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What’s the difference between custodial and non-custodial wallets? And why can using a non-custodial wallet save you from losing access to your crypto?
Understanding the different types of crypto wallets is the first step in keeping your coins safe and secure for years to come.
The Coinbase scandal and why it matters
Coinbase created quite the scandal in the crypto community when they admitted that not everyone’s funds are safu. Coming off the back of a nearly half-billion dollar loss in Q1 of 2022, Coinbase announced that if they went bankrupt there’s a chance that customer deposits could be used to pay off debtors.
According to a company announcement, “Because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings, and such customers could be treated as our general unsecured creditors.”
Brian Armstrong, Coinbase’s CEO, quickly released another statement claiming that user deposits are safe and Coinbase isn’t at risk of going bankrupt. However, those are exactly the statements we would expect any CEO to make. Amidst the uncertainty, there are two things we can say for sure.
- Keeping cryptocurrency on an exchange is not as safe as storing money in a bank account. Banks are highly regulated and have FDIC insurance which protects deposits up to $250,000. Crypto exchanges are far less regulated and typically have limited or no insurance for their customers.
- Custodial wallets, like Coinbase’s wallet, are riskier than non-custodial wallets. Why is that? Well, let’s find out!
Custodial wallets
A custodian is a company that holds other institutions’ financial assets. BNY Mellon is the world’s largest custodian and they warehouse a cool $25 trillion worth of assets. Hundreds of other smaller custodians offer a wide range of services, custodianship of everything from US Treasuries to Bitcoin. Custodians live and die by their reputation, and these firms go to great lengths to serve their clients. However, at the end of the day the customer simply trusts that the custodian will allow them to access their money. As we’ll see though, this doesn’t always work out.
Russia had several hundred billion dollars worth of assets in the United States, and then the US Treasury froze that money. Russia lost everything overnight, with little recourse to recover their assets. Whether or not you believe this action was justified, America’s decision to freeze Russia’s assets is a vivid example of why trusting a custodian can be dangerous.
On a smaller scale, people who use PayPal trust that the service will let them withdraw their assets at any time. However, this isn’t always what happens. There are numerous headline examples of PayPal freezing accounts and banning transactions to organizations they deem unfavorable. Therein lies the crux of the custodian problem.
Whether it’s a sovereign state like Russia, or Uncle Roy with his $50 on PayPal, a custodial service controls the customer’s money. People and institutions who deposit their assets with a custodian trust that they’ll be able to get their money back, but this is not guaranteed.
As it relates to crypto, a custodial wallet is one in which a third party controls the cryptocurrency in the wallet. Coinbase is a great example of a custodial wallet. People who keep their crypto on the exchange are trusting that the company will let them withdraw their coins at any time. However, Coinbase has a history of freezing accounts and blocking withdrawals.
Venmo is another example of a custodial wallet. When someone buys crypto from Venmo, they’re sacrificing control of their coins. Venmo can block transactions or even freeze all of the coins in a user’s account. If a custodial wallet provider freezes a user’s account, there is nothing the user can do to override that decision. They must appeal to the custodial wallet provider and hope that the custodian will unlock their account and let them transact again.
One of the core tenants of cryptocurrency is that you can be your own bank. However, for that to happen an investor must ditch the custodial wallet and use a non-custodial wallet like Exodus.
Non-custodial wallets
Admittedly, the phrase “non-custodial” doesn’t automatically evoke a sense of security. Non-custodial isn’t a term that rolls off the tongue, however, the meaning is actually very simple once you understand it. Non-custodial means that there is no custodian; the user is the only person who has access to the funds. You can also think of it as "self-custodial".
For example, although Exodus contains a wallet, the company has zero control over what users do with their money. Exodus cannot freeze the crypto in anyone’s wallet or block transactions; it’s impossible. It’s the difference between shouldn’t and can’t. A custodial wallet provider shouldn’t freeze a user’s account, while a self-custodial wallet like Exodus can’t freeze an account.
When you use a self-custodial wallet you are acting as your own custodian. A self-custodial wallet provides each user with a seed phrase that they should write down and store somewhere safe. If a user loses access to their account, they can restore their funds using the seed phrase. The user is responsible for managing their own account and keeping their crypto safe.
The only way to reap all of the benefits of crypto and “be your own bank” is to keep your crypto in a self-custodial wallet. Only by using a self-custodial wallet can you be sure that no organization will ever freeze your account or block transactions.
Not your keys, not your crypto
Self-custodial wallets require a certain amount of responsibility from the user. You need to write down the seed phrase and keep it safe. There is no other way to get your crypto back, no customer service line or account representative that can restore access or reverse a transaction.
While self-custodial wallets demand a certain amount of planning, the reward is worth it. Cryptocurrency is the first time in history that people can use digital money that’s not controlled by the government or a private corporation. Monetary freedom is a really big deal and it’s one of the reasons that so many people are bullish on digital assets. So make the most of it!
Ready to buy and custody your own Bitcoin? You can buy Bitcoin (BTC) in Exodus using a credit / debit card, bank account, or Apple Pay. For a simple, step-by-step guide on how to buy cryptocurrency in Exodus using Ramp network, head to our knowledge base.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.
