by Daniel Taylor
April 2023
Each wallet type comes with its own benefits, drawbacks, and trade-offs in terms of security, simplicity, and features. But which is the right wallet for you? And what should you know before selecting a wallet?
Just as there’s more than one cryptocurrency, so too there’s more than one type of cryptocurrency wallet – or ways to store your crypto.
While the number of cryptocurrencies and tokens runs into the thousands, there are just two main kinds of crypto wallet to choose from: custodial and non-custodial, sometimes also referred to as ‘hosted’ vs ‘self-hosted’ respectively.
Each wallet type comes with its own benefits, drawbacks, and trade-offs in terms of security, simplicity, and features. But which is the right wallet for you? And what should you know before selecting a wallet? In this article you’ll discover:
- How crypto wallets work
- The difference between custodial and non-custodial wallets
- The pros and cons of each wallet type
- Considerations when choosing a wallet
- The Zumo solution
How crypto wallets work
Before we dive into the differences between various cryptocurrency wallets, we need to understand some basics about what a cryptocurrency wallet is and how it works.
The term wallet can be a confusing term for people because a cryptocurrency wallet doesn’t actually contain any crypto. A Bitcoin wallet, for instance, doesn’t contain any bitcoin. Instead, what the wallet contains are the digital keys that allow you to send and spend your bitcoin, and prove your ownership of it. In that sense, you can think of a crypto wallet as more of a bank card – something you control that authorises the spending of your money.
Crypto keys operate in pairs: a public key that supplies your external address – the identifier you share publicly to get paid, or to make a payment to someone else; and a private key (to be kept private at all costs!) that acts like the stamp of approval on your transactions.
What a crypto wallet is there to do is to manage all those key pairs for you so that you can store and transact in the cryptocurrencies you want.
For this purpose, a crypto wallet will have a ‘master key’, otherwise known as a seed phrase or backup phrase. A string of words usually 12 or 24 words in length, this backup phrase is the seed that stores all the information needed to recreate all of your keys and recover all of your funds.
Keeping this backup phrase safe is priority number one, as anyone who has access to it has access to all your keys and all your money.
Custodial vs non-custodial: what’s the difference?
With a non-custodial wallet, you control, or ‘self-custody’, the keys and the master back-up phrase of your crypto wallet.
On the one hand, this gives you a high degree of autonomy and control – in fact, about the closest you can get to being your own bank. It doesn’t matter if you delete your wallet application, lose your wallet device or even are cut off from using a certain wallet interface: so long as you keep your ‘master key’ backup phrase safe, you can re-import it in any compatible wallet application and always have personal control over your money on the blockchain.
On the other hand, if you ever lose this phrase and the access to your wallet – or the phrase is somehow compromised – you will not be able to access any of your money associated with that wallet. Just as importantly, anyone who comes into possession of your backup phrase will have 100% equal control over your funds. This is a very different setup to get your head around compared to a traditional account-based system like an email account, where losing the password is not fatal, because you can always ask the email provider to reset it.
It’s also worth bearing in mind that with a non-custodial wallet, all transactions will be signed and executed on the blockchain using your individual wallet’s keys, and so will be subject to blockchain fees. This can be quite cost intensive if you are making a high volume of transactions, or want to send comparatively small amounts.
A custodial wallet aims to remove some of this complexity by taking care of your crypto for you and providing you with a managed account.
For example, a cryptocurrency exchange will give you a wallet address you can use to deposit funds, but it will not provide any corresponding private key. Once your funds are on the platform, the platform provider (or ‘custodian’) will take responsibility for your crypto via its own infrastructure arrangements, and you won’t have to worry about storing backup phrases or any aspect of wallet management.
As with non-custodial storage, this has its pros and cons. On the one hand, you get some of the advantages you’d think of with an ordinary bank account: a large organisation with pooled security resource to look after your funds; fast, cheap transactions and transfers on the platform itself (because transactions don’t necessarily need to take place on the blockchain); and an easy, frictionless experience.
On the other hand, you don’t get the same degree of transparency and ownership because, well, again, think of a bank account. You’re relying on the company that’s hosting the wallet to keep your funds safe, maintain its services and records, and hopefully, give you what you ask for when you want to withdraw it. Because you don’t control the private keys to your digital assets yourself, you should think of your custodial wallet as more of an ‘IOU’ – a promise from the platform to you to pay the amount of crypto it owes to you at the point you want to withdraw it to your own custody. To some people, that’s a big deal; to others it won’t matter at all. Be aware that any cryptocurrency you do entrust to a custodian is not currently protected by regulation; unlike a bank, your deposits will not be covered by the Financial Services Protection Scheme and you will be unable to appeal to the Financial Ombudsman Service if you have a complaint.
The benefits of custodial and non-custodial wallets
Now that you know broadly how each wallet type works, the pros and cons of each should be apparent.
Custodial Wallet Benefits
- Setup is quicker because there are no private keys to store with the user
- Even if you lose access details to your wallet, your funds should be safe because you can always seek support from the custodian who controls the keys
- Someone else takes the burden of responsibility for securely storing your crypto
- No blockchain network fees when you are moving money around within the limits of the custodian’s platform (good for active traders and small amounts)
Custodial Wallet Drawbacks
- You don’t directly own your crypto, and are reliant on the custodian acting diligently to safeguard your funds.
- In the event of a hack or the custodian acting in bad faith (e.g. going into receivership) you could lose your crypto and your access to services
- Custodians may be legally compelled to share data about your crypto holdings with third parties (e.g. government agency), and could be obliged to freeze your assets or otherwise restrict your activity on their platform
Non-Custodial Wallet Benefits
- Highly secure (provided private keys are properly generated and managed)
- You alone own and control your crypto
- Even if you delete the wallet or lose access to the wallet application, you can always regain access using your backup phrase
Non-Custodial Wallet Drawbacks
- You’re 100% responsible for managing your own security, and keeping your backup phrase private and stored in a safe place
- If you lose access to your wallet and backup phrase, or someone else gets possession of it, you lose your crypto
- You have to pay blockchain network fees anytime you want to move your money around (not good for active traders and small amounts)
Some people prefer to entrust their crypto to a custodian that specialises in such matters. Others feel more comfortable with a non-custodial wallet, knowing that the safety and ownership of their funds is in their own hands.
There’s no right or wrong answer as to which wallet type is ‘best’; rather it comes down to personal preference and what you intend to do with your crypto holdings.
The Zumo solution
Following our latest release, Zumo now gives you the freedom to choose for yourself which way (or combination of ways) you want to manage your money.
When you first sign up, you’ll automatically be set up with a ‘Zumo Trade’ wallet. This is Zumo’s custodial wallet and allows you to get up and running with some of the benefits we’ve discussed: quick-and-easy set-up; no headaches about safely storing wallet backup phrases; and frictionless, low-fee trading/send functionality for those who want to be moving in and out of various digital currencies on a more regular basis, or just want an easy way to manage small amounts of crypto. One of the key motivations behind Zumo Trade was to remove the blockchain network fees you pay whenever you execute a transaction on the blockchain. Using your new custodial Zumo Trade wallet, exchanges will no longer have network fees attached and will be cheaper for you than ever before.
Once you’ve familiarised yourself with things, all our customers also have access to set up a Zumo Infinite wallet, which is our companion non-custodial wallet. If you already have a Zumo account, your existing wallet will now become your Zumo Infinite wallet and all funds you access via Zumo will be available here. Zumo Infinite maintains our founding commitment to give you a simple and secure way to hold funds on the blockchain, accessible only by you and, in time, will also act as your portal to access and connect with a variety of decentralised and on-chain applications.
Both your Zumo Trade and your Zumo Infinite wallet (if enabled) will live together in the same familiar Zumo app. From here, you’ll be able to transfer funds between your Trade and Infinite wallets at any time, with the note that Zumo Trade is now where all exchanges are handled, so you’ll need to make sure that appropriate funds are transferred to your Trade wallet if you wish to make an exchange.
We hope this will provide our customers with the best of both worlds: the self-security and ownership of the non-custodial wallet for those who want it; and the zero hassle, transaction cost-effectiveness and flexibility of the custodial wallet for those who don’t.
Conclusion
We recognise that people will have different needs and preferences when it comes to crypto. And hopefully, having read this article you have a better idea of the crypto wallet solution that best suits your needs.
We’re not here to tell you what to do with your money – that you can decide for yourself. What we are here to do is to give you the solutions to make the most of your money whichever option (or combination of options) you choose.
For a beginner-friendly crypto wallet option, and to find out more about the Zumo solution, download our simple app available via the Google Play and Apple App stores.
