If there is one word that defines the philosophy behind cryptocurrency, it would be “freedom”.
The entire premise of decentralised finance and the crypto tokens that flow through it via the blockchain is the idea that the person who should be in control of their money is the person who owns it, and they have the right to manage their assets however they like.
Taking this control is thankfully much easier than you might expect, and it starts with the crypto wallet app you choose, which serves as the digital tool for holding your tokens and ensuring that you can both send and receive digital currency.
Much like how there are lots of different ways to store fiat currency, from bank accounts to locking it up in a safety deposit box, there are a lot of different wallet types suited for different types of users, different levels of experience and technical knowledge.
These range from a piece of paper with the two wallet keys on them to complex physical pieces of hardware, but the main divide is between custodial and non-custodial wallets.
Both have their uses, but to understand which might be right for your DeFi needs, you need to know the differences between the two.
What Is Crypto Custody?
The important dividing line when it comes to different crypto wallets is the idea of custody, or who ultimately has possession and access to your various blockchain assets.
The design of cryptocurrency since the first Bitcoin whitepaper is based on a simple principle rather famously explained in two sentences by Andreas Antonopoulos.
“Your keys, your crypto” and “Not your keys, not your crypto” are at the core of how crypto works, and are at odds with how, for example, a fiat bank account works, where the ownership of money that is not cash in your hand is somewhat nebulous, as is seen whenever there is a run on the banks.
A custodial wallet works, to a degree, like a bank account system, in that your wallet and keys are in the control of a third-party organisation such as a crypto exchange, who operate the wallet on a user’s behalf and organise transactions through their own interfaces.
This means they get some of the benefits of a centralised financial institution alongside some of the drawbacks.
The big advantage of custodial wallets is that they are very easy to set up and use, being very familiar to anyone who uses a banking app and allowing easier transfers of crypto to fiat currency and vice-versa.
It also has a degree of convenience and peace of mind; if you just want to make a few purchases or investments with crypto and are not interested in the more holistic aspects of decentralised finance, a custodial wallet will generally be an adequate starting point.
There are also the support structures that can come through trusting a larger institution, such as customer service, account recovery if you lose your login credentials and access to certain features like lower transaction fees and trading options, although the latter tends to only be available with custodial wallets tied to an actual exchange.
The big disadvantage comes back to the “not your keys, not your crypto” maxim; you do not have
direct control over your private keys and they are at the mercy of the particular institution that holds them.
This means that the institution has control over your digital assets and there is therefore trust placed on them to ensure that your assets are available as and when you need them.
Cryptocurrency is, by design, a trustless system precisely because the more third parties that are added to a system, the more inherently risky the system is, and there have been cases where exchanges have frozen assets stored in custodial wallets.
The alternative is a non-custodial wallet, which is typically the preferred standard and what many wallet apps will offer.
A non-custodial wallet is different because the private key and recovery seed phrases are kept by the wallet holder themselves, without any need for a third party.
There are quite a few advantages, such as much greater control over your own cryptocurrency, the option to take your wallet completely offline (known as a cold wallet) and the ability to personalise your security and avoid having your assets seized.
The big consequence of this freedom is that it adds responsibility, and whilst you can use a wallet app that makes it easier to store and organise your keys for various wallets and various chains if you lose your private key, you lose any access to your crypto. No keys, no crypto.
In practice, many people use multiple wallets for different purposes, using cold non-custodial wallets for long-term storage of major assets whilst having a custodial or non-custodial hot wallet for making purchases and investments.