Custodial wallets are cryptocurrency wallets where the private keys are held and managed by a third party, typically a cryptocurrency exchange like Coinbase or Binance. While they offer convenience through features like password recovery and simplified interfaces, they introduce counterparty risk because the user does not have direct control over their private keys. If the custodial service is hacked or becomes insolvent, users may lose access to their funds, which is why the crypto community often says 'not your keys, not your coins.'
Example
“A beginner crypto investor stores their Bitcoin on Coinbase's custodial wallet for convenience, understanding that Coinbase holds the private keys on their behalf. For greater security and full control, they would need to transfer their funds to a non-custodial wallet like a Ledger hardware device.”