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Have you ever wondered how and where cryptocurrency is stored? There are many different types of wallets that token holders can use to store cryptocurrency. Generally, they can be divided into two broad categories: custodial and non-custodial.
A custodial wallet, such as Binance Custody, is a service that owns the wallet’s private key and stores the owner’s assets. The Binance account is also a custodial wallet. When using a non-custodial wallet, only its owner has full control over the assets. Examples of non-custodial wallets are MetaMask and Binance Chain Wallet.
Both types of wallets have their pros and cons. In this article, we will explain their differences so that you can choose the right option.
Introduction
If you've ever used Bitcoin or other cryptocurrencies, you know how important a digital wallet is. It allows you to make transactions, trade on a cryptocurrency exchange and use applications on the blockchain. Therefore, it is important to understand how cryptocurrency wallets work and the differences between custodial and non-custodial wallets.
How do cryptocurrency wallets work?
A crypto wallet is a tool used to interact with a blockchain network. It allows you to send and receive cryptocurrency as well as access decentralized applications (DApps).
Contrary to popular belief, cryptocurrency wallets are not designed to actually store digital assets. Instead, they generate the information needed to use the cryptocurrency. However, most users use this wording to make it easier for novice traders to understand the mechanism, so we will use this term in this article.
A cryptocurrency wallet consists of two main components - a public key and a private key.
If someone wants to send cryptocurrency, they can use one of the addresses generated using the wallet's public key. Wallet addresses and the public key can be shared with other users (hence the term “public”).
A private key is similar to a confidential password in that it signs transactions and provides access to funds. As long as the private key is secure, the owner can access the cryptocurrency from any device.
Although cryptocurrencies are digital assets, cryptocurrency wallets with public and private keys can come in different forms. They can be printed on a piece of paper, accessed through wallet software, or stored offline in a hardware wallet.
Some wallets also support the storage and transfer of NFTs—non-fungible tokens issued on the blockchain.
But regardless of the type of wallet, it will always be either custodial or non-custodial.
What is a custodial cryptocurrency wallet
A custodial cryptocurrency wallet is a wallet in which private keys are stored and managed by a third party on your behalf. In other words, the owner of such a wallet does not have full control over his funds and cannot sign transactions. But a custodial wallet also has its advantages.
At the beginning of Bitcoin, all users had to create and manage their own wallets and private keys. While there are many benefits to having complete control over your funds, it can be inconvenient and even risky for less experienced users. For example, if private keys are compromised or lost, the user will permanently lose access to their cryptocurrencies. Blockchain analysis shows that more than 3 million BTC may be lost forever.
There have also been cases where heirs were unable to access assets because the private keys only belonged to the original owner of the cryptocurrencies. Such incidents can be prevented by sharing the keys with the custodian.
Even if you forget your exchange password, you will most likely be able to regain access to your account with the help of support. However, if you are using a non-custodial wallet, the responsibility for the security of your cryptocurrency rests solely with you.
Therefore, in some cases it is better to rely on a custodial wallet. But this also means that you will have to trust your private keys to a third party. This is why it is so important to choose a reliable exchange or service provider that you can completely trust.
First of all, you need to find out basic information about the custodian, its regulation, services, method of storing private keys, and insurance.
For example, Binance Custody is regulated, compliant, and offers standard insurance for Binance corporate accounts. It also offers crime insurance and other customized insurance options. Binance Custody uses multi-signature wallets, a protocol that eliminates centralized risks by requiring parties to approve transactions before execution.
What is a non-custodial cryptocurrency wallet
A non-custodial wallet allows users to own and control their private keys. This option is best suited for those for whom it is important to manage their funds independently. Since there are no intermediaries in this case, owners of non-custodial wallets can trade cryptocurrency directly. This is a suitable option for experienced traders and investors who know how to use and protect their private keys and seed phrases.
A non-custodial wallet is needed to interact with a decentralized exchange (DEX) or decentralized application (DApp). For example, it is needed for the popular decentralized exchanges Uniswap, SushiSwap, PancakeSwap and QuickSwap.
Non-custodial wallets are provided by services such as Trust Wallet and MetaMask. Remember that when using a non-custodial wallet, you are solely responsible for the safety of your seed phrase and private keys.
Comparison of custodial and non-custodial wallets
Pros and cons of custodial wallets
The main disadvantage of custodial wallets is the need to transfer funds and private keys to a third party. In most cases, they also require you to go through a KYC process. However, their advantage lies in peace and convenience. Owners do not need to worry about losing their private key, and in case of problems they can always contact support.
When using a custodial wallet, make sure the company you choose offers a high level of security and insurance. Choose reliable custodians that are regulated and compliant.
Keep in mind that some custodians have requirements for their users. For example, Binance Custody is a service provider that currently only serves enterprise users. For more information, please see the Binance Custody FAQ.
Pros and cons of non-custodial wallets
Non-custodial wallets offer complete control over keys and funds without third-party intermediaries. In other words, the assets belong entirely to the owner of the wallet, which can be its own bank. Additionally, non-custodial wallet transactions are faster because users do not have to wait for confirmation of withdrawals. Finally, if you don't have a custodian, you don't have to spend extra money to hold your assets.
At the same time, one of the disadvantages of using non-custodial wallets is the complexity of use. As a rule, they are less user-friendly and understandable for novice users. This problem should be resolved as non-custodial services develop.
It is worth considering that owners of non-custodial wallets are fully responsible for their keys and must take precautions. If in the case of custodial wallets security is provided by the custodian, then the owners of non-custodial wallets are responsible for security themselves.
To secure your cryptocurrencies and protect yourself from hackers, you need to take the following security measures:
Use a strong password.
Enable two-factor authentication (2FA).
Beware of scams and phishing attacks.
Please use caution when clicking links or downloading new software.
Compatibility of wallets and cryptocurrencies
Both types of wallets are suitable for storing crypto assets, including NFTs. Most traders and investors use both types of wallets depending on the situation. Just make sure your wallet supports the type of cryptocurrency you want.
Different blockchains use different types of cryptocurrencies. They can be classified by token standards, but keep in mind that the same tokens can run on multiple blockchains under different standards. For example, BNB is a BEP-20 token on the BNB Smart Chain and a BEP-2 token on the BNB Beacon Chain.
Several common token standards are described below:
BNB Smart Chain: BEP-20, BEP-721, BEP-1155
BNB Beacon Chain: BEP-2
Ethereum: ERC-20, ERC-721, ERC-1155
Solana: SPL
MetaMask, Trust Wallet and MathWallet are non-custodial wallets that support most popular crypto assets. If you don't know what tokens your wallet supports, check the official information or documentation.
Sometimes wallets are updated and the list of compatible tokens expands. For example, Binance Custody now supports BTC, ETH, BCH, LTC, BUSD, BNB, CAKE and many other ERC-20 tokens. But gradually the service will include more tokens to keep up with demand.
Summary
Which wallet is better to choose, custodial or non-custodial? Most users use both types of wallets depending on their specific needs. To have full control over your assets and use blockchain technology to interact with DeFi applications, choose a non-custodial wallet. However, if you are looking for a service provider who can take care of storing your assets while you trade or invest, then it is better to opt for a reliable custodian.
Remember that whatever the type of wallet, you should always be careful and use reliable methods to protect your funds.
