Custodial is a term commonly used in the context of cryptocurrency wallets or exchanges. It refers to a setup where the service provider holds the necessary private keys to access a customer’s funds, while also offering a login account.
One of the defining features of cryptocurrencies is that the owners always have complete control over their funds. Each public address is linked to a private key that is known only to the owner, ensuring that no unauthorized access can occur.
While some cryptocurrency users prefer to manage their own keys, others may find it more convenient to opt for a custodial setup. Custodial wallets cater to these users by allowing them to delegate the management of their private keys and access their funds through a simple login-password system.
Centralized cryptocurrency exchanges also commonly offer custodial services. These exchanges enable customers to deposit their cryptocurrency funds into an exchange account and trade them for other cryptocurrencies or fiat currencies. The trades are recorded on the exchange’s internal balance sheet rather than directly on the blockchain. Throughout this process, the customers’ funds are held in custody by the exchange until they are withdrawn.
While custodial services offer user-friendly and efficient solutions, they do come with certain risks. The concentration of a large number of customers’ funds in one place makes custodial services an attractive target for hackers, government censorship, and hardware malfunctions.