To get into the question of what are the custodial and non-custodial ways to store your crypto, let's first recap the most important points about crypto wallets, as those concepts are inextricably linked.
What Is a Cryptocurrency Wallet?
A cryptocurrency wallet is a tool for interacting with cryptocurrencies in the blockchain. With it, you can create and manage addresses for storing and transferring digital assets. This is an application with an interface and various functions for managing the address and the cryptocurrencies stored in it.
What Are The Public And Private Keys On The Crypto Wallet?
When creating an address, the wallet generates keys - cryptographic identifiers, a kind of "identity card" with which you get access to funds in your account (address in the blockchain).
Each address usually has a pair of keys - public and private. They are linked and linked to a specific address.
The address in the blockchain is a "compressed" version of the public key that any other user can see. The private key is used to create digital signatures and check transactions. It is known only to the owner of the address, as it gives access to his funds.
Keys are not needed to enter the cryptocurrency repository - the login and password indicated during registration are responsible for this.
Why Do You Need A Seed Phrase?
Today, most wallets support another level of user authentication - using a seed phrase. This is a unique sequence of 12 or 24 words in English that serves as a password for restoring access to an address or transferring it to another wallet.
The seed phrase, like the private key, is meant only for the owner of the address, you should not, under any circumstances, transfer them to anyone. If the seed phrase is lost or stolen, you may lose access to the funds.
Is It Possible For A User To Have More Than One Crypto Wallet?
One user can have any number of addresses and wallets. Usually, they use both a personal wallet and a built-in wallet in various applications, for example, on cryptocurrency exchanges.
What Is A Custodial Crypto-Wallet?
A custodial wallet is an application for storing and transferring cryptocurrencies, the notable feature of which is that its operator (custodian) manages the addresses of users or has access to their private keys. In addition, customers of the asset custodian must undergo the identity verification procedure (KYC).
Difference Between Custodial And Non-Custodial Wallets?
The centralized exchanges have a built-in custodial wallet. Although each customer has a separate account and balance, all funds are stored in a small number of addresses managed by the crypto exchange. This simplifies working with trading tools and allows you to avoid paying for transactions inside the platform.
Individual customers rarely encounter custodial wallets outside of special applications. However, such solutions are often used by institutional investors - companies that operate in large amounts. They transfer cryptocurrencies with an increased level of security and other services, for example, insurance. Famous custodians: Xapo, BitGo, Gemini, and Coinbase Custom.
What Are The Shortcomings Of The Custodial Crypto Wallet?
The main drawback of custodian storage is the ability of the custodian to gain access to client cryptocurrencies.
The exchange administration owns private and public keys from addresses that store the crypto assets of customers. Centralized storage of large amounts of funds makes trading platforms a frequent target of hacker attacks. As a result of hacks, individual users may lose their funds.
In addition, an exchange is a legal organization that is obliged to obey the law and requirements of law enforcement agencies. At their request, it can both provide customer data and freeze their funds in their wallet — for example, in case of sanctions or seizure of property by court order.
Another unpleasant point is the possible lack of access to your assets during technical work since the custodian can disable access to users if necessary.
What Is A Non-Custodial Cryptocurrency Wallet?
The non-custodial cryptocurrency wallet allows the owner of the address to retain full control of the stored funds since it does not transfer its private keys to anyone. Such an application cannot freeze or manage the funds of users but is not responsible for their safety, either.
It is usually an application that can be downloaded to a PC, mobile device, or as a browser extension. To create an address in the blockchain through a non-custodial application, you do not need to go through KYC.
The publication of their source code provides additional reliability to popular non-custodial wallets. This allows independent experts to make sure that the application is safe. Also, such projects often support a whole community of programmers.
How Did Non-Custodial Wallets Affect the Crypto Industry?
This category of wallets provides users with quick access to the protocols of decentralized finance (DeFi), and Web 3.0, as well as to the markets of non-replaceable tokens (NFT). For example, the Uniswap trade protocol does not require registration and KYC and AML procedures. Instead, the user connects to it through his browser wallet with support for the Ethereum network.
Are Non-Custodial Wallets Safe?
Popular non-custodial wallets are reliable but still have their drawbacks.
If the private key and the phrase for restoring it are lost, the funds will also be irretrievably lost. It is worth being particularly careful with storing data in your memory or on paper.
From a security point of view, the best solution is hardware wallets (Ledger, Trezor, or KeepKey), although they are not so easy to use, and can also have vulnerabilities in the code or get lost. They can also be stolen. "Cold" wallets recommend for storing large volumes of cryptocurrencies.
How Do I Set Up A Non-Custodial Wallet?
Registering and configuring a cryptocurrency wallet takes a couple of minutes. You only need to download the application to a mobile device or connect as an extension for a browser (for example, Google Chrome). Then enter the password and name. Also, the application generates a seed phrase that needs to be saved in a safe place. After that, with a few exceptions, you can start using your wallet.
Custodial Vs Non-Custodial Storage
Funds involved in trading or investments (in the same vein, staking) can be stored in the custodial wallet of a third-party application (for example, on an exchange). However, you should enhance profile security, such as two-factor authentication.
And we recommend keeping unused digital assets in your non-custodial cryptocurrency wallet, which only you have access to at the level of a private key.
What Are Hot And Cold Wallets?
All wallets are divided into two types: "hot," existing only as digital applications, and "cold," based on physical media.
It will be enough for the novice user to start with a "hot" or software wallet. They can be used on almost any platform and device.
One of the most popular "hot" crypto wallets for Ethereum and EVM-compatible networks is MetaMask. Also, ETH and ERC-20 tokens can be stored in MyEtherWallet. For Bitcoin, a time-tested cryptographic repository, Electrum, is often used.
There are also multi-currency wallets that support many blockchains at the same time, for example, Exodus, Blockchain.com, or Trust Wallet.
"Cold," or hardware wallets, are devices the size of a flash memory card in which crypto assets are stored offline. This gives maximum protection against hacking. To make transfers, the "cold" wallet must be synchronized with the blockchain through a computer connected to the Internet.
How To Secure Your Crypto Wallet?
Make sure that the secret phrase (seed phrase) for restoring the crypto wallet is in a safe place. Do not tell it to anyone, write it on paper or engrave it on a metal plate.
It is not recommended to make a digital copy of sensitive data, such as a seed phrase or password from a cryptocurrency console. It's not safe to take a screenshot of your phone, send a copy of a secret phrase by email, or store it in an app on a mobile device that's connected to the Internet. Information can be stolen using malware.
Fear phishing. This is a type of fraud in which scammers receive a login and password to the wallet by imitating representatives from websites of some popular crypto services. Phishing links are very similar to the URL of a real application but still differ from it in 1 or 2 characters. Therefore, carefully double-check the addresses of websites (or, rather, store them in bookmarks) on which you enter data to access your funds.
Be careful with the emails. If you are asked to provide confidential information about the cryptocurrency, you are asked to go to unknown websites or send assets, do not click on the link.
Do not store cryptocurrency in only one wallet. Determine in advance for what purposes you need assets and split coins. You can leave the assets that will be needed for quick operations in custodial crypto wallets, - it is better to save in non-custodial ones the assets that you intend to store.
If you decide to leave assets in the custodial crypto exchange wallet, set up account security: connect two-factor authentication, and verify by phone number or email.
