The first time I heard someone use the terms custodial and non-custodial, I thought they were referring to the janitors who come clean our office building in the evenings. It was promptly pointed out that the word I was thinking of was custodian and maybe I should take a moment to revisit my bitcoin vocabulary worksheet.
Having done just that, I can safely say that I’m prepared to discuss what the differences between custodial and non-custodial cryptocurrency exchanges are, and specifically how these differences relate to buying and owning bitcoin.
What is a custodial exchange?
The word custodial originates from the early 17th century from the Latin word custodia which has a double meaning of both custody and protection. The word custodia indicates both possession and responsibility.
This makes perfect sense when applied to a cryptocurrency exchange, a business that offers customers the ability to buy and sell bitcoin, and possibly other digital currencies. A custodial cryptocurrency exchange holds onto a customer’s bitcoin and the private key associated with the customer’s digital wallet.
In other words, a custodial exchange keeps possession of your bitcoin, and is responsible for the safe use of your private key when you buy or use your bitcoin. This is not unlike a traditional banking model where the bank holds your money and is responsible for moving it when you pay bills or transfer funds to other accounts.
What is a non-custodial exchange?
As you would expect, a non-custodial cryptocurrency exchange does not hold its customers’ bitcoin and does not store their private keys. When you purchase bitcoin from a non-custodial exchange, it gets transferred to your digital wallet and you are responsible for keeping both your bitcoin and your wallet’s private key safe and secure.
A non-custodial exchange is similar to taking physical cash out of your account and keeping it in your wallet or purse. Once you take possession of your currency, you have total control over its storage and use, and total responsibility for keeping it safe.
Advantages and disadvantages
So what are the key advantages and disadvantages of custodial and non-custodial bitcoin exchanges?
A custodial exchange takes responsibility for holding your bitcoin and keeping your private key secure. This arrangement provides greater convenience, but it also presents a major disadvantage: risk. The safe storage of your bitcoin is completely reliant on the security precautions the exchange has put in place.
Further, custodial exchanges typically do not provide insurance covering any loss of the bitcoin it holds for its customers. If the exchange’s security is breached and your bitcoin is stolen, the theft will likely not be covered by insurance and your bitcoin will be lost.
A CNBC article from August 2021 describes how customers had thousands of dollars in bitcoin stolen from custodial exchange accounts, with no form of recourse offered by the exchange. Another infamous incident is the Mt. Gox theft where over 600K bitcoin held by the Mt. Gox exchange were stolen over a two-year period.
Another disadvantage of using a custodial exchange is the potential threat of government interference with your account. For example, the recent war in the Ukraine has led some governments to prevent cryptocurrency transactions from custodial exchanges in a number of regions.
What about a non-custodial exchange? The chief advantage of a non-custodial exchange is the customer has total control over their bitcoin and the private key for their digital wallet. This gives the customer the autonomy to buy, store, and use their bitcoin as they wish, without interference from the government or a law enforcement agency.
But, as any amazing Spider-Man can tell you, “with great power comes great responsibility.” The integrity of your digital wallet and its contents is entirely in your hands. If you ever need to restore your digital wallet but you don’t have a backup of your private key or your recovery seed phrase, the bitcoin in that wallet could be lost forever.
Which exchange is better?
The key issue of custodial vs. non-custodial exchanges circles back to the dual-meaning of the word custodia: custody and protection. Or put another way, ownership and responsibility.
In the previous century, our relationship with money was largely based on having physical cash in our pockets. This was no different from how most people owned items like books, music, and movies—as physical objects they bought and kept in their possession.
The shift from analog to digital property, combined with the proliferation of cloud services and mobile computing, resulted in the transfer of ownership and responsibility of much of what we purchase to businesses and their massive datacentres.
We rely on companies to keep track of the digital assets we purchase, and to provide secure and on-demand access to these assets. In this regard, many modern companies are custodial vendors. These businesses maintain ownership and responsibility over your digital purchases, while providing a convenient and reliable means through which to access and use them.
Most people today have this same relationship with their money. They rely on banks to safely hold their money and provide ready access to it when desired. Banks are custodial vendors that primarily offer digital currency services.
The question is: does this same custodial vendor model make sense for bitcoin?
How to own your money
At Bitcoin Well, we believe that bitcoin can give people full ownership and responsibility over their money. We see bitcoin as a viable alternative to giving your money to a bank and then paying them so you can use it under the terms and conditions they impose.
Put another way: your money should not be like a streaming service for music or movies. You should own your money and have full control and responsibility for it. This idea of financial independence is one of the guiding principles of bitcoin.
This is why Bitcoin Well is a non-custodial bitcoin vendor. We think you should have ownership of your bitcoin, and should also have responsibility for keeping your digital wallet and its contents secure.
There is a tradeoff between ownership and convenience when it comes to using a non-custodial bitcoin exchange. We don’t view this as a bad thing. Bitcoin ownership is meant to change the value proposition around how you keep and use your money, while challenging the traditional money system and how it is configured to compromise your total net worth.
Our online Bitcoin Academy and Bitcoin for Beginners sessions can teach you all about what bitcoin is and how it can be a part of your financial life. For more information, visit https://bitcoinwell.com/learn/