicly visible. This is a string of letters and numbers where one can receive funds sent to the wallet.
As you might guess, a private key is something a little more personal. Whoever controls the wallet’s private key also controls the funds, because private keys are used to send money from the wallet.
A wallet’s private keys are stored as a seed phrase. This is a cryptographically generated list of words, usually 12 or 24 of them, that correspond to the private keys of that specific wallet.
The seed phrase can be used to regenerate the wallet in case the device is lost or stolen. It is important to remember to keep the seed phrase safe, as whoever controls this effectively controls the coins in the wallet.
This is where the idea of the type of wallet you choose becomes important. Custodian wallets allow someone else to have custody of the wallet’s private keys, while non-custodial wallets allow individuals to retain control of their private keys.
Hot and cold crypto wallets
There are different types of non-custodial wallets, hot wallets and cold storage wallets being the two main types.
A hot wallet is a non-custodial wallet that is connected to the internet. These wallets are usually apps on cellphones or other devices, but because they are connected to the internet, they remain under constant threat of attack. It would be wise to keep only a small amount of crypto, such as daily expense amounts.
The other type of non-custodial wallet is known as a cold storage wallet, which uses what is called a hardware device. They are called cold rooms because they remain disconnected from the Internet. Trezor and Ledger are two of the most popular brands offering these devices.
This type of storage is really only recommended for holding a fairly large amount of cryptocurrency, since their price is moderate. It’s theoretically safer to be disconnected from the internet, but it also makes it a bit more difficult to access funds. This inconvenience is offset by the added security of offline crypto storage.
As non-custodial wallets allow individuals to have complete control over their crypto, they come with personal responsibility. Individuals need to figure out how to properly save their seed phrase and protect it from any unforeseen disasters. If done incorrectly, all funds could be lost.
Meanwhile, with custodial crypto wallets, the responsibility for security now lies with the wallet provider. They have the private key of the wallet, and with this ownership of the private key,
they control the funds associated with that wallet. They should be trusted for wallet security and to return funds to you on demand.
With all funds in one place, the custodial wallet operator has now created a huge incentive for hackers. With such high rewards for successfully hacking a custody wallet, there have been many such cases. Unlike a bank, which may be FDIC insured, many of these custodial wallets have no way of reimbursing users if their funds are stolen.
What is the best crypto wallet?
Considering which is preferable depends on several factors. How much crypto do you have? How responsible are you? Do you feel comfortable trusting others? Do you know what you are doing when you send and receive cryptos? These are just some of the things to consider when deciding whether to choose a non-custodial or custodial crypto wallet.
Perhaps an ideal solution would be a combination of the two. Users who are not up to the challenge of keeping their passphrase stored securely should simply opt for custodial wallets. While keeping funds in a custodial wallet, users could also work on learning more about storing their crypto, so that they might one day switch to a non-custodial wallet.
For non-custodial wallets, multi-signature wallets are also another option. These are wallets where many private keys must be entered in order to move the funds. For example, with a 2 of 3 multi-signature wallet setup, it would take 2 of the 3 keys to spend the wallet funds. These keys could be stored on hardware devices to further increase security.
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