What is the difference between custodial and non-custodial wallets?

When you hold your crypto currencies, it is stored inside a cryptocurrency wallet (or in short, crypto wallet), a digital wallet that allows you to store your funds. From this wallet, you can send cryptocurrency to others, and receive from others. The ‘other’ can be a person, a business or simply a smart contract that is executing. Some known cryptocurrency wallets are accounts that you may have on exchanges like Binance or Coinbase for example.

Now at the heart of the cryptocurrency space, is the intention to bring power back to the people and that is why innovators in this space have built and continue to develop what is known as non-custodial wallet.

To understand the difference between custodial and non-custodial, let’s begin by looking at a custodial wallet first. If something is custodial, it literally means your data or your funds are in the custody or the possession of a third party. This means they are responsible for looking after the information that you deposit with them. Banks are a great example of this: when you deposit your money with your bank they own your account and they have full access to your funds. You therefore have to trust that they won’t run off with your money. Luckily they don’t, however, when dealing with third parties, there are always some concerns. We’ve all heard stories of someone not being able to withdraw their funds or having their bank account frozen. You may even have had this problem yourself, requiring you to call the bank and sort things out.

The good thing about a custodian wallet is that someone takes care of your funds for you, in exchange for a fee. That’s a lot of responsibility not being put on your shoulders. On the bad side of things, there is no 100% certainty that the custodian wallet provider is fail-proof. If a custodian wallet gets hacked, then those holding their money there are likely to lose all of it. A known example is Mt Gox where 850.000 bitcoins were stolen. In 2019 Quadriga was hacked and 190M$ was gone!

This is where non-custodial wallets come in, such as Exodus, Hashpack or the very popular Metamask. With non-custodial wallets you are in full control of your crypto. No account is required, you don’t need to give up any private information and you don’t require the authorization of a third party to access your account. A non-custodial wallet is like owning a digital safe where only you have access to.

Now, the above sounds like non-custodial wallets are great, but sadly enough, with every advantage comes a drawback. Non-custodial wallets allow a higher level of control, but definitely require a higher level of responsibility and security, as well as good understanding of how these wallets work.

Non-custodial wallets are more than just “I add an extension in my browser and that’s it”. A first difference in non-custodial wallets is that there are hot wallets and cold wallets. Metamask is a perfect example of a hot wallet, as it is connected to the internet. Cold wallets are not linked to the internet, and in most circumstances come in the form of a hardware device, like Ngrave.

Scams and phishing attempts with hot wallets are abundantly present: lots of non-aware people get hacked where they link their non-custodial wallet to a certain website, and this fraud website then executes code (smart contract) to transfer valuable items in the wallet to their own wallet addresses. No revert possible, no phone number to call, nowhere to file a complaint. And indeed, we all believe “this won’t happen to me”, but we know several crypto experts who were virtually robbed even when they did take precautions and were vigilant. In crypto space, a lot of intelligent people are active and sadly some believe that the weaknesses of the system should be exploited in their favor.

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