Why Non-Custodial Wallets Matter
When holding bitcoin, there are both custodial and non-custodial wallet solutions. A custodial wallet is a cryptocurrency bank account. The custodial wallet service is holding the user’s private keys and protecting them in the manner they deem most effective — a model that has faltered many times from a security standpoint.
This model results in a large pool of value being held in one central location. However, unlike the traditional banking system, cryptocurrency transactions are irreversible and, to a large degree, anonymous. The combination of these factors creates strong incentives for malicious actors to commit a digital bank robbery.
In order to protect funds in a custodial solution, a large amount of funds must be held in “cold storage”. This means the private keys are protected from a digital attack. However, in order for funds to be sent over the Bitcoin network, the funds need to be held in a “hot wallet”.
This creates a paradox for the custodial solution — funds need to be held in a hot wallet in order for account holders to have the ability to transact, yet they need to be held in cold storage for security purposes. As the custodial user base grows, more funds have to be held in the hot wallet, thus increasing the incentives for a malicious attacker.
If funds continue to be held in cold storage, rather than available in a hot wallet, users begin to see performance deficiencies. The custodial solution has to first release the funds from cold storage, then send the funds on the account holder’s behalf. Because of this, users see exponentially increasing time delays in their transactions being processed.
Alternatively, non-custodial solutions push security to the edges of the network, on the individual devices of users. This solution eliminates a central point of attack, increasing both security and unobstructed usability.