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Can you compare custodial vs non-custodial crypto wallets?

An overview of the large wallet players: Metamask, Rainbow, Phantom, Coinbase etc 1. How does the feature set of custodial vs non-custodial compare? 2. User growth of each 3. Trends

Rohit Kaul

Research at Sacra

A crypto wallet is an app or a physical device that allows users to store, send and receive their crypto assets. It consists of a key pair: A public key that’s the digital address of the wallet to send/receive crypto and a private key that’s like a password to access the wallet. There are two types of wallets, depending on who manages the private key.

  • Custodial wallets (aka hosted wallets) where the company offering the wallet manages the private key.
  • Non-custodial (aka self-custodial) wallets where the user controls the private key and the platform can’t access their crypto assets. 

Custodial wallets

These are the most convenient way to set up crypto wallets, predominantly used by new crypto users. When you buy crypto using an exchange, the crypto is automatically stored in a custodial wallet. The main benefit is that the wallet provider manages the private key behind the scenes. So you don’t have to worry about getting locked out of your crypto if you can’t remember it.

The key drawback is that the custody of your crypto is with the wallet provider. So you can be deplatformed and lose access to your crypto. Moreover, your crypto’s security depends entirely on the security measures taken by the wallet provider. Custodial wallets can’t access many crypto applications such as NFT marketplaces, play-to-earn games, and tokenized social media. 

Custodial wallets make money by charging a transaction fee, which could be a spread on buying or selling transactions. 

Non-custodial wallets

For non-custodial wallets, you are responsible for managing and keeping the private key safe. The obvious benefits are that these wallets are more secure and allow you to move your crypto to any wallet provider using your private key.

The key drawback is that if you lose the private key, the wallet provider cannot reset it for you, and there’s no way to access your crypto. These wallets allow you to access more crypto applications such as staking, purchasing NFTs, and play-to-earn games. 

Non-custodial wallets can be web applications, desktop/mobile applications, or a physical device such as a pen drive.

Non-custodial wallets make money by charging a transaction fee on crypto swaps when one crypto is exchanged for another. Hardware wallets charge separately for the physical device.

Some tailwinds support the sustained growth of custodial wallets.

Crypto exchanges drive custodial wallets’ growth

Crypto exchanges such as Coinbase, FTX, and Binance are growing rapidly as many new users get into the crypto ecosystem to make money by buying and selling crypto. Coinbase exchange’s user accounts grew 2X in 2021 to reach 89M. FTX’s user base grew 15X in 2021 to reach 5M. 

Familiar user experience

Custodial wallets are popular because they make buying and selling crypto convenient, with user experience similar to a digital bank. In comparison, new users find the UX of non-custodial wallets complex. For instance, the onboarding process prompts them to save and not lose the 12-word private key, which is unnerving. An email address or a phone number is insufficient for signing up for a non-custodial wallet. 

Lower fees

Some custodial wallets offer free on-platform transactions by not registering them on the blockchain. For instance, users of Freewallet (custodial) saved $500,000 in one year for inter-Freewallet transactions. This is not possible for non-custodial wallets. 

Non-custodial wallets are gaining traction, driven by these tailwinds.

Gateway to decentralized apps

Decentralized apps (dapps) such as NFT marketplaces, play-to-earn games, and tokenized social networks have become popular in the last 2 years. Dapps connect with non-custodial wallets to authenticate users and use the stored crypto for transactions. For instance, users store earned crypto from Axie Infinity (a play-to-earn game) in their wallet, use it to buy NFT on OpenSea (NFT marketplace), and keep the NFT safe in their wallets. Thus, the wallets become the hub for using dapps.

Browser extensions and mobile apps

The availability of non-custodial wallets as browser extensions and mobile apps is helping their growth. MetaMask’s MAU grew 6X in just 12 months to reach 32M in April 2022. In just six months, another non-custodial wallet Phantom grew from no users to 2M MAU. Large exchanges such as Binance and Coinbase have also launched non-custodial wallets to cater to evolved users. 

Risk of deplatforming in custodial wallets

Custodial wallets can ban users and lock them out of their crypto assets. Recent user blocking events during the Russia-Ukraine war and trucker strike in Canada show that this is a real risk.

Key Companies

Metamask (Non-custodial)

Features

  • Metamask is an Ethereum-based wallet with a browser extension & mobile app for buying/swapping crypto, holding & displaying NFTs, and staking through third-party validators. 
  • It connects and authenticates users with decentralized Ethereum apps (aka dapps) such as play-to-earn games, tokenized social networks, and NFT marketplaces.
  • Its key innovation was taking crypto wallets away from the difficult-to-use desktop apps to highly accessible browser extensions. These browser extensions interact with JavaScript on dapps, which ping users to connect MetaMask wallets and enable transactions.
  • Metamask is open source, and a sizable development community is supporting it.
  • It allows users to back up the private key on iCloud but has issued warnings to turn off this setting after a recent wallet hacking.
  • It makes money by charging swap fees of 0.875% that users pay to exchange their tokens.

Key metrics

  • MetaMask has 32M MAU as of Feb 2022 and grew 5X in just 12 months.
  • MetaMask’s revenue from swapping fees grew 24X in 2021, from $1.8M to $44M.
  • As of March 2022, MetaMask is pulling in about $21M per month at an ARR of $252M.

Funds raised

  • MetaMask’s parent company ConsenSys is valued at $7B (March 2022) and has raised $725M.

Phantom (Non-custodial)

Features

  • Phantom is the largest Solana-based wallet, launched in April 2021. It mirrors what MetaMask is doing for the Ethereum blockchain. 
  • Like MetaMask, it has a browser extension & mobile app, allows buying/swapping crypto, holds & displays NFTs, provides staking through third-party validators, and connects with other Solana dapps.
  • Unlike MetaMask, it's a closed source app.
  • Phantom plans to launch an Ethereum wallet to directly take on MetaMask in 2022.
  • Phantom charges 0.85% as swap fee for select crypto assets: SOL, USDC, USDT, UST, ETH, BTC, renBTC. 

Key metrics

  • Phantom crossed 2M MAU in one year post-launch. For comparison, MetaMask reached 2M MAU in five years.

Funds raised

  • Phantom has raised $118M and was last valued at $1.2B (Jan 2022).

Rainbow (Non-custodial)

Features

  • Rainbow is an Ethereum-based wallet available as a mobile app for iOS and Android and doesn’t have a browser extension.
  • Compared to MetaMask, Rainbow positions itself as a fun way to use crypto with emojis, rainbow gradient buttons, and quirky visuals aiming to get casual users to Web3.
  • Users can buy/swap crypto using built-in Uniswap integration, fund wallet using Apple Pay, send and receive crypto, hold & display NFTs, and connect with other Ethereum dapps.
  • Like MetaMask, it is open source and has a developer community supporting it.
  • It lets users back up the wallet on iCloud (something MetaMask has warned users to turn off).
  • It’s unclear how it makes money, but it could be charging transaction fees on swaps like other wallets.

Key metrics

  • Data on MAU/revenue is not available.

Funds raised

  • Rainbow has raised $19.5M.

Freewallet (Custodial)

Features

  • Freewallet is one of the oldest custodial wallets, launched in 2016 with a mobile app and website.
  • It’s for users who want a convenient way to buy/sell a large selection of crypto without additional features such as staking, lending, NFTs, or connecting with dapps. Accounts can be created using email, Facebook, or phone number.
  • Transfers between Freewallet accounts are instant and free as they are not written to the blockchain.
  • Freewallet supports 100+ cryptocurrencies that can be bought using debit cards/credit cards.
  • It keeps part of its crypto holdings in cold storage but doesn’t specify how much.

Key metrics

  • Freewallet has 3.5M+ user accounts.

Funds raised

  • Freewallet hasn’t raised equity/debt funds.

Coinbase Exchange (Custodial)

Features

  • Coinbase offers a custodial wallet through a mobile app and website. 
  • Many features are similar to Freewallet, such as instant & free transfers between Coinbase users, easy signup using email, buying crypto through bank account, debit cards, and Apple Pay, and keeping crypto in cold storage (98% of holdings).

Key metrics

  • Coinbase exchange’s user accounts grew 2X in 2021 to reach 89M. Its average Annual MTU (Monthly Trading Users) is 8.4M.

Funds raised

  • Coinbase’s market cap is $32.36B, and it raised $567M before going public.

Feature comparison

None