Custodial vs Non-Custodial Wallets: Which One is Right for You?

If you are into Blockchain development, Crypto Wallets are secure storage for digital assets, allowing users to transfer, receive, and utilize digital assets such as Bitcoin, Ethereum, Ripple, or NFTs. With the growing popularity of cryptocurrency purchases, it is essential to consider the storage of your digital assets. This raises the important decision of choosing between a custodial or non-custodial wallet to ensure the safety and security of your funds.

But what is that? Let’s dive in to understand the difference between custodial vs non custodial wallets . 

Custodial vs Non custodial wallets -

What is a Custodial Wallet?

A custodial wallet is when the user doesn’t have the private key & delegates a third party to manage their private keys. This confers total control over the user's cryptocurrency assets to the service provider, which includes the handling of the user's wallet key, transaction signing, and protection of the user's digital assets.

‍

Generally, providers of custodial wallets are cryptocurrency exchanges which offer users mobile or web applications to access their wallets. The user manages their funds and performs transactions through the provider's interface. This is done to ease the interface for new users. Providing a better user experience improves the overall adoption of crypto currenny without having to deal with complexities of key management. It is a tradeoff between good user experience & security. 

For this reason, users have to depend on the service provider to secure their tokens and deploy strong security measures to deter unauthorized access. The measures adopted may consist of two-factor authentication (2FA), email confirmation, or biometric authentication like facial recognition or fingerprint verification.

Advantages:

• Wallet interfaces are typically designed to be user-friendly and easy to set up.
• The user interface feels familiar and does not require advanced technical knowledge to manage a wallet account, making it less stressful to manage for new users.
• A few wallet providers furnish their users with full account recovery in case of password loss or forgetfulness. This feature can offer more assurance to users who worry about the possibility of losing access to their funds.

Disadvantages:

• Custodial wallets do not grant users absolute authority over their keys and funds.
• The security of the keys and funds is solely the responsibility of the wallet service provider.
• If users lose their private keys or seed phrase, they will lose access to their funds, as they cannot be recovered without this information.

What is a Non-Custodial Wallet?

A non-custodial wallet, also referred to as a self-custody crypto wallet, puts the responsibility of managing funds entirely on the user. With non-custodial wallets, users have complete control over their crypto assets and execute transactions independently using their private keys. There are different types of non-custodial wallets, including browser-based, mobile, and hardware wallets.

When a user creates a non-custodial wallet, they receive a seed phrase consisting of 12 randomly generated words that can be used to generate public and private keys. The seed phrase serves as a backup or recovery mechanism in case the user loses access to their original device. However, anyone with the seed phrase can gain full control of the wallet's funds, so users must keep their seed phrase secure. If the seed phrase is lost, the user won't be able to access their funds.

Users must manage and execute transactions using their private keys. Depending on the non-custodial wallet type, the transaction can be reflected on the blockchain in real-time or signed offline and uploaded to the blockchain later for confirmation.

Advantages

• Non-custodial wallets grant users complete ownership and authority over their digital assets. 
• Non-custodial wallets allow users to store their private keys offline, enhancing security and rendering it difficult for malicious actors to pilfer them. 
• Non-custodial wallets engage with the blockchain directly, facilitating direct participation in decentralized applications and the transfer of cryptocurrencies.

Disadvantages:

• Users are solely responsible for managing and keeping their private keys secure. If the keys are lost or stolen, or if the seed phrase is misplaced, the user will lose access to their funds.
• Non-custodial wallets generally lack recovery mechanisms in case the private keys are misplaced, which may be a concern for certain users. 
• The interface of non-custodial wallets can be intricate and less intuitive, demanding some degree of technical proficiency to use effectively.

Key Differences between Custodial Wallet and Non-Custodial Wallet:

Private Key: In contrast to custodial wallets where a third party manages the private key, non-custodial wallets offer users full autonomy over their blockchain assets and associated services.

Transaction Type: Non-Custodial wallets show transactions in real-time on the blockchain, while Custodial wallets do not reflect transactions in real-time on the blockchain.

Security Measures: Custodial online crypto wallets store user data in hot and cold storage, which can make them susceptible to data breaches by hackers. In the past, major data breaches have occurred, exposing the vulnerability of custodial wallet security. 

On the other hand, non-custodial crypto wallets keep all user information with the users themselves, thereby minimizing the risk of data theft, provided that users do not disclose their details or misplace their devices.‍

Data Recovery: In Custodial wallets, the third-party provider holds the private key, which means that if the user loses access to their data, they can regain it by requesting the provider. ‍

This is not possible in the case of Non-Custodial wallets, where the user is the sole authority and responsibility for managing their own private key.‍

Data Access: Custodial wallets rely on the third-party provider to hold the private key, giving users the ability to recover their data by requesting the provider. ‍

However, this is not the case with Non-Custodial wallets, where users have complete authority and responsibility for managing their own private keys.‍

What’s better for the user?

Storing crypto assets can be done using either custodial or non-custodial wallets, which are preferred by traders and investors depending on their needs. However, it's crucial to verify if the selected crypto wallet supports the specific type of cryptocurrency one wishes to store since different cryptos require different storage methods.

Some Popular Examples Custodial vs Non-Custodial Wallets

Custodial Wallet: CoinBase, Binance, Kraken

Non-Custodial Wallet: Ledger, Trezor, Electrum 

The choice of wallet, be it custodial or non-custodial, presents unique pros and cons. Custodial wallets may appeal to those who prioritize convenience and recovery options. Non-custodial wallets, on the other hand, offer complete ownership and control over private keys, making them the preferred option for users who seek maximum control.‍

At Arcana Network we believe that users who are just entering the web3 ecosystem should have access to benefits of both worlds i.e. simple UX of a custodial wallet & security of a non - custodial wallet. Hence Arcana Auth provides dApp builders to assign a non custodial wallet to the users while onboarding them via familiar Web2 methods like social auth or passwordless auth. The wallet being a non custodial wallet has options to sign up using familiar options without compromising on security.