In cryptocurrency wallets or exchanges, a custodial setup refers to a system where the service provider holds the private keys necessary to access a customer’s funds while offering a login account.
Private Key Ownership
One of the fundamental aspects of cryptocurrencies is that they remain under the complete control of their owners.
Each public address is associated with a unique private key known only to the owner, enabling them to access and manage the funds stored in that address.
While self-management of private keys is a key feature and advantage for some cryptocurrency users, others may find the responsibility and complexity of securely managing their keys outweigh the benefits of maintaining full control over their funds.
In such cases, custodial wallets are available, where the service provider manages the user’s private keys, allowing access to funds through a simple login-password mechanism.
Custodial Services for Seamless Crypto Trading
Centralized cryptocurrency exchanges are another form of custodial service.
These platforms enable users to deposit their cryptocurrency funds into an exchange account and trade them for other cryptocurrencies or fiat currencies.
Internal Exchange Ledger and Fund Custody
The exchange records these trades on its internal balance sheet rather than directly on the blockchain.
During the process, the customer’s funds remain in custody from the moment of deposit until they are withdrawn from the exchange.
Custodial Service Risks
While custodial services are user-friendly and efficient, they come with certain risks.
By storing many customers’ funds in one location, custodial services become attractive targets for hackers, government interventions, or even hardware failures that could result in the loss of funds.