Choosing a crypto wallet: Custodial vs Non-custodial crypto wallets

As an extension of the crypto and blockchain-related articles, today’s topic is about how you can store cryptocurrencies that you own.
Crypto wallets come in two forms – custodial solutions where third parties such as exchanges have control over your cryptocurrencies; and non-custodial solutions where you have control your cryptocurrencies.
Let’s take a step back to understand the bigger picture.
Cryptocurrencies are a radically new form of technology where your assets are stored on the blockchain instead of in an account (e.g. bank account, custodial account) somewhere.
Crypto wallets are just the front-end (i.e. user interface) to interact with the blockchain.

Introduction to the Blockchain

In a traditional ownership model, when you own something, you can prove it either by…
  • Physically owning it (e.g. your cash in your wallet)
  • Legally owning it (e.g. your property)
  • or some other form of ownership like voting control
If you store your assets with a third party – let’s say a bank – then you legally own the assets through some form of contractual agreement, and on the bank’s books, your assets are their liabilities – which represent an obligation on their end to pay you back.
When you initiate transactions, the banks sends the funds through a settlement layer, for example, in Singapore we use GIRO, MEPS+, SWIFT or FAST for inter-bank transfers, a centralized party like the MAS clears the transactions (usually by Real-Time Gross Settlement).
However, on the blockchain, where no single entity holds your assets and the entire settlement layer is decentralized, proving ownership and making transactions with your crypto assets is through something called private keys.

What are private keys

Private keys are simply a series of private alphanumeric code that is mathematically paired to a public key – this is a core concept of asymmetric cryptography or public-key cryptography.
Cryptography is just the process of encrypting and decrypting information.
When it comes to blockchains and cryptocurrencies, you use your private key to digitally sign transactions.
This private key is paired with a corresponding public key – your public blockchain address – which you share freely with others.
 
How a private key and public crypto address is related

Private keys and public keys on the blockchain

A blockchain is a digital network that operates on top of the Internet.
On the blockchain, information, transactions or assets can move without an intermediary like a bank, a tech company like Facebook, or a clearing network like Visa.
In fact, no single party holds control in this decentralized network, hence the security of transactions on the blockchain takes a unique form.
Public keys are hashed into an alphanumeric address – which is a piece of information used to share with others on the network. For example, you can use this address to allow others to route assets to you – this is your public identity on the blockchain.
On the other side, there’s a corresponding private key to your public key, which is a highly secure, randomly generated alphanumeric code that proves that you’re the owner of that particular public key.
Together, private and public keys are used to transact, prove ownership, and access assets on the blockchain.
Losing your private keys means losing access to your funds associated with that public key.

Signing and making transactions on the blockchain with a wallet

If you want to send someone else a cryptocurrency on the blockchain, you need an interface to make transactions – this usually comes in the form of a software or hardware wallet, but other methods like the command line interface exist too.
For example, on the Ethereum blockchain, there are several popular software wallets like Trust Wallet that can help you interface with the Ethereum network.
A software wallet is usually a downloadable program or app linked to the Internet, while more convenient to make transactions, is still susceptible to a virus or malware attack.
There are also hardware wallets like the Ledger and Trezor wallet which allow the private keys to be stored even more securely on a physical hardware device – although they are more secure, they are very inconvenient to use.