Hosted Wallet

A hosted wallet is a cryptocurrency wallet in which a third-party service, such as an exchange, broker or payment company, holds the private keys that control the assets on the user's behalf. The user logs into an account, sees a balance and can instruct transfers, but the provider is the party that actually signs transactions on the blockchain. The balance the user sees is an entry in the provider's own books, and its value depends on the provider holding the matching assets and honoring withdrawals.

Hosted wallets are also called custodial wallets. Their counterpart is the unhosted wallet, also known as a self-hosted or non-custodial wallet, in which the user alone controls the keys.

Most large providers do not keep a separate blockchain address for each customer's holdings. Instead, they hold customer assets in a small number of pooled, or omnibus, wallets, much like a pooled account in banking, and record each customer's entitlement in an internal ledger. Transfers between two customers of the same provider are often just ledger entries and never touch the blockchain. Deposits from outside are credited when the provider sees them arrive at a deposit address, and withdrawals are sent from the provider's own wallets.

Providers usually divide their holdings between hot wallets, connected to the internet for day-to-day withdrawals, and cold storage for the bulk of assets. Keys may be protected with multi-signature arrangements or multi-party computation, so that no single employee can move funds alone.

Because a hosted wallet provider holds and transmits value for others, regulators generally treat it as a financial intermediary. In the United States, FinCEN's 2019 guidance on convertible virtual currencies states that a hosted wallet provider that accepts and transmits value is a money transmitter, subject to registration and the Bank Secrecy Act, and many states also require a money transmitter license or a specific virtual currency license. In the European Union, the Markets in Crypto-Assets Regulation (MiCA) treats custody and administration of crypto-assets for clients as a licensed crypto-asset service and imposes requirements on segregation of client assets and record-keeping.

Hosted wallet providers must apply customer due diligence, monitor transactions, file suspicious activity reports and comply with the Travel Rule, which requires originator and beneficiary information to accompany transfers between regulated providers. Many use blockchain analytics to screen deposits and withdrawals against sanctioned or high-risk addresses.

• Control: in a hosted wallet the provider signs; in an unhosted wallet the user signs with keys or a seed phrase they hold.
• Recovery: a hosted wallet user who forgets a password can usually regain access through the provider; an unhosted wallet user who loses the keys loses the assets.
• Counterparty risk: a hosted wallet depends on the provider's solvency and honesty; an unhosted wallet does not.
• Compliance: regulated providers can freeze, screen and report; unhosted wallets are outside that perimeter, which is why regulators focus on transfers between the two.

The phrase "not your keys, not your coins" summarizes the trade-off from the user's side.

The main risk is that the provider's records do not match its actual holdings. Exchange collapses, from Mt. Gox in 2014 to FTX in 2022, showed that customers of a failed provider become creditors in an insolvency process and may recover only part of their assets, years later. Other risks include hacks of hot wallets, account takeover, withdrawal freezes during market stress, and the possibility that the provider uses customer assets for lending or trading.

Regulators and customers have responded by demanding segregation of client assets, independent audits and proof of reserves. Proof of reserves can show that a provider controls certain assets at a point in time, but on its own it does not show the provider's liabilities, so it is not a full substitute for audited financial statements.