Custodial and Non-Custodial Wallets: Key Differences Explained

A custodial wallet is a wallet held by a third party, like an exchange, also known as a virtual assets service provider (VASP).

In a custodial wallet, the service provider is responsible for generating and storing the private keys. Users don’t have direct access to their keys and must rely on the custodian’s security measures. This means that if the provider is compromised, i.e a data breach, or acts maliciously, users risk losing their funds.

Users manage their digital assets through accounts set up by the custodian, typically accessed via a username, password, or other authentication methods.

Examples of custodial wallets include those offered by crypto exchanges (Kraken), online wallet platforms (Coinbase Wallet), and some mobile wallet apps (Xapo Bank).

Custodial wallets are managed by a third party, typically an exchange or wallet service, that holds the private keys on behalf of the user, offering ease of use but also certain trade-offs. 

They are user-friendly, requiring no private key management, and provide recovery options if login details are lost. Often integrated with exchanges for seamless trading, they also benefit from the custodian’s security expertise and professional infrastructure. However, users have reduced control over their assets, face counterparty risks such as hacks or insolvency, and may encounter withdrawal restrictions due to platform downtime or limits.

Custodial wallets are ideal for new users who may find managing private keys challenging, offering a simpler and more accessible entry into crypto. They are also convenient for active traders who frequently operate on exchanges, as well as institutional investors who require solutions that support regulatory compliance and reporting.

A non-custodial wallet (self-hosted wallet) is a type of digital wallet that is managed and controlled entirely by the wallet user, rather than by a third-party service such as an exchange. This setup gives individuals full control over their private keys, and therefore over the security and management of their digital assets.

Non-custodial wallets provide enhanced security because the private keys are stored locally on the user’s device instead of on a centralised server, reducing the risk of a single point of failure or large-scale hacking attacks targeting a service provider.

These wallets can take the form of either software or hardware. Software wallets, like Electrum, are installed on a user’s computer or mobile device, while hardware wallets, such as Ledger, are physical devices specifically designed to securely store private keys offline.

Non-custodial wallets (self-hosted wallets) give users full control of their assets, as they hold their own private keys, offering greater privacy and fewer restrictions compared to custodial wallets. Assets are kept directly in the wallet-owner's control, removing the risk of loss due to exchange mismanagement or insolvency. Users can move their assets freely without withdrawal limits or third-party involvement. 

They are inherently safe because only the wallet owners hold the private keys needed to access the assets. Moreover, unlike exchanges, which use a single address per user, making transactions traceable, self-hosted wallets allow you to generate a new address for every transaction, enhancing privacy.

However, this control comes with higher responsibility; losing private keys results in permanent loss of access, and the lack of recovery options means mistakes, such as sending funds to the wrong address, cannot be undone.

Read more: 5 Benefits of Self-hosted Wallets

Non-custodial wallets (self-hosted wallets) are well-suited to experienced crypto users who are confident in managing their own private keys and security. However, with growing awareness of the risks associated with exchanges and the rise of user-friendly platforms like Ledger, these wallets are increasingly attracting novice users as well. 

Additionally, they remain a preferred choice for long-term holders (“HODLers”) seeking secure storage, DeFi users who need direct access to decentralised applications, and privacy-conscious investors who value greater control and anonymity compared to custodial options.