Every year, more people are learning about digital currency and attempting to find a wallet for these cryptocurrencies. Many individuals choose to keep their crypto assets in custodial wallets. What these wallets are, what their benefits and drawbacks are, etc. - we will discuss each of these topics in depth.
What is a custodial wallet?
A custodial cryptocurrency wallet is a form of digital wallet that involves a third-party service provider that holds users private keys on their behalf. Private keys are secret codes that allow users to access and manage their cryptocurrencies.
Custodial wallets are considered to be highly trustworthy and one of the most secure because if you lose access to your account, or it is hacked, you can contact the service provider to have access to your funds.
Additionally, custodial wallets include:
- the safe storage of cryptocurrencies;
- easy access to your money via a simple interface;
- integration with multiple cryptocurrencies;
- 2FA, which provides additional security, is available as an option.
- Instant transactions in the wallet;
- customer support for issues or questions that may arise, etc.
Advantages and disadvantages of a custodial wallet
Advantages:
✅ Increased safety.
Custodial wallets typically implement multiple effective security protocols to safeguard their funds, including:
1. Encryption. These can be private keys and login data. They facilitate the prevention of unauthorized access to the wallet and its contents.
2. Cold storage. Providers keep funds in cold storage, which means that they are stored offline in a safe location that isn't connected to the internet, which makes it harder to hack them.
3. 2FA. To enhance the security of their accounts, custodial wallets encourage users to enable two-factor authentication (2FA) while logging in and making transactions.
✅ User-friendly experience.
Custodial wallets are characterized by:
1. Clear interface. Easy-to-use interfaces facilitate the viewing of the balances, conducting transactions and altering the settings.
2. Integration with other platforms. Some custodial wallets have additional integration with other platforms (e.g. Binance), which facilitates the purchase and sale of cryptocurrencies or the exchange of these for other assets.
3. Mobility. Users can manage their money via apps for mobile devices.
✅ Backup and recovery.
Some of the common mechanisms for backup and recovery that are offered by wallets include:
1. Phrases/words that allow you to regain access to your wallet. It's vital to keep these words in a secure location, anyone who has access to them can also take possession of the wallet.
2. Back up data to an email. This can guarantee access to one's wallet information, even if their device is lost or stolen.
✅ Customer support.
The most common services for customer support that are offered by wallet providers include:
- assistance via email (users request assistance via email and receive a response from a representative of the support service).
- online chat (the user communicates with the support service representative directly);
- knowledge base (a section that contains information that can answer the majority of common questions).
Disadvantages:
❌ Limited control.
Users of custodial wallets don't have direct control over their finances, as the service provider has the capacity to access and manage their finances on their behalf. While this may facilitate some practical benefits and security, it also implies that users are dependent on the provider to act in their best interests and safeguard their funds.
❌ Counterparty risk.
The service provider may be hacked or become bankrupt, which would lead to the loss of user funds. To minimize the risk associated with this, it's crucial to choose a trustworthy custodial wallet provider that implements strong security protocols.
❌ Service provider dependency.
When utilizing a custodial wallet, users are dependent on the service provider to store funds along with their terms and conditions. If the policies are altered, users may not have access to their funds or may be subject to additional fees or regulations.
❌ Privacy concerns.
Custodial wallets are often necessitated by access to personal information and KYC (Know Your Customer) and AML (Anti-Money Laundering) procedures, which may lead to privacy concerns for some users. Despite the necessity of these procedures to prevent illegal behaviour, users who value their privacy may perceive them as intrusive or suspicious.
Conclusion
Custodial wallets have benefits, including additional security measures and ease of use, but they also have risks, like the potential for harm from third parties, dependency on providers of service, and privacy concerns.
In instances where the option is between a custodial wallet and a non-custodial wallet, users should consider their personal preferences and the potential dangers of either wallet. It's also essential to choose a trustworthy provider with a solid security and privacy policy.
