Do you ever feel uneasy about placing your cryptocurrency holdings in a centralised exchange that provides only custodial trading? You may have asked if it's possible to use your own private, offline wallet in tandem with a trading platform. Discover why non-custodial trading might be the solution to trade safely and without worrying about who has custody over your bitcoin.
Exactly what does "Custodial Exchange" mean?
If you want to trade or utilise a custodial exchange, you'll have to give up custody of your Bitcoin. Exchange operators often run and regulate the wallets, which is why they are called "managed." Most people who have utilised a cryptocurrency exchange that deals in fiat currency have done so through a custodial exchange. Even the first generation of peer-to-peer markets is mostly run as escrow services.
While there is value in using a custodial platform, it's crucial to be aware of the potential downsides you may have overlooked.
Benefits of a Centralized Custodial Exchange
Reduced duty, as keeping track of one's own keys is unnecessary.
Since no on-chain transactions are necessary, trades may be executed more quickly.
If you forget your password, you can probably just reset it.
The Drawbacks of a Centralized Custodial Trade System
Exposure to the platform's risk since it stores your money
Checking the financial viability of a strictly custodial trade might be challenging.
Users may bear the financial cost of a hacker attack.
To what extent does a non-custodial exchange differ from a traditional custody swap?
Contrarily to a custodial exchange, where your money are held by the exchange on your behalf, a non-custodial exchange allows you to trade while keeping custody of your private keys. One of the reasons non-custodial exchanges may be so safe is that only you have access to your private keys, which means only you can decide what happens to your cash.
A non-custodial Bitcoin exchange that allows for P2P trading is a great option if you'd rather not utilise a traditional bank or wire transfer. Peer-to-peer (P2P) trading is a fantastic way to trade Bitcoin and other popular cryptocurrencies utilising payment methods such as cash that would otherwise be inaccessible.
The advantages of a non-custodial exchange
Keep your account mnemonic and private key secure.
Due to the lack of a central entity managing your hot wallet, the security of your cash is not at danger.
Non-custodial interactions are typically more discreet than custodial ones.
Drawbacks of a Non-Custodial Exchange
Transaction times for non-custodial transactions may be longer since they occur on-chain.
When using non-custodial wallets, it is often impossible to reset the password.
If you fail to create a backup of your wallet files before the platform crashes, you will lose access to them.
Should we consider decentralised exchanges to be non-custodial?
Although most non-custodial exchanges also qualify as decentralised, the converse is not always true. The term "decentralised" has been used rather liberally in recent years, which has diluted its meaning a little. To sum up, it's important to keep in mind that "non-custodial" is not synonymous with "decentralised," and that while the two concepts often go hand in hand, this is not always the case.
What is the procedure for trading without a custodian?
While there is considerable variation, there are also certain consistent features to look for in most situations. Typically, bitcoin scripts or other kinds of multi-signature transactions, in which several people are required to sign a transaction, are used by platforms that enable non-custodial bitcoin trading.
For example, smart contracts are frequently utilised to facilitate on-chain trade in the Ethereum ecosystem. Although more and more cryptocurrencies are adding support for non-custodial trading, very few non-custodial exchanges have emerged to really facilitate this. To at least some extent, crypto-to-crypto transactions aren't the only ones possible.
A non-custodial exchange often consists of three parties: the buyer, the seller, and an arbitrator or moderator. In a non-custodial trade, the escrow must be funded by the seller, who may do so by depositing funds into a designated wallet, completing a predetermined set of actions, or engaging with a smart contract built for the purpose. The arbitrator's duty is limited to stepping in during a trade disagreement and determining the correct owner of the crypto, and they should only have access to release the cash to either side and not assume ownership of the funds themselves. They usually charge a little fee for their assistance.
An arbitrator is unnecessary when a smart contract handles both payments and the exchange of cryptocurrencies in a non-custodial transaction. One payment cannot be validated on-chain in other sorts of trades (often non-custodial P2P trades), therefore disagreements are inevitable. Because of the constraints placed on the arbitrator, they would be unable to take the cash and hence do not represent a third-party risk in a regular business transaction.
The blockchain networks itself serve as the underlying technology for non-custodial trades, reducing the need for trusted third parties. It's a novel and intriguing take on a problem that's been significant long before cryptocurrencies were invented: how to do business with a minimum of risk.
Should we prefer trades that include custody or those that do not?
Your own circumstances and tastes should determine the sort of trade that works best for you. If both non-custodial and custodial forms of exchange will adequately address your needs, you should always select the latter. However, you should consider the dangers involved with using a custodial platform if you need to make quick crypto transactions or if that is the only place you can find a certain trading pair. Keep in mind that the speed of non-custodial trading might vary depending on the cryptocurrency, the frequency of its blocks, and the size of the transaction fees.
Let's say you're interested in non-custodial trading but are concerned about its inherent volatility. If so, one option is to use a decentralised P2P exchange to trade stablecoins for the currency you like to use.
The Basics of Non-Custodial Exchange
Keep in mind that each time you deposit cash into a custodial exchange, you are essentially handing up ownership of those funds to the exchange itself. Sadly, many consumers make the mistake of entrusting their whole bitcoin holdings to custodial systems. Several custodial platforms have unexpectedly shut down or been insolvent over the years due to hacks, bad management, or even legal action, which may result in you losing custody of your cryptocurrency before you ever realise it has occurred.
Using a non-custodial exchange, protecting your privacy, and keeping your private keys safe are all important steps to fully embracing cryptocurrency's capabilities.
Trying a non-custodial trade
Ready to give non-custodial trading a shot? Bitcoin Babe offers a number of non-custodial trading options via LocalCoinSwap!
This awesome article was inspired by gingerbreadfork on the LocalCoinSwap Academy