Cryptocurrency wallets are essential tools for storing, managing and accessing digital assets like Bitcoin or Ethereum. One important aspect of using cryptocurrencies is the need for a digital wallet to store and manage your assets. There are two main types of cryptocurrency wallets: “hosted and unhosted,” or a “third-party wallet and self-custody”.
In this article, we will discuss the differences between these two types of wallets and why self-custody wallets, which are recently called “unhosted” wallets, are generally considered the best option for most users.
What are hosted wallets?
Hosted cryptocurrency wallets, also known as third-party or custodial wallets, are digital wallets that are provided and managed by a third-party service. These services store your private keys on their servers, which means that you do not have direct control over your keys. Instead, you rely on the service to keep your keys secure and to facilitate transactions on your behalf.
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Some examples of hosted cryptocurrency wallets include exchanges like Coinbase, Binance, or FTX. These wallets are often convenient for beginners because they are easy to set up and use. They also offer additional services such as buying and selling cryptocurrencies, margin and futures trading, competitions, quizzes, and much more. Exchanges will do anything to lure traders into their platform.
However, there are also significant risks associated with using hosted wallets. Because you do not have direct control over your private keys, you are trusting the wallet service to keep your keys secure and to act in your best interests. If the service is hacked or goes out of business, you could lose access to your funds. Yes, that is exactly what happened with FTX. They didn’t act in the customer’s best interest.
Additionally, some hosted wallet services have been known to freeze or seize user accounts, which can be frustrating and inconvenient. There are many examples, including BlockFi, Hodlnaut, Celsius, and many others in 2022, where investors using these wallets remained empty handed at the end.
What are “unhosted” wallets?
“Unhosted” cryptocurrency wallets, also known as self-custody wallets, are digital wallets that give you complete control over your private keys. Instead of relying on a third-party service to store your keys, you store them yourself, either on your computer or on a hardware device (e.g. Trezor, Ledger).
There are several types of self-custody cryptocurrency wallets, including software wallets, paper wallets, and hardware wallets. Software wallets are digital wallets that you install on your computer or mobile device. Paper wallets are physical documents that contain your public and private keys, which you can use to access your cryptocurrencies. Hardware wallets are physical devices, such as USB sticks, that store your private keys offline, providing an extra layer of security.
“Unhosted” cryptocurrency wallets offer several benefits over hosted wallets. Because you have complete control over your private keys, you are not reliant on a third-party service to keep them secure. This means that you are less vulnerable to hacks and other security threats. Additionally, you have full control over your funds, which means that you can make transactions without the need for approval from a third party. But regulators don’t like it.
Where did “unhosted” wallets come from?
Actually, there is no such thing as “unhosted” wallets. The name suggests they are not hosted by any party, but it’s the users hosting them. That is why the best name for them is “a self-custody wallet.” While governments don’t see inside your real wallet, for some reason, they want to have better oversight of what you have inside your digital wallet.
The United States federal government may be considering a controversial proposed rule. It would apply to know-your-customer (KYC) laws on “unhosted,” or self-hosted crypto wallets. FinCEN, the US agency charged with keeping tabs on money laundering initially recommended the rule in late 2020.
If this proposal were to become law, crypto exchanges would be compelled to collect personal information from customers seeking to withdraw funds to their own wallets. Former Treasury Secretary Steven Mnuchin was the driving force behind the regulation. This name “unhosted” wallets has been created by regulators, who want to monitor every transaction over $1,000.
Financial Action Task Force (FATF) suggested that exchanges should report any transactions worth more than $1,000 and identify the identity of the “unhosted” wallet owner. Moreover, FATF would ask exchanges to verify this information, putting a heavy burden on enterprises like crypto exchanges.
Why self-custody wallets are the best option
Overall, self-custody wallets are generally considered the best choice for most cryptocurrency users. While hosted wallets can be convenient for beginners, they do not offer the same level of security and control as “unhosted” wallets. By using a self-custody wallet, you can take responsibility for your own security and have complete control over your funds.
There are a few key considerations to keep in mind when choosing a self-custody wallet. First, you should choose a wallet that supports the cryptocurrencies you want to use. Some wallets only support a few cryptocurrencies, while others support a wide range. You should also consider the security features of the wallet, such as two-factor authentication.
Finally, you should consider the user experience and whether the wallet is easy to use and understand. If you want to trade and take advantage of leverages and other trading tools, then using a hosted wallet is a good choice. But investors who hodl their positions long-term should consider using a self-custody wallet over a third-party one.