In the wake of the recent FTX meltdown, exchanges and platforms hacks, it’s become important to decide where to keep your coins. In a custodial wallet or non-custodial wallet? Let’s find out where is the safest.
A custodial wallet is a digital wallet which you do not have full control over its contents. The provider of such wallet has full control over the wallet as it has the private keys of the wallet. Examples of custodial wallets are those provided by an exchange or a platform. The provider gives you access or limited access to the wallet and can withdraw or withhold the privilege and access anytime, with or without prior notice.
A picture-perfect example would be your PayPal account or wallet. PayPal can choose to freeze or suspend access and withdrawal from the wallet anytime. This makes it impossible for you to use the wallet anytime you want to.
For More Context
A custodial wallet is a type of cryptocurrency wallet where the private keys to the wallet are managed and held by a third party, such as a cryptocurrency exchange or other financial institution. This means that the owner of the wallet does not have direct control over their funds and must trust the custodial provider to handle and secure their cryptocurrency.
Custodial wallets are often used by individuals and institutions who are new to the world of cryptocurrency and are not yet comfortable with managing their own private keys. They can also be used by investors who want to store large amounts of cryptocurrency and want the added security of a third party holding their keys.
One advantage of using a custodial wallet is that the provider typically offers a high level of security, with multiple layers of protection such as cold storage and two-factor authentication. This can provide peace of mind for users who are concerned about the safety of their funds.
However, using a custodial wallet also has some drawbacks. Because the private keys are managed by a third party, users do not have complete control over their funds. This can make it more difficult to access and use your cryptocurrency, and you may be subject to the policies and restrictions of the custodial provider. Additionally, if the provider is hacked or goes out of business, you may lose access to your funds.
Some examples of custodial wallets include:
Cryptocurrency exchanges: Many exchanges, such as Coinbase and Binance, offer custodial wallet services to their users. These wallets are managed by the exchange and the user’s private keys are held by the exchange. This means that the user does not have direct control over their funds and must trust the exchange to handle and secure their cryptocurrency.
Online wallets: These are web-based wallet services that are managed by a third-party provider. The user’s private keys are held by the provider, and the user accesses their wallet through the provider’s website. These wallets are convenient to use, but they are also considered to be less secure than non-custodial wallets, as the user’s funds are vulnerable to potential security threats such as hacking. Examples of online wallets include MyEtherWallet and Blockchain.com Wallet.
Bank accounts: Some banks offer custodial services for cryptocurrency, where the user’s private keys are held by the bank and the user can access their funds through the bank’s online platform. These services are convenient to use, but they are also subject to the bank’s policies and restrictions, and the user must trust the bank to secure their funds.
Brokerage accounts: Some brokerage firms offer custodial services for cryptocurrency, where the user’s private keys are held by the brokerage and the user can access their funds through the brokerage’s online platform. These services are convenient to use, but they are also subject to the brokerage’s policies and restrictions, and the user must trust the brokerage to secure their funds.
Overall, custodial wallets can be a useful tool for those who are new to cryptocurrency and want an added level of security for their funds. However, it is important to carefully research and choose a reputable custodial provider, and to be aware of the potential drawbacks of using a custodial wallet.
In summary all Centralized exchanges offer custodial services with their wallet offerings. When you use them, you trust them with your tokens and coins. In the situation where there is a hack by malicious entities and players, you are at the mercy of the security level of the platform and exchange.
There are cases where it is the platform of exchange that turns rogue, mismanages or embezzles users fund like in the case of the defunct FTX of SBF’s fame. You can easily kiss your funds goodbye in the blink of an eye. This was the case of millions of users who had life savings, capital and peoples investing on the exchange.
There were cases too, of companies and startups who had funds in FTX too, all of them jostling to withdraw their funds and ultimately couldn’t because FTX had pushed the Withdrawal suspension button on them.
If and only if these customers had the understanding that their funds could go to nothing in an event such as the Bank Run that happened with FTX, they would have probably held their fund in a non-custodial wallet.