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For anyone thinking of investing in cryptocurrencies, one of the most pressing issues could be how to store your digital assets. Crypto holders mainly use non-custodial wallets or custodial exchange wallets. The two are different and have unique features, advantages, and disadvantages.
What is a Crypto Wallet?
A crypto wallet is a program of software used to store, send, and receive cryptocurrencies. The wallet also allows the user to perform and track transactions on the blockchain using private cryptographic keys.
Decentralized wallets exist in form of mobile apps and physical devices that allow crypto holders to have full control over their assets. Storing your coins in the best crypto wallets is highly recommended to keep them safe and secure.
What are Cryptocurrency Exchanges?
While wallets and exchanges may have almost the same types of roles, the two are different. Compared to a wallet where the asset holder has full control of the funds, a cryptocurrency exchange is a website or service where users convert/exchange or buy and sell crypto.
Some exchanges have integrated wallets where users transfer their cryptocurrencies after buying them. This, users do not need to install or manage their own wallet programs. In this case, cryptocurrencies exchanges function similarly to traditional banks by holding funds on behalf of users and allowing them access to the funds. The only difference between banks and cryptocurrency exchanges is the level of regulation involved.
Key Terms to Note
Before diving deeper into the differences of storing cryptos in wallets versus exchanges lets define three basic terms;
- Private Keys; they are secret random digits attached to a certain cryptocurrency balance. It is these keys that the account holder uses to manage the funds. Whoever gets access to these keys also gains access to the funds associated with the account.
- Custodial wallet; Funds in a custodial wallet are secured by a custodian or a third-party entity that holds funds on behalf of its users. It is the custodian that holds the private keys.
- Non-custodian wallet; Funds deposited in non-custodial wallets are secured by the original owner. They are also called decentralized wallets and it is only the asset owner that knows and has access to private keys.
Storing Crypto on an Exchange
Funds deposited in exchanges are stored in custodial wallets with the exchange in charge of private keys while it allows funds owners to access their money in the central wallet.
When to Store in an Exchange?
Storing cryptos in an exchange can be convenient for those who regularly trade on the exchange. Additionally, exchanges work well for new and inexperienced traders who only want an account and a password as opposed to memorizing and securing long private keys.
However, there are serious risks associated with storing cryptos in exchanges. Being public platforms, exchanges may sometimes attract bad actors who may hack or steal funds stored in central wallets. These central wallets are especially a big target from malicious actors due to the large sum of money they store. They are not recommended for long-term storage.
Storing Crypto in a Decentralized Wallet
As earlier indicated, decentralized or non-custodial wallets come in form of apps and devices that allow crypto holders to have full control over their funds. Users of these wallets are assigned a private key, which they need to memorize and keep safely. Anyone who accesses the private keys also accesses the funds stored in the associated wallet.
Risks for a Non-Custodial Wallet
Non-custodial wallets are generally safe and less prone to hacking. You can only lose your money in non-custodial wallets under two circumstances;
- When you lose or forget your private key.
- When someone with bad intentions gains access to your private keys.
A bad actor can access your private keys by using malware to hack the system or physically viewing your private key.
Another potential risk with a non-custodial wallet may come when you digitally store your private keys as it exposes them to malware. However, unless when stored digitally, it is harder for hack to hack into the crypto exchange and also gain access to your private wallet. This makes non-custodial wallets generally safer compared to exchanges.
When to Store in a Non-Custodial Wallet?
Due to the level of security, non-custodial wallets are usually recommended as the default storage solution for long-term storage or for large amounts of funds. In addition, non-custodial wallets support multiple assets and users can access other decentralized apps within the wallets themselves.
You can only opt to store your funds in an exchange if you are certain of the security of your money or if it is more economical and convenient.
The Security of Private Keys
The security of a non-custodial wallet largely depends on how well the user can secure private keys. Even if you lose a phone with your wallet on it, no one can access your funds unless they have private keys.
The only way hackers can access your funds without using your private key is by executing a Brute force attack, which involves using a series of computers to guess the private keys. This is hard considering each complete private key is made up of a series of keys so large that even computers find it hard to guess.
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