Custodial vs self-custodial wallet pros and cons

Digital currency wallets allow users to hold and exchange digital assets by connecting to and interacting with a particular blockchain network. But how are these wallets safe? Each wallet generates a unique address that acts as an identifier to locate your digital assets on the blockchain. So, you can rest assured that each wallet exclusively tags your assets.

Crypto wallets have two types of keys:

• Public keys: Public keys are, in essence, the address of your crypto wallet. Think of it like the weblink of your personal blog. They exist to receive incoming digital currency and encrypt outbound transactional data. Simply put, it is the address you provide others when they decide to send some coins your way.
• Private keys: Private keys are like the PIN to your safety deposit box and should remain well-guarded as they authenticate ownership of digital assets. Anyone who has access to the private keys will be able to move and withdraw the currency inside the wallet in and around the blockchain. In other words, this is the key you need to keep away from prying eyes. 

Before choosing between custodial and self-custodial wallets, you need to know how the two options differ in key management.

What are custodial wallets & how do they work?

Custodial wallets work as a third party with access to your private key, much like a bank does. The third-party has complete control over your digital assets, and all you need to do is give the green light before sending and receiving payments. Easy. 

What are self-custodial wallets & how do they work?

Self-custodial wallets are the original protocol for crypto technology, and give you complete control over all your virtual moolah, including your private key. They also offer more freedom with how you choose to move your coins around. 

How do I know which type of crypto wallet to choose?

You should consider the following factors before deciding whether a custodial versus self-custodial wallet is right for you.

1. Security

Custodial wallets are less secure when compared to self-custodial wallets. As a third-party handles sensitive user data and keeps it on the internet, it poses the risk of cyber breaches. With self-custodial wallets, the user has complete discretion over how and where they keep their private keys and recovery phrase. So write it down on paper and not on your smartphone’s ‘notes application’!

2. Offline accessibility

To access your funds and details online, you need to log in to your custodial wallet and request a transaction via a centralized authority. The entire process requires internet connectivity and takes up a fair bit of time, and is not the best option if you are always on the move and need things done fast.In self-custodial wallets, there is no such prerequisite. You can view and manage your funds through software that lives locally on your computer, or through a mobile app. 

3. Recovery of funds

Fund recovery is a significant factor to consider. Custodial wallets allow users to regain access to their funds when they lose their login credentials, as they can rely on the third-party application to retrieve the private key.The process differs for self-custodial wallet users. Once you lose your private key and the accompanying recovery phrase, it is lost in the blockchain forever. Consider it similar to losing the key to your home and it's the only one you had.‍

In summary: custodial versus self-custodial wallet pros and cons

Let's discuss the pros and cons of using custodial and self-custodial wallets.

Custodial wallet pros:

• Convenience: Custodial wallets are convenient to use, as you do not have to worry about losing your private keys.
• Support: Custodial wallets are generally the only way of accessing and trading on a lot of the most popular crypto exchanges.

Custodial wallet cons:

• Risk of theft: When using custodial wallets, your assets are being held by another person/entity, which means there is a risk of them just taking the funds.
• Loss of control: When you use a custodial wallet, you are giving up control of your funds to a third party.  
• Fees: Custodial wallets typically charge higher fees for their services, which can add up over time.

Self-custodial wallet pros:

• Your keys, your crypto: With a self-custodial wallet, you are in total control of the key to your wallet, and are not relying on a third party to hold your funds.
• Easier to set up: There are no or only light Know Your Customer (KYC) requirements to own a self-custodial wallet.
• Lower fees: Self-custodial wallets often have lower transaction fees than custodial wallets. This is because they do not need to pay for the costs of running a central server or maintaining a third-party service.

Custodial wallet cons:

• Risk of non-recovery: As you are in control of the wallet’s security. If you lose your private keys, there is no way to recover them. This means that you could permanently lose access to your funds.

Closing thoughts

As Bill Gates puts it, ‘the future of money is digital currency.’ And that future lies in your hands. Your choice in custodial versus self-custodial wallets largely depends on how you see yourself traversing the digital asset economy in the years to come. But hopefully, this article gives you a solid overview of the differences and pros and cons of comparing each type, to help you make an informed decision.