Custodial vs. Non-Custodial Wallets Explained

Key Takeaways

• Custodial and Non-Custodial crypto wallets have different approaches to private key management, offering various degrees of security or privacy.
• Custodial wallets imply a 3rd party service provider who stores and manages assets while you, as a user, order transactions via the wallet UI — similar to how banking works.
• Non-custodial wallets work with the user holding and managing crypto assets directly, having full responsibility and ownership. Keys are usually stored locally on user devices or in hardware wallets.

In crypto, wallets are the essential tools that allow users to store, manage and transact their digital assets. There are two main types of crypto-wallets: custodial and non-custodial. Understanding their differences is crucial for making informed decisions about managing crypto assets.

This article explores custodial and non-custodial wallets, providing a comprehensive comparison.

How Crypto Wallets Work

All cryptocurrency wallets function through the use of both public and private keys.

The public keys are the public addresses that allow other users to find and interact or transact with your blockchain address. They are visible to everyone if your address is active (e.g., via block explorers).

The private keys are not visible to the public but are privately linked to your blockchain address. There can be different approaches to managing private keys, depending on the sophistication of security and privacy features.

Custodial and non-custodial wallets are different applications of private key management.

But before diving into custodial vs. non-custodial crypto wallets, we should understand crypto keys and their functions in wallets.

Understanding Crypto Keys

A cryptographic key represents a piece of information (usually a string of data) used to lock or unlock cryptographic functions such as authentication, authorization or encryption.

Crypto keys are of different types based on the functions they perform.

Blockchain addresses (aka user accounts) have two types of keys: public and private. Understanding how they work helps you choose the safest option for your crypto.

What is a Custodial Wallet?

A custodial wallet works with a third-party service provider who holds and manages your private keys: they store and control your funds and assets. At the same time, they allow the sending or receipt of payments. It is similar to how traditional banks manage your money.

Typical custodial wallets are those on (centralized) exchanges. They often offer additional services such as trading and lending, which can be convenient for users looking for simple all-in-one solutions.

Famous examples of custodial wallets include Coinbase, Binance and Crypto.com.

Benefits And Limitations Of Custodial Wallets

Custodial wallets offer several advantages, given their web2/traditional finance approach to crypto:

• Ease of use and familiar customer service practices
• Account recovery options
• Direct access to features like trading and lending
• Batching transactions (grouping more transactions into one single operation)

However, these wallets also come with certain limitations inherent to their private key approach:

• Potential security risks associated with third-party asset management ( from Mt. Gox's bankruptcy in 2014 to that of FTX in 2022)
• Less focus on privacy (Know Your Customer procedures required)
• No immediate access to funds (since stored by the 3rd party)
• Limited withdrawals as per service provider options
• No dApp compatibility (by design)

What is a Non-Custodial Crypto Wallet?

Non-custodial, a.k.a self-custodial wallets, give users control over their private keys. They work by storing the private keys locally, on user devices, or in actual physical form: written down or as hardware wallets.

This wallet type focuses on user control and privacy, entrusting the responsibility of managing keys and assets directly to the users.

Non-custodial wallets on Ethereum are split into two classes, depending on crypto account type: externally-owned accounts (EOAs) or smart contract accounts/smart accounts (SCWs/SAs). These, in turn, offer different levels of complexity, some even delivering one-stop-shop solutions in crypto (understand more about EOAs vs. Smart Contract Accounts in our dedicated article).

Well-known non-custodial (self-custodial) wallets include software options, MetaMask, Trust Wallet, Ambire Wallet, Argent, XDeFi, Candide or Safe, and hardware wallets like Trezor or Ledger.

Benefits And Limitations Of Non-custodial Wallets

Non-custodial wallets provide a series of user and DeFi-driven benefits :

• Complete control and ownership over funds or assets
• Privacy focus (KYC not mandatory with all non-custodial wallets)
• Account recovery and social recovery options
• Immediate access to funds
• Unlimited withdrawals
• Batching transactions (SAs)
• dApp compatibility (including access to decentralized exchanges, trading and lending platforms)

The limitations of non-custodial wallets are also drawbacks that come with design:

• Increased user responsibility (direct key and asset ownership)
• A steeper learning curve for new users due to higher complexity
• Seed phrases and physical storage options are easier to compromise (EOA class)

Custodial vs. Non-custodial Wallets — a comparison at a glance:

Which should you choose?

When choosing between custodial and non-custodial wallets, consider your needs for security, control, user experience, and personal preferences.

For crypto beginners, a custodial wallet can be a comfortable option. And it can be a working one if the user does not expect to explore Web3 and DeFi in-depth or is not bothered by 3rd party risks.

However, experienced crypto enthusiasts usually prefer non-custodial wallets for their control, flexibility and security, especially when holding long-term assets.

Ambire is a self-custodial crypto wallet that brings the best of both worlds together: the ease of use and smoothness of custodial wallets (including email sign-up) and the security and sophistication of smart contract wallets (with advanced Web3 features like batching transactions, paying fees in stablecoins, interacting with dApps and many more).

Conclusion

The primary difference between custodial and non-custodial wallets lies in managing private keys. Understanding these differences is paramount when choosing the right wallet.

By considering factors such as security, control and user experience, you can decide which wallet type best suits your needs.

Custodial wallets were the first to take off in the crypto world, yet their popularity is fading due to cases of bankruptcy and mismanagement of user funds (inherent to 3rd party ownership).

Non-custodial wallets are gaining continued traction also through the advent of account abstraction (AA) and its benefits in the Ethereum space. Leveraging  AA and features like social login/recovery and dApp integration could make non-custodial wallets the safest and most feature-rich option for the future.

If you’re thinking of exploring crypto, sign-up with Ambire in less than a minute to see how easy Web3 onboarding can be.

Already in crypto for some time? We recommend joining the early user community for the Ambire mobile app — see for yourself how we're pushing the boundaries of what smart contract wallets can do 🚀

FAQs

Q: Should I use a custodial or non-custodial wallet?

A: When choosing between custodial and non-custodial wallets, consider your needs for security, control, user experience, and personal preferences. For crypto beginners, a custodial wallet can be a comfortable option. However, experienced crypto enthusiasts usually prefer non-custodial wallets for their control, flexibility and security, especially when holding long-term assets. The main difference lies in who owns the assets: in custodial set-ups, a 3rd party holds and manages assets, while in the non-custodial one, the user has full ownership.

Q: Is MetaMask a custodial or non-custodial wallet?

A: MetaMask is a non-custodial crypto wallet that uses the Externally Owned Account approach .

Q: Are non-custodial wallets safer?

A: Security is usually a personal perspective: you should always research and understand the best security set-up for your personal needs. Usually, experienced crypto users prefer non-custodial wallets to custodial ones.

Non-custodial wallets exclude counterparty risks by ensuring asset ownership stays with the user.

EOA (Externally Owned Account) non-custodial wallets use the seed phrase approach for storing your private key. In these cases, the seed phrase is the actual account, and compromising the seed phrase (loss/forget/phishing etc.) means losing your account and assets.

In the Ethereum space, Account Abstraction wallets (Smart Contract Wallets) are currently considered the safest option as they can provide sophisticated and/or hybrid approaches to security, such as using  2FA or multisigs (assigning addresses/wallets as keys or signers, including having hardware wallets).

Q: What is the risk for a non-custodial wallet?

A: Non-custodial wallets place all responsibility in the hands of the user as the sole owner of the wallet account. Full ownership can sometimes be daunting for newcomers to crypto.

In the case of Externally Owned Account (EOA) non-custodial wallets, the biggest risk is losing/forgetting/compromising the seed phrase, which means compromising the account.

Q: Why non-custodial wallets are better?

A: Non-custodial wallets are preferred for their superior security model, which excludes 3rd party risks. In the Ethereum ecosystem, the Account Abstraction protocol allows Smart Contract Wallets to perform complex functions and offer benefits such as paying gas in stablecoins, batching transactions, account or social recovery, integrations with dApps etc., giving users full access to Web3 and DeFi.

Q: What are the disadvantages of custodian accounts?

A: The main disadvantage of a custodial account is that assets are held and managed by a 3rd party, meaning they have ownership over funds, and the users could be exposed to mismanagement of assets.

Q: What is the main benefit of keeping your crypto in a non-custodial wallet?

A: The main benefit of non-custodial wallets is that your crypto assets remain entirely in your ownership, and no 3rd party can have access to them.

Q: Are custodial accounts a good idea?

A: Custodial accounts can be a comfortable solution for users that need to quickly exchange, borrow or lend crypto and go through familiar account set-up (usually custodial wallets are on exchanges). However, due to 3rd party ownership of account funds, custodial accounts are not recommended for long-term asset deposits or managing complex crypto portfolios, as they cannot provide hybrid, state-of-the-art security models.

Q: Which wallet is best for crypto?

A: Depending on what you intend to do in the crypto space, different wallets allow different levels of operation complexity, privacy, or security. Currently, in the Ethereum space, account abstraction wallets (smart contract wallets) like Ambire or Safe are considered the most complex asset management tools, able to interact with Web3 dApps and offer the most advanced DeFi features.

Q: Can non-custodial wallets be hacked?

A: Non-custodial wallets generally have a lesser risk of being hacked compared to custodial wallets, given each one’s security model: in non-custodial wallets, the funds are never transferred to a 3rd party, so the user maintains full ownership, as well as responsibility. There have been more visible cases of custodial wallet hacks than non-custodial. However, most security breaches in non-custodial setups appear when users neglect to follow security protocols and expose their account data, keys, access data etc. or interact with malware.

Hackers believe everything can be hacked in one way or another. So it is up to the user to stay vigilant and informed regarding security options and threats.

Q: Do custodial wallets need KYC?

A: Yes, usually custodial wallets work through a 3rd party provider that needs to associate personal data with your account and go through standard Know Your Customer procedures.

Q: Can a non-custodial wallet be frozen?

A: “Freezing assets” is a concept that implies someone has control over your account and funds (like custodial wallet set-ups). In the case of non-custodial wallets, the user has full ownership of their assets, so no other party or authority can freeze the assets since they are on-chain and governed only by the owner of the account keys. However, Smart Contract Wallets such as Ambire allow for account lockdown in case of suspicion of compromise, through its robust smart contract security features.

Interested in Ambire? Follow us:

Discord | X (Twitter) | Reddit | GitHub | Telegram | Facebook