Custodial vs. Noncustodial Wallets: Which Should You Use?

As wallets continue to evolve from a simple store-of-value product to a critical infrastructure component and passport that underpins everything in web3, we examine what to look for as you explore the next iteration of the internet.

When you're investing in cryptocurrency, the right wallet is essential. Crypto wallets help to keep your assets safe by ensuring that only authorized people can access the funds. However, it can take a little time to choose the best type of wallet for you. 

Most crypto wallets can be categorized as either custodial or noncustodial. Both styles have their own pros and cons, so the right choice really just depends on your situation. To choose the best type of wallet for your needs, explore this helpful guide.

What Is a Custodial Crypto Wallet?

A custodial crypto wallet is a type of crypto wallet for which a third party holds onto the private keys for the customer. The owner of the crypto can send or receive payments, but they do not manage their keys themselves.

Custodial crypto wallets are frequently used by crypto exchanges and other decentralized finance (DeFi) companies. When you put your funds in a custodial wallet, you’re essentially outsourcing wallet management to the exchange, which becomes responsible for completing transactions, holding your keys and storing your funds securely. The upside is that you can access your funds by entering just a single key. 

Bybit Wallet

If you’re looking for a great custodial crypto wallet to use, consider signing up for a Bybit account and setting up your own Bybit Wallet — a web3–compatible wallet that can be created in one click, and aims to give users convenience and peace of mind without the hassle of a complex seed phrase. Bybit is known to be trustworthy and reliable with its industry-grade security and 24/7 live customer support, so you can rest assured that your funds will be kept safe.

If you already have a Bybit account, you may wonder what the difference is between your existing Bybit account and the new Bybit Wallet. Think of your Bybit account as a platform for you to store and trade your crypto on the Bybit exchange. The Bybit Wallet, on the other hand, is a custodial crypto wallet that not only holds your assets and private key, but also gives you direct and complete service to the decentralized web of DeFi, GameFi and NFTs. It’s your operating system to web3 with on-chain behaviors and benefits all in one place.

Here are a few of the exciting things you can look forward to with Bybit Wallet: 

• Bybit Web3 App and Web Version (October 2022)

• Bybit Wallet Chrome Extension (October 2022)

• APEX Integration (November 2022)

• Swap (November 2022)

• IDO Functions (December 2022)

• Airdrop Management (December 2022)

• NFT Asset Display (December 2022)

• Cross-Chain Compatibility (December 2022)

• Decentralized Identity Management (Q1 2023)

With so many features, Bybit Wallet aims to be the preferred gateway to the web3 ecosystem, not only for Bybit users, but for all other crypto users worldwide.

How Does a Custodial Crypto Wallet Work?

To understand how a custodial crypto wallet works, it’s essential to know how crypto wallets function. Unlike a real-world wallet, crypto wallets don't contain your actual funds. Instead, a standard wallet contains the addresses where your cryptocurrency is located, the public key that lets you set up transactions, and the private key to authorize transactions.

If you have a custodial crypto wallet, you don't keep track of the keys or the addresses yourself. Instead, you have an account with a third-party business that holds all this information for you. To access your account, you log in with a username and password, just as you would for an email address or social media account. This login then authorizes the company to perform crypto actions on your behalf.

Once you log in, you use the custodial crypto wallet company's interface to manage your funds. You can do things like see your balance, send money, or purchase more coins. What you see on the interface is not the blockchain or the cryptocurrency itself, but rather an intermediary. You’re essentially telling the company what actions you want to perform on the blockchain, and then they handle the details for you.

What Is a Noncustodial Crypto Wallet?

A noncustodial crypto wallet is a crypto wallet for which the person who owns the funds in it also manages them. The user has control over their own crypto keys, and handles transactions themselves.

Like a custodial crypto wallet, a noncustodial crypto wallet is typically still a product provided by another company. However, noncustodial crypto wallets do not manage cryptocurrency for you. You’ll need to keep track of your public and private keys, and input them each time you make a transaction. Because of this requirement, noncustodial crypto wallets tend to be a little more complicated to use. Some noncustodial crypto wallet options, like MetaMask, try to be user-friendly, while others like MyEtherWallet are more technical to use.

How Does a Noncustodial Crypto Wallet Work?

Noncustodial crypto wallets may sound a little simpler, since third parties aren't involved in each transaction. However, despite being theoretically straightforward, a noncustodial crypto wallet can, in reality, be fairly complicated. Noncustodial crypto wallets can work in a variety of ways, depending on the sort of wallet you have and the type of crypto you want to work with. Unlike most custodial crypto wallet services, noncustodial crypto wallets can be software or a piece of hardware.

There are different procedures in place, depending on the sort of noncustodial crypto wallet you have. However, they all follow the same basic concept: They give you a place to store your crypto funds, and you use a public key and a private key to access the funds. When you want to receive funds, you can give people your public key. In order to accept crypto assets, send funds and complete other transactions, you need to enter your private keys in your crypto wallet.

With a noncustodial crypto wallet, you’ll need to perform transactions yourself on the blockchain of the crypto you're working with. These transactions are typically reflected in real time on the chain. However, some hardware noncustodial crypto wallet options allow users to sign a transaction offline with their private key, and then upload it to the blockchain for confirmation.

Types of Noncustodial Crypto Wallets

Since there's sufficient variety in how noncustodial crypto wallets work, it can be helpful to take a closer look at the different types. If you decide to work with a noncustodial crypto wallet, you can use one or more of these options.

Hardware Wallets

A hardware wallet is a small module that often looks similar to a USB stick. It remains turned off when you aren't using it, and doesn't have its own internet connection. When you want to make a transaction, you connect the wallet to a computer or mobile device. It then transmits your crypto keys to the blockchain to finalize the transaction. You usually need physical possession of this type of hardware wallet to manage your funds. If you lose the hardware wallet and don't have your keys memorized, your crypto funds may be lost.

Browser-Based Wallets

A browser-based crypto wallet is usually a type of browser extension. You download it onto your computer and connect it to your preferred web browser. When you want to take part in crypto exchanges, or send your crypto assets to someone else, you open the extension and input your private key. Browser-based noncustodial crypto wallets let you retain full control over your keys, coins and passwords. Many browser-based wallets give you a seed phrase that’s linked to your crypto wallet. You can enter the seed phrase on another device to regenerate your wallet. This provides an additional measure of security in case you lose access to the device on which you originally accessed the wallet.

Mobile Wallets

Mobile crypto wallets combine the flexibility of browser wallets with the portability of hardware wallets. This type of wallet is usually a mobile app. You download and install it on your phone, and it offers a variety of ways to manage and use your crypto keys. You can enter keys to sign transactions or simply store them within the wallet to retain access to your crypto assets. Like browser-based wallets, a mobile wallet typically provides you with a seed phrase. This long string of words is something you can input on another phone to restore access to your keys.

Custodial vs. Noncustodial Crypto Wallets

Now that you know the basics of custodial and noncustodial crypto wallets, it's time to take a closer look at them. Though they do have a few things in common, custodial crypto wallets tend to be vastly different from noncustodial crypto wallets. Here are some of the main similarities and differences.

Custodian of Private Key

This is the primary difference between a custodial and noncustodial crypto wallet. With a custodial crypto wallet, the third-party business is responsible for keeping track of your private key and using it to finalize transactions. Meanwhile, with a noncustodial crypto wallet, you’re in charge of your own key.

Recovery of Funds

If you lose access to your primary method of reaching your crypto assets, it’s a lot easier to recover your funds on a custodial crypto wallet than on a noncustodial one. You can log in to your account from various devices, and if you lose your password, you can follow the steps to recover it and regain control of your wallet. Typically, the company that manages your wallet has customer service available to assist you, and if a malicious actor hacks your account, they can attempt to help you restore your crypto assets. For example, if you ever require any assistance regaining control of your Bybit Wallet, Bybit’s 24/7 live customer support will certainly come in handy and be there for you every step of the way. 

A noncustodial crypto wallet does offer some recovery options, but they’re not as widespread. Some types of hardware wallets may not offer any recovery options at all. Most browser and mobile wallets provide users with a seed phrase. However, if you lose your seed phrase, you usually have no way to recover funds. It’s also possible to fall prey to scams, such as phony websites that trick you into inputting your seed phrase so malicious actors can steal your funds.

Security

Usually, custodial crypto wallets are less secure. To manage your crypto assets for you, their platforms retain vast amounts of highly confidential information. If someone hacks their storage, the hacker can get your private and public keys. Meanwhile, with a noncustodial crypto wallet, you're retaining the data yourself. It’s therefore much harder for malicious actors to access the information that’s stored solely on your device. If you prioritize security, it's a good idea to consider hardware wallets. However, you should still be wary, as anyone who gets hold of your password on your noncustodial crypto wallet can still access it and drain your funds. 

Transaction Type

When a custodial crypto wallet approves a transaction for you, things are a little more complex. The platform has to use a central exchange to approve your transaction and pass on the information to the blockchain. This can result in higher transaction fees and a slight lag before the transaction is recorded. Noncustodial crypto wallets use direct transactions. They record changes to the blockchain in real time, and the lack of intermediaries means that transaction fees are often lower.

Offline Accessibility

In order to function, custodial crypto wallets need to access the internet. Without connectivity, they can't communicate with the central authority and transmit your authorizations. While some noncustodial crypto wallets do use the internet to work, it's not an absolute requirement. There are plenty of hardware wallets that operate offline. You can put in your keys offline, and only need to briefly connect to the internet to update the blockchain. 

KYC/AML Procedures

Many people use DeFi services because they want more anonymity and privacy. However, some crypto wallets are heavily regulated. Custodial crypto wallets often qualify as a financial service that must meet local standards for anti-money laundering (AML), and verify users with know-your-customer (KYC) protocols. Meanwhile, noncustodial wallets are less standardized. Many are simple pieces of hardware that can be sold without requiring users to provide their names or financial details. This provides a more private experience for customers.

User-Friendliness

User-friendliness is a somewhat complex thing to analyze since every service is so different. Generally, custodial wallets are easier for people to use. Once you log in, you can send and receive funds with a simple click.

Meanwhile, noncustodial wallets require inputting long strings of numbers and performing other tasks. However, keep in mind that custodial wallets don’t guarantee any given service is easier to use. Every business is different, and the interfaces for some custodial crypto wallets can be very confusing. 

With Bybit, you won’t have to worry. Bybit Wallet offers a user-friendly interface to ensure that you have easy access to every feature on the Bybit platform, as well as web3 applications. The Bybit Web3 Portal even has guides and tips to help you out on your web3 journey. 

Advantages of Using Custodial Crypto Wallets

Why should you give a custodial crypto wallet a try? There are several advantages to working with these types of crypto wallets.

Ease of Use

For many customers, the main perk of a custodial crypto wallet is that it’s fast and easy to use. Especially if you're new to working with digital assets, a custodial crypto wallet can be very reassuring. It functions just like a regular online account, and uses the standard username and password setup that most customers are already familiar with. Letting a third-party business handle your private keys also simplifies the process of buying and selling crypto. Instead of having to enter long private keys and figure out the blockchain, you can just click simple buttons that say things like Transfer Funds or Buy Crypto.

More Recovery Options

If you've heard stories of people who bought hundreds of BTC in the 2010s and lost their private keys, you know how important recovery is. For most crypto owners, the idea of suddenly not being able to access their funds is a nightmare. Custodial crypto wallets provide a lot of reassurance. They hang onto your private keys for you, so you never have to worry about losing them. Instead, you just need to remember a simple account name and password. If you lose access to these details, the crypto wallet company is there to help you prove your identity and recover control of your account.

Less Stressful to Manage

Leaving another company to handle your private keys for you can be less stressful. You don't have to worry about making mistakes, or learning the ins and outs of working with the blockchain. Since the company handles each transaction for you, you can’t accidentally send your funds to the wrong public key. And as long as you're practicing basic security standards, you don't have to worry about hacks, either. The third-party service handles security for you and may be legally required to compensate you if you are hacked.

Disadvantages of Using Custodial Crypto Wallets

Though there are certainly a lot of perks to working with a custodial crypto wallet, there are also some potential downsides. Here are a few things you need to be aware of before you settle on a custodial crypto wallet.

Reduced Security

Working with a custodial crypto wallet company does come with some inherent security risks. Though most reputable companies work hard to secure their users' private data, third-party services have more points of vulnerability. Each time you conduct a transaction, you have to connect to the internet and send and receive information online. Furthermore, a lot of important user data, including private keys and locations for crypto assets, all have to be stored in a massive database. Hackers are aware of how valuable these digital assets can be, so they often target custodial crypto wallet companies. Any time you select a custodial crypto wallet, you have to be willing to accept the higher risk of hacking.

Less Privacy

Every custodial crypto wallet company has to do some basic user verification before providing an account. They do this because they can face a lot of legal consequences if they provide their services to criminals. Unfortunately, all of the user verification and anti-laundering standards come at a price. Users typically have to give the company information such as their name, location and age. Some sites may also require your social security number or bank account numbers. If you don't want random companies learning about your financial business, a custodial crypto wallet might not be right for you.

Lack of Direct Ownership

Due to the custodial crypto wallet’s setup, you’re essentially letting a third-party system hold onto your crypto funds for you. Since they have the keys to your digital assets, they’re in possession of those funds. Much like storing your money in a bank, this comes with some risks. If you break the wallet's terms of service, they may be able to freeze your account and hold onto your funds indefinitely. Furthermore, if you use your assets in an illegal way, the government can require the wallet company to freeze your funds or turn them over to the government.

Advantages of Using Noncustodial Crypto Wallets

There are plenty of reasons to work with a noncustodial crypto wallet, as they provide many helpful benefits for their users.

Better Security

If you’re using a noncustodial wallet, your funds are a lot more secure. Since these crypto wallets don't contain access to hundreds of users of accounts, they aren't as big of a target for hackers in the first place. Furthermore, if a hacker does decide to try hacking into your account, it's a lot harder. All the information about your digital keys isn't floating around on the web where it's easy to steal. There's no user account that a scammer can phish their way into, and there are fewer software vulnerabilities to exploit. Noncustodial crypto wallets also offer offline versions that provide even more security. This cold storage method is almost impossible for a hacker to mess with. Unless they physically go to your house and get your crypto wallet, your funds are secure.

Instant Transactions

A huge advantage of a noncustodial crypto wallet is that it gives real-time updates on the blockchain. With a custodial crypto wallet, each transaction you make requires you to tell the wallet provider what you want, and then wait on them to do it. This slight lag can cause a lot of problems. At best, it results in a longer wait before you get your money. In worst-case scenarios, it can cause contracts to fall through or cause you to miss out on a sale. 

If you want instant, reliable transactions, a noncustodial crypto wallet is the way to go.

More Control Over Your Funds

Within the crypto world, a popular saying is, "Not your keys, not your coins." This statement expresses the importance of having control over your own keys. With a noncustodial crypto wallet, you never have to worry about another party taking your crypto. As long as you keep things secure, the coins are always in your possession. There’s no risk of a third party preventing your access to your coins. Your account can't be frozen for misbehavior, and you don't have any limits on how you can use your money. If you got into crypto for the freedom of DeFi, a noncustodial crypto wallet is an ideal choice.

Disadvantages of Using Noncustodial Crypto Wallets

Despite all of their benefits, these crypto wallets aren't for everyone. Here are a few things you need to keep in mind.

Lack of a Backup Option

These crypto wallets don't store your keys in a database, which can be a problem if you lose them. If that occurs, there aren't many ways to access your crypto assets. Most noncustodial crypto wallet options do provide a seed phrase, which you can use to regenerate the wallet if you lose the device the original wallet was stored on. However, this means you only have one chance to restore your wallet. If you lose the device with the keys and don't remember your seed phrase, you're out of luck. These crypto wallets don't come with a friendly customer service team who can reset your password and log you back in to your account.

Less Easy for Novices

A big downside of a noncustodial crypto wallet is that it can feel a little confusing. These DeFi wallets don't use the classic username and password combination most people are already used to, and their interfaces can be quite complex. Even with the best UI in place, crypto wallets that aren't custodial tend to be more challenging. Users have to personally sign transactions, instead of just clicking a Buy or Sell button. Noncustodial crypto wallet options require at least a basic working knowledge of what a blockchain is and how cryptocurrency works.

More Responsibility for Your Own Security

For some users, the idea of having more control over their crypto wallets is a great thing. However, this extra power does come with a little more pressure. You can't sit back and know that a multimillion company with several security experts is handling your security. Instead, you have to be a little more proactive. Leaving your hardware crypto wallets lying around would be just as dangerous as leaving a billfold sitting out. Furthermore, since you actually know your own crypto keys, there's more of a risk that you could accidentally give them away. Mistakenly letting the wrong person see them could lead to the loss of your crypto assets.

Which Wallet Type Should You Use for Your Crypto?

Ultimately, all types of crypto wallets have their own advantages. There's no absolute best type of wallet to use. Some people prefer using a noncustodial crypto wallet because they value security, while others prefer using a custodial crypto wallet because it puts their mind at ease when it comes to handling transactions and fund recovery. That being said, the right choice really just depends on your situation and your preferences.

One custodial crypto wallet we’d recommend trying out is Bybit Wallet. Bybit has a proven track record when it comes to security. In addition, you’ll never have to worry about losing access to your funds because Bybit’s 24/7 live customer support will always be there to help you out. 

With Bybit Wallet, you don’t just get the sole function of keeping your funds safe, you’ll also be granted access into the web3 world of DeFi, GameFi and NFTs. 

You’ll never have to be afraid of missing out on any airdrops because Bybit Wallet collects them automatically for you. It’s also cross-chain compatible. With all of these benefits, Bybit Wallet is certainly one of the best custodial crypto wallets you can use. So sign up for a Bybit account and set up your Bybit Wallet now. 

Closing Thoughts

Both noncustodial and custodial crypto wallets can be an excellent way to store your crypto assets. Though a noncustodial crypto wallet can be a little more secure, a custodial crypto wallet is often a bit simpler to use. Ultimately, as mentioned, the right one depends heavily on your style and preference. If you’re unsure, you can always try out a few different options to identify the right style for you.