Custodial Wallets: Benefits, Risks, and Examples
Custodial wallets are third-party wallets that are managed and controlled by a company or organization, rather than the individual user.
These wallets are important for users who are new to cryptocurrency or who do not want the responsibility and technical knowledge required to manage their own wallets.
However, custodial wallets do come with certain risks, including the risk of the company going bankrupt or losing access to the user’s funds.
Let’s dive into the further details.
What are the differences between Custodial and Non-custodial Wallets?
Understanding the difference between custodial and non-custodial wallets is important for crypto users because it determines who has control over the private keys to their crypto assets.
A custodial wallet is one where a third-party service provider holds the private keys on behalf of the user, while a non-custodial wallet allows the user to have sole control over their private keys.
Custodial wallets may offer more convenience and ease of use, they also come with more security risks since the user is relying on a third-party to keep their crypto assets safe.
On the other hand, non-custodial wallets put the responsibility and control entirely in the hands of the user, but may require more technical knowledge and can be less user-friendly.
By understanding the differences between these two types of wallets, crypto users can make an informed decision on which type of wallet is best suited for their individual needs and level of risk tolerance.
What are the Benefits of Custodial Wallets?
Some users prefer custodial wallets because they offer a higher level of security and many more things as follow,
Ease of Use – Custodial wallets are generally very easy to set up, and users can begin buying and selling cryptocurrencies almost immediately. Users do not need to worry about the technical aspects of cryptocurrency storage, such as private key management.
Customer Service Support – Custodial wallets also offer timely customer support which could be of great help to new users who may face difficulties while using the wallet.
Security Features – Custodial wallets often have rigorous security measures in place, such as two-factor authentication, encryption, and manual review of transactions.
Since custodial wallets hold their users’ private keys, they often have advanced security features necessary to keep these keys secure.
Backup and Recovery – Many custodial wallet providers offer backup and recovery services in case of lost keys or other technical difficulties. This can be especially useful for new users who may still be learning the ins and outs of the crypto world.
Access to Platform Features – Some custodial wallets offer additional features, such as staking rewards, access to decentralized exchanges, and other ways to earn cryptocurrency. These can be particularly attractive to new users who are still learning about the ecosystem.
Insurance against hacking – Some custodial wallets offer insurance against hacking or theft, providing an added layer of protection for those who want to feel secure.
So overall, custodial wallets provide an easy, secure, and user-friendly option for those new to cryptocurrency trading and investing, who may not have the technical expertise to manage their cryptocurrencies themselves.
Well-known Custodial Wallet Providers
- Binance Wallet
- Kraken Wallet
- Gemini Wallet
- BitGo Wallet
- Circle Wallet
- Exodus Wallet
- com Wallet
- Robinhood Wallet
- Uphold Wallet
What are the Risks associated with Custodial Wallets?
Custodial wallets are digital wallets that store your cryptocurrency assets on your behalf, just like a bank stores your money. While custodial wallets offer convenience and ease of use, they come with several risks, including:
Loss of Control
When you entrust your cryptocurrency assets to a custodial wallet, you are handing over control of your funds to a third-party, So that you are at the mercy of the wallet provider, and if they experience a data breach, mismanage your funds, or disappear altogether, you could lose all your money.
Custodial wallets are centralised, which means they are vulnerable to hacking attacks. If a hacker gains access to the wallet provider’s servers, they could steal your assets and leave you with nothing.
Unlike non-custodial wallets, which allow you to control your private keys and access your funds from anywhere, custodial wallets typically limit your access to your funds.
You may be required to go through a verification process, wait for approval, or deal with restrictions on withdrawals and transfers.
Lack of Anonymity
Custodial wallets often require you to provide your personal information, such as your name, address, and ID verification. If you value your privacy, this could be a major concern.
Incompatibility with Certain Cryptocurrencies
Custodial wallets typically support only a limited number of cryptocurrencies, which means you may miss out on investing in other promising assets.
Overall, while custodial wallets may be convenient for some users, they come with significant risks that could result in the loss of your cryptocurrency assets.
You have to weigh the pros and cons carefully before choosing a custodial wallet and do your research to ensure that the wallet provider is reputable and takes security seriously.
Examples of Custodial Wallet Hacks and Security Breaches
Here are a few examples of custodial wallet hacks and security breaches-
1. Mt. Gox: Mt. Gox was a Tokyo-based Bitcoin exchange that was hacked in 2014. The hack resulted in the loss of about 850,000 Bitcoins, which were worth about $460 million at the time. This was one of the largest crypto hacks in history and led to the company’s bankruptcies.
2. QuadrigaCX: QuadrigaCX was a Canadian cryptocurrency exchange that was hacked in 2019. The hack resulted in the loss of about $190 million worth of cryptocurrency, including Bitcoin, Ethereum, and Litecoin. The company’s CEO, who was the only one with access to the exchange’s funds, died unexpectedly, leaving the funds unrecoverable.
3. Bitfinex: Bitfinex is a Hong Kong-based cryptocurrency exchange that was hacked in 2016. The hack resulted in the loss of about 120,000 Bitcoins, which were worth about $72 million at the time. The company managed to recover some of the funds, but many users were left with losses.
4. Coincheck: Coincheck is a Japanese cryptocurrency exchange that was hacked in 2018. The hack resulted in the loss of about $530 million worth of NEM cryptocurrency. Like Mt. Gox, this was one of the largest cryptocurrency hacks in history.
These examples highlight the risks associated with custodial wallets, as users do not have full control over their funds. Instead, users have to rely on the security measures put in place by the custodian, which can be vulnerable to cyberattacks and human error.
How Legal Issues can Impact on Safety?
Top major risk associated with custodial wallets is the potential impact of regulatory changes and legal issues on their safety.
Regulatory changes can affect custodial wallets in several ways like, if a regulatory authority decides to impose strict guidelines on how these wallets should be operated or mandates reporting requirements on transactions, the costs of compliance could be significant. This could lead to an increase in fees or even force some custodial wallet providers out of business.
Legal issues such as lawsuits or bankruptcies can also impact the safety of custodial wallets.
In the event of a lawsuit or bankruptcy, assets held by the custodial wallet provider could be frozen or seized, leading to loss or restricted access for users. This risk can be reduced by selecting a custodial wallet provider that is well-regulated and financially stable.
Overall, while custodial wallets offer convenience and ease of use, users must be aware of the potential risks and carefully consider the regulatory and legal landscape when selecting a provider.
It’s necessary to do your research, choose a well-regulated and reputable provider, and consider diversifying your cryptocurrency holdings among multiple wallets.
Consider Non-Custodial Wallets as an Alternative
Non-custodial wallets, also known as “self-custody wallets,” are digital wallets in which users store their own private keys.
Private keys are a string of random characters that function as a password to access and manage the cryptocurrency stored in a digital wallet.
With a non-custodial wallet like Coinbase, users have complete control over their private keys and are responsible for securing the wallet and backing up their private keys in case of loss or damage.
These kind of wallets are often preferred by experienced cryptocurrency users who prioritize ownership and decentralization.
Some crypto users use non-custodial wallets as a backup option to hold their cryptocurrency in case their primary custodial wallets get hacked or face other security breaches.
Custodial wallets remain popular among novices in the crypto space, who may not have the technical expertise to secure their assets in a non-custodial wallet.
They may value the convenience and simplicity of using a third-party service provider to manage their assets’ security.
A few of Non-Custodial Wallet providers are,
- MyEtherWallet (MEW) – A web-based wallet that supports Ethereum and ERC-20 tokens.
- Ledger Nano S – A hardware wallet that supports a range of cryptocurrencies, including Bitcoin, Ethereum, and Litecoin.
- Trezor – Another popular hardware wallet that supports multiple cryptocurrencies and offers advanced security features such as two-factor authentication.
- Exodus – A desktop wallet that supports multiple cryptocurrencies and provides a user-friendly interface.
- Atomic Wallet – A multi-currency wallet that supports over 300 cryptocurrencies and provides users with complete control over their private keys.
- Trust Wallet – A mobile wallet that supports both iOS and Android platforms and offers support for a wide range of cryptocurrencies.
- MetaMask – A browser extension wallet that allows users to interact with decentralized applications (dApps) on the Ethereum network.
While custodial wallets may not be the ideal option for some crypto enthusiasts, they still hold a significant advantage for those seeking simplicity, convenience, and security.
By allowing a third-party to hold and manage their assets, these individuals can avoid the risks associated with self-custody while still benefiting from the growth potential of cryptocurrencies.
Whether you choose a custodial wallet or opt for a more hands-on approach, it is essential to understand your unique investment needs and goals.
At the end of the day, the crypto world is constantly evolving, and the best approach is often the one that works best for you. So, do your research, stay informed, and never stop learning – because that’s the key to success in the fast-paced and ever-changing world of cryptocurrencies.