Cryptocurrency wallets are important for investors since they enable users to store, send and receive funds. In response to recent events that saw Celsius, FTX and BlockFi go bankrupt, self-custody has become a major talking point.
Storing cryptocurrency into personal wallets that let users control the private keys is a great way to improve security for investors. However, many people still prefer to use exchanges due to the convenience of doing so.
Some people may be asking themselves which storage option is better; centralized exchanges or a decentralized wallet? Security or convenience? The obvious answers are decentralized wallets and security.
However, while exchange wallets and non-custodial wallets may serve different purposes, they still complement each other and can work well together.
How an exchange wallet works
Cryptocurrency exchanges allow users to buy, sell, and trade cryptocurrency. In order to trade on an exchange, users need to deposit fiat currency (to purchase crypto directly) or cryptocurrency (to trade).
Wallets on exchanges are centralized, and users do not control the keys (unless using a decentralized exchange/DEX). However, exchange wallets come with a few benefits.
Firstly, since the wallet is built into the exchange, users can trade straight away without having to deposit any funds or crypto into their accounts. Secondly, exchange wallets tend to deduct transaction fees from the token the user wants to transfer.
For example, a user would typically need Ethereum (ETH) to transfer an ERC-20 token like USDT. This can be cumbersome if the user has no ETH, meaning they must deposit or buy ETH before transferring the USDT.
However, exchange wallets, like those on Binance, deduct the fee from the token. This way, users can transfer tokens quickly and effectively. One drawback to this is that exchanges usually charge a withdrawal fee on top of the transaction fee, which is also deducted from the token balance.
In summary, exchange wallets are built into the platform and deduct transaction fees from the token balance. This makes the transfer process convenient for users, but a withdrawal fee may be built into the transaction fee.
How non-custodial wallets work
Non-custodial or self-custody wallets are personal crypto wallets that let users control the private key and seed phrase. The main benefit of self-custody wallets is that users have access to their funds at all times. There is no need to log into a platform, but security is down to you since you own the wallet.
When a centralized exchange is hacked or goes bankrupt, it's difficult for users to recover their funds, and withdrawals may be disabled. However, with a self-custody wallet, the funds are always under your control, but you need to ensure that your seed phrase is kept offline in a safe place. Another thing to note is that dusting attacks can occur, where malicious actors send very small amounts of crypto to your wallet. These small transactions can contain links to malicious websites in the memo when viewed with a block explorer.
In other cases, custom tokens or NFTs can be sent to personal wallets without the user's permission and contain malicious code. The good news is that you can simply ignore these deposited assets, and you'll be fine. Don't try to transfer or interact with them in any other way, or simply create a new wallet within the app to be extra careful.
The main drawback of self-custody wallets is that transactions can be cumbersome. For example, if a user wants to send USDT to an exchange, they need to log in, get the wallet address and paste it into their self-custody wallet. Users must also ensure they have the right cryptocurrency to pay the transaction fee (ETH if sending USDT on Ethereum and TRX if sending ETH on TRON). Despite this, self-custody wallets are always recommended for security purposes.
Exchange and self-custody wallets work together
The best solution is to have a personal, non-custodial wallet alongside your main exchange wallet. Most of your funds should be kept in your self-custody wallet, and your exchange wallet should contain only the amount you intend to trade with.
Sometimes a problem has more than one right answer, and both exchange and personal wallets can be used together when managing investors' funds.