Non-custodial Exchange vs Custodian Exchange: Benefits and Weaknesses

Non-custodial Exchange vs Custodian Exchange: Benefits and Weaknesses

Last Updated on April 29, 2022 by Opeyemi Quadri

Different types of exchanges exist in the cryptocurrency world, with different features and functionalities. We have those that can be regarded as “custodial exchanges”.

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These platforms, which are also known as centralized exchanges, were structured to have control over the assets of their users. Usually, such platforms have in place KYC guidelines that their users must appropriately satisfy before they can be enabled to trade or conduct other transactions. Popular custodial exchanges out there includes Binance and Coinbase.

On the other hand, there are “Non-custodial Exchanges”. These are also known as decentralized exchanges, and they permit their users to trade and carry out other transactions without being controlled by the type of structures found in centralized exchanges.

This is usually possible through the usage of the peer to peer features available, which eradicates the need for KYC. A major example of a popular non-custodial exchange out there is Whalesheaven.

Difference Between Custodial and Non-Custodial Exchanges

A major distinction between custodial exchanges and non-custodial exchanges is that users using the latter cannot store their tokens on the platform. The users hold their digital coins in their personal wallets, as the exchange doesn’t have custody of any cryptocurrency.

The exchange however enables users to link the interface of their wallet to their own platform whenever they want to engage the market to either buy or sell cryptocurrencies.

What is a Non-custodial Exchange?

There are different ways people use the expressions “custodial” and “non-custodial”. However, when it comes to crypto, these things point to platforms that enable people to trade digital currencies, and we start talking about a wallet to house digital assets too.

Now, there are also custodial wallets and non-custodial wallets. In the latter category, users have full control over their private keys. This means it has been made in a way that no other person can access their keys. They are the only ones with access, and they don’t need any third party to control or access their private keys.

From the above, you should discover already that users towing the non-custodial path must ensure their private keys don’t get missing. Private keys must be well protected and kept in a safe place.

They are responsible for the safety of their keys and wallet and are usually admonished to take further smart steps as far as security is concerned, to enable them to keep their funds very safe.

Due to the control it brings, it is usually seeing many large-volume traders prefer non-custodial exchanges and wallets over the other category types.

Also, it should be noted that when creating a non-custodial wallet, you have the chance to add a password that is known to you only, and you should ensure it’s one that can’t be easily guessed by others.

Non-custodial wallets can be in different types, and you can go for whichever format you are comfortable with. Let’s explore the different types of non-custodial wallets we’ve got out there.

Hardware Wallets

These wallets are physical and tangible devices that are made to store information up to its disk size. They are usually recommended for folks dealing with a very huge amount of crypto. Users of these sorts of wallets can easily gain access through the usual username and password.

Web-Based Wallets

These wallets are pretty popular and preferable by several users in different places around the globe. They can easily access their wallets with a smartphone or laptop (or any other appropriate device) with an internet connection, and it doesn’t matter where they are in the world. Users of web-based wallets will require a private key to log in.

Mobile Wallets

There are innovative apps that allow users to create a wallet and enable them to transfer assets to other wallets without delay. These non-custodial wallets are solely the responsibility of their users.

Having explained the types of non-custodial wallets out there, it should also be added that you can easily link your non-custodial wallets with a non-custodial exchange for crypto transactions without unnecessary limitations and restrictions.

There are no centralized bodies that will intervene in the way you have decided to do your thing while trading. Decentralized exchanges allow different users to trade using peer to peer networks, as much as they desire.

If you are particular about trading anonymously, this is something you can jump on to carry out your transactions. There are no need for KYC and the likes, hence you are not really known.

It is understandable if you want to trade without having to upload your personal documents on a platform where your identity will be known to those controlling the operations of the platform. This is one crucial hedge non-custodial exchanges have over the other ones.

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 Non-custodial Exchange vs Custodial Exchange

We must admit that there are more crypto users using custodial exchanges than non-custodial exchanges. Hence, the likes of Binance, Paxful, LocalBitcoins, Remitano which are custodial exchanges are more popular in the cryptocurrency world.

These are established platforms that have been consistent with ensuring the security of wallets and keys of their users.

Why Custodian Exchanges Have More Users

There are several reasons many users are usually interested in custodial exchanges. These include:

Easy-to-use User Interface (a big selling point, assuring newbies that they won’t encounter difficulties using the platform).

Superb features that fascinate different classes of crypto traders. For instance, it is possible to leave your digital assets in a savings account and it grows with interest.

Disadvantage:

Custodian exchange platforms have their disadvantages too.

Third-party risk:

There are cases where people lose their digital assets due to an error from the platform. There are cases where wrong or fraudulent transactions were executed.

Fraud and scams happen more on custodian exchange, that’s one of the reasons such platforms advocate the use of two-factor authentication.

Lack of anonymity

We should also consider the lack of anonymity attached to these platforms since users must adhere to Know Your Customer guidelines before they can be permitted and enabled to carry out transactions. Additionally, custodial exchanges basically allow trading with listed coins.

Benefits of Non-custodian

On the other hand, if we are going to discuss the edge that non-custodial exchanges have over their counterparts.

Anonymity

Now, this may not be a big deal to you, but it is to several others. You don’t have to encounter anything related to KYC if using non-custodial exchanges, hence your identity is secured, and you can trade anonymously.

Less Third-Party Risk

Additionally, it should be added that non-custodial exchanges come with less 3rd party risk, since you are in charge of your digital coins, and no other party have custody of your assets.

Of course, you should ensure you only patronize non-custodial wallets made by firms with a great reputation.

This is because, the provider of a non-custodial wallet can place malicious code in your app, and your assets could eventually be wiped.

Freedom of P2P transactions

Still talking about benefits attached to non-custodial exchanges, we should also emphasize the freedom of P2P transactions. You can get coins that are unlisted if you desire since you are dealing directly with another user who has them.

But then, just as custodial exchanges have disadvantages, non-custodial exchanges also come with downsides.

Weaknesses

First, it is a disaster if you forget your passport. There are several people with millions of digital assets in their wallets but they ended up losing them all because they couldn’t remember the password of their wallets.

This factor is one of the prominent reasons many users are uncomfortable with custodial exchanges since the platforms can always help them recover their password if they forget what it is. Therefore, if you are going to be using non-custodial exchanges, ensure you don’t forget your password.

However, we can’t ignore the fact that non-custodial exchanges are still keeping the crypto sector decentralized – which is its primary identity.

Verdict

Of course, we can’t also ignore the fact that currently, crypto is tilting towards the centralized model, as many people are comfortable with platforms like Binance due to their impressive features. However, it is necessary that cryptocurrency trading should remain decentralized too, and non-custodial exchanges are helping to ensure this.

Nevertheless, since your assets belong to you, you can always settle for whichever you feel more comfortable with – be it a custodial or non-custodial exchange.

Custodial platforms are very easy and straightforward to use, and there are many things you can do with your assets. On the other hand, non-custodial exchanges allow you to buy digital currencies directly and have control over your stuff. You can also buy unlisted crypto coins and trade anonymously.

Non-custodian is good for pro and crypto traders who can learn faster. While custodian exchange is can be used by newbies.

Recap:

Using non-custodial exchanges to trade cryptocurrency minimizes 3rd party risk for you, which is something that is a big concern for custodial platforms. There have been cases where custodial exchanges were hacked and many traders lost their digital investments (although the big platforms may end up refunding a part of the crypto stolen, or even all of it).

Nevertheless, you don’t come across such when you use non-custodial exchanges, since assets won’t be stored in a centralized portal but in your own personal non-custodial wallet known to just you.

Users are however expected to own a wallet directly on the blockchain network or a wallet that they can access from a non-custodial platform.

Above all, Non-custodian exchanges are the through the definition of what bitcoin and cryptocurrencies were designed to achieve: complete anonymity.

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