A custodial wallet is a crypto wallet that does not give the user the right to self-custody i.e., the exchange or the wallet provider controls the private keys.
These are basically exchange wallets that you get with crypto exchange accounts like Binance or OKX. However, non-exchange custodial wallets also exist like Satoshi Wallet.
How Custodial Wallets Work?
Custodial wallets also rely on a cryptographic algorithm to generate public and private keys. Public keys can be shared with others to receive crypto while private keys are used to access your crypto on the blockchain.
However, in this case, the exchange retains the private keys but allows you the added benefit of recovering crypto wallets even if you forget the password, which is not present in non-custodial wallets.
Fun Trivia: A cryptocurrency never leaves the blockchain. It is the private keys that you store in your wallet.
Types
Exchange Wallets
These wallets are those that come with an exchange and are embedded inside the exchange account. You can obtain the public keys to these wallets but not the private keys.
Non-Exchange Wallet
There are many non-custodial wallets that operate independently. I have been using one such wallet since 2021, i.e., the Wallet of Satoshi.
Advantages
Password Recovery
You can easily recover your password or restore your wallet with just a simple email-based or social recovery option.
This feature is soon expected to be introduced with non-custodial wallets too (via account abstraction) but has not been done yet.
Easy to Use
These wallets are created for beginners and provide better safety when interacting with unknown sites or dapps.
Disadvantages
Censorship
Custodial wallet user’s worst nightmare is censorship. Since wallet providers are mostly exchanges and regulated apps on the Apple App Store or Google Play Store, they are prone to get censored by governments or app providers.
In such cases, users might lose access to all their funds with or without notice.
This is why PayPal was criticized after the launch of PYUSD.
In another incident, Indian crypto exchanges were sanctioned from 2018 to 2020 and users received an ultimatum to sell their crypto or lose them forever. I too had to sell crypto when the markets rallied the most in these years.
