According to research conducted by Binance, 92.1% of its institutional and VIP customers store their crypto directly on the exchange. Despite contradicting the root principle of Bitcoin and blockchain technology, which suggests rightful ownership of one’s money, exchange wallets, or so-called custodial wallets, surprisingly remain the most popular option among crypto investors.
Perhaps this is a matter of convenience, or maybe it’s just plain carelessness, either way we can’t be a judge of that. But if it’s a lack of knowledge of crypto and blockchain that makes people risk their funds, we’d be happy to define a fundamental difference between custodial and non-custodial wallets.
Hopefully, you’ll make the right choice once you’re properly informed.
The main problem with custodial wallets is that they are not private.
Cryptocurrency wallets use two sets of keys – public and private, where private keys are responsible for encrypting your wallet (if you want to learn more about blockchain encryption, read our article on private keys). In other words, your private key is the tool that unlocks your blockchain wallet and, thus, protects your assets.
You don’t just give your apartment keys to strangers, don’t you? So why would you trust them with your private keys?
There are a few ‘advantages’ to custodial wallets.
- Less responsibility: you cannot lose your keys since you don’t hold them
- Convenience: when using the exchange’s native wallet you can just leave your funds until you decide to sell them
Both of these arguments are not particularly convincing as they only feed your laziness and put your money at risk.
There’s a big downside to using custodial blockchain wallets.
- You don’t control your crypto
- Hackers love targeting exchanges which means that your funds are at constant risk
- Your funds can be blocked for multiple reasons such as KYC restrictions, court order, etc
Obviously, there is a large number of crypto investors that are mainly interested in getting profits and aren’t too keen on the philosophy of blockchain and the financial revolution.
However, if alongside all the profits you get a secure way of storing your money, why would you say no to that?
Non-custodial wallets are the ones that let you hold and manage your cryptocurrency and do not own your private keys. Usually, private keys are kept on your device, whether it’s a mobile phone, laptop, or a specialized hardware wallet. And, as you might have guessed, there’s a wide range of non-custodial wallets. They come in all shapes and sizes, from hardware devices to mobile apps to desktop software.
When using a non-custodial wallet, you need to understand one thing: being the sole owner of your funds comes with more responsibility and you must protect your wallet accordingly.
What does this mean? How do you secure your funds?
Non-custodial HD wallets use a mnemonic phrase to protect and backup your wallet. It is a 12 (or more) word phrase that you need to write down and keep safe. If you lose it or share it with somebody else, you will lose the ownership of your blockchain assets as well.
Here are a few tips regarding your mnemonic:
- Write your phrase on a non-electronic device (a good old piece of paper will do, just don’t lose it too!)
- Do not write it down on the same device that you use to access your wallet
- If somebody asks you to share your mnemonic phrase with them, they’re a scammer! No wallet provider will ever ask you to share your mnemonic!
Proof of Keys
The issue of owning your cryptocurrency is getting hotter and hotter with time. On January 3rd, 2019, cryptocurrency and blockchain enthusiasts all over the world held a protest action Proof of Keys that encouraged all the crypto owners to withdraw their assets from exchanges.
The event aims to challenge the current situation with third-parties controlling funds and private keys and remind the community about their rights and responsibilities. And it seems like it’s going to be an annual activity.
The Bottom Line
You’ve got two choices: control your money by yourself and use non-custodial wallets and finally take charge of your finances, or stay in the comfort zone that bank-like exchanges are happy to provide and risk losing it all.
So which one will it be?