The Oxford dictionary description for custody is as follows:
custody; noun: The protective care or guardianship of someone or something.
Custodial wallets are products and services that hold your cryptocurrency in trust, and let you access it. Non-custodial wallets, however, let you control your own bitcoin, ethereum or other crypto solely as a tool, leaving full control of the funds in your own hands. While using a custodial wallet or exchange looks similar to using a regular bank account, using a non-custodial wallet is more like using a tool to send, receive and make use of your own funds solely without contacting any other party: Without logins, passwords.
Some people call non-custodial wallets ‘decentralized wallets’, as controlling your own funds aligns with the spirit of decentralized power of decision making. However, the term ‘decentralized’ is correctly used in the context of blockchains, the underlying technology that wallets provide access to.
What are custodial wallets?
Now, let’s take a look at custodial wallets.
There are two categories of companies that offer custody of cryptocurrency: Crypto exchanges and custodial wallet apps or websites.
Often simply called ‘wallets’, custodial wallet services are companies that store your private keys on their own servers.
The main advantage of custodial wallets is that they might be able to recover your wallet in case of lost passwords.
If, however, a custody service loses your funds or gets them stolen, the company won’t be able to recover those by themselves.
Sadly, later happens more often than we would like: Alone in 2018, $856 million worth of crypto has been stolen from exchanges. While this allows for hacks, custodial wallets might also simply lose your money, or freeze your accounts.
What are non-custodial wallets?
While custodial wallets and exchange accounts hold your crypto in their own accounts, non-custodial wallets give you full control over your funds.
For example: imToken is a non-custodial wallet app. Opening it the first time will ask you to backup your secret Mnemonic phrase (which is similar to the private key), allowing you to restore your crypto account with any wallet at any time. Therefore, you stay in full control of your own account.
How do non-custodial wallets work under the hood?
Your private keys - the keys that proof ownership of your crypto address on the blockchain - are encrypted and securely stored on your device, and never leave it.
As you are in full control of this private keys, you are also in full control over your money.
However, the great possibility of owning control over your own funds, means that you need to take great care of your private key. If you lose it, you will never be able to restore access to your funds.
For example, in case you lose your phone or if you delete the app, you will be able to recover the access only with your private key (or ‘seed phrase’ or ‘Mnemonic seed’).
Learn more about what Mnemonic seed phrase and private keys are here.
How to securely store your private key and Mnemonic seed phrase?
Please backup your Mnemonic and private key in a secure place. A secure place is not accessible from the internet, maybe on a piece of paper. If you want to store a backup on a computer, then make sure that the key is encrypted with a password, and better not connected to the internet.