Custodial and non-custodial Lightning Wallet or safekeeping of the Bitcoin balance on a Bitcoin Lightning Wallet
This is the subject of the second part of the Artiek series “Types and functions of Bitcoin Lightning wallets.” This second part is about the storage of Bitcoin funds on a Bitcoin Lightning Wallet and who has access to these funds. It is about:
- The difference between whether the Bitcoin balance is held externally or is held and managed by the user of the Bitcoin Lightning Wallet themselves. In English we speak of Custodial Lightning Wallet vs. Non-Custodial or Self-Custody Lightning Wallets.
- What are the advantages and disadvantages of these wallet types and
- What fees are incurred when I use a Lightning Wallet?
- We then provide an overview of the various Lightning wallets for beginners, advanced users and operators of their own Lightning nodes.
This article is also available as a video on the joint YouTube channel of Coincharge and Coinpages in German with the title:“Custodial und Non-Custodial Lightning Wallet oder Verwahrung des Bitcoin Guthabens auf einer Bitcoin Lightning Wallet“
Third-party custody vs. self-custody
In the first part, we talked about the various components of a Lightning Wallet. One important component is the key storage. Are the keys stored on your own Lightning Wallet or with the Lightning Wallet provider?
If the keys are held by the provider of the lightning wallet, this is referred to as a custodial wallet.
If you hold the private keys yourself, this is referred to as non-custodial or better self-custody, which can be translated as self-custody.
The European Union has enacted crypto regulation with MiCa and introduced the terms hosted and unhosted wallet.
A hosted wallet is a custodial wallet, i.e. a wallet where the funds are held by a service provider or bank. An unhosted wallet is when you manage your crypto assets yourself.
Third-party custody vs. self-custody
Custodial vs. Self-Custody
Hosted vs. unhosted
- Third-party custody – My sats are held by the provider of the Lightning Wallet
- Self-custody – My sats are with me. Not your keys – Not your Sats
In summary:
If the provider of the Lightning Wallet has access to the keys, then they have access to your Bitcoin balance and this is referred to as third-party custody or a custodial wallet.
If you as the user of the Lightning Wallet have access to the keys, then you yourself have access to your own Bitcoin balance and this is referred to as self-custody or a self-custodial or non-custodial wallet.
Advantages and disadvantages of third-party custody (custodial)
Disadvantages of the Custodial Lightning Wallet
In the case of a third-party Lightning Wallet, the balance is held by the operator and provider of the respective Lightning Wallet. The wallet provider takes care of everything in the background for the users of the Lightning Wallet. Once you have installed the Lightning Wallet on your smartphone, you can either make a deposit via Bitcoin or have some Sats sent to you via Lightning. The Lightning Wallet is available immediately. Only when making a deposit via Bitcoin do you have to wait for up to six confirmations before the balance can be used without restriction. As a user of a custodial wallet, you must be aware that the balance is held by the wallet provider and that there is a risk of total loss of the balance. For this reason, larger amounts should never be paid into a custody wallet. The operator of the Lightning Wallet knows all your Lightning payments, so there is no privacy vis-à-vis the operator.
Advantages of the Custodial Lightning Wallet
A custodial wallet is the perfect wallet for beginners. It is very easy to use and offers an all-round carefree package. If you have any problems with the wallet, you can contact the operator, who can reset passwords and provide support if necessary. Another advantage of the Custodial Lightning Wallet is that you can receive a Lightning address, which is not possible with self-custody wallets.
Overview of entry-level Lightning wallets
In the illustration above we have an overview of some Custodial Lightning Wallets, which can also be described as entry-level wallets. Here we find the Lightning wallet from Alby, which we have already seen in the browser extension. Then we have Blink, the former Bitcoin Beach wallet. Bitkit, Lifpay and Sudonym are some newer Lightning wallets. With LightningTipBot, we have the Lightning wallet for Telegram and the Satoshi wallet is the most widely used Lightning wallet and can be described as the market leader. The BlueWallet is no longer included, as the custody service for the Lightning Wallet was discontinued in April 2023 and only a self-custody service will be offered in future.
Advantages and disadvantages of self-custody (non-custodial)
How a non-custodial or self-custody Lightning Wallet works
With a self-custody Lightning Wallet, we store our funds ourselves. The Bitcoin ethos “Not your keys – not your coins” should also apply to a Lightning Wallet. Many people may be put off by a self-custody Lightning Wallet at first glance because it looks a little complicated. However, it is more likely that people are put off by the unknown. That’s why we want to briefly explain what happens with a self-custody lightning wallet to reduce the inhibition threshold before using a self-custody lightning wallet. When we use a custody Lightning wallet for the first time, we can immediately receive and send Lightning payments, as the wallet operator has already opened a payment channel for us in the background. With a self-custody wallet, a channel must first be opened between our Lightning wallet and the wallet operator as the Lightning service provider. A channel opening must be confirmed on the Bitcoin blockchain and can therefore initially take at least one hour. The costs for this channel opening or the costs for the Bitcoin transaction on the Bitcoin blockchain are fees that are deducted from the deposit amount. Many users are put off by these high costs and believe that these costs are incurred for every Lightning payment. This is not the case. These fees are only incurred when opening and closing a channel and are borne by the wallet user. If payments are later processed via the payment channel, only the normal routing fees are incurred, which depend on the fees charged by the nodes on the route for routing a Lightning payment. These routing fees are identical for custody and self-custody wallets. When depositing or receiving bitcoins on the Lightning wallet, the amount is not available immediately, but only after six confirmations on the blockchain, which can take over an hour. So if you want to use the new self-custody Lightning Wallet and first make a deposit via Bitcoin, you have to wait at least an hour for the Bitcoins to be credited and then another hour for the payment channel to be opened. Only then can the first Lightning payment be made. As you are responsible for your own balance, you should also keep the seed safe. A backup option for the Lightning Wallet on the corresponding cloud service of the smartphone used is usually offered.
Disadvantages of a self-custody Lightning Wallet
The disadvantage of using a self-custody Lightning wallet is that the wallet provider does not provide you with your own Lightning address. So if you want to use your own Lightning address to receive Lightning payments, you must also use a Custodial Lightning Wallet or operate your own Lightning Node. As already described, it takes longer before a newly set up Lightning Wallet can be used for the first time. There are costs for the necessary channel opening, which are initially confusing and lead to the false assumption that these costs are incurred every time the Lightning Wallet is used. It also gives the impression that a Lightning payment does not work if you want to receive or send a Lightning payment. The reason for the non-functioning is usually the limited capacity of the channel between the Lightning Wallet and the wallet provider. The Bitcoin balance is tied up in this shared payment channel when the channel is opened. The channel capacity usually results from the first Bitcoin deposit and the same amount that the wallet provider also makes available in this channel on its website. If a payment is to be made that exceeds the capacity of the channel, this payment cannot be forwarded and an error occurs. This is a problem that does not occur with custodial Lightning wallets. Some users are somewhat unaccustomed to developing a sense of personal responsibility for their funds. This includes writing down the seed securely and keeping the backup safe. It’s the unknown that scares people off. Once you’ve done it once, you lose the fear and see that it’s simple and straightforward. In the next videos, we will take a closer look at the individual self-custody wallets and explain how to use your self-custody wallet.
Advantages of a self-custody Lightning Wallet
The unbeatable advantage of a self-custody wallet is that you have full control over your balance.
A nice side effect is that you learn and better understand how Lightning works.
Overview of Lightning wallets for advanced users
A self-custodial wallet is perhaps something for experienced users or for users of a custodial wallet who now want to go one step further and try out a self-custodial wallet in addition to a custodial wallet.
Here we have compiled an overview of the most frequently used self-custodial wallets. In alphabetical order, we have the Blixt wallet, which at first glance is really a bit complicated to use. One of the most popular custody lightning wallets is the Blue Wallet, which will no longer offer a custody service from April 2023, but will introduce a self-custody service. The Electrum wallet is a desktop Lightning wallet and is not very intuitive to use at first glance. We recommend the Lightning wallets for smartphones from Breez, Muun and Phoenix. We will take a closer look at these Lightning wallets in the next few videos.
Node operator Lightning Wallets
So far, we have looked at the Lightning wallets that can be used as users and users. Now let’s take a brief look at the wallets that can be used if you operate your own Lightning Node. If you operate your own Lightning Node, this is of course always a self-custody Lightning wallet.
Joule is a Lightning Wallet that is used as a browser extension and is connected to your own Lightning Node. Joule can then be used to conveniently make payments from your own Lightning Node. With LNBanks, we have a Lightning Wallet that is part of the BTCPay server. A BTCPay server has a Lightning Node that carries out the Lightning payments of the entire BTCPay server. With the help of LNbanks, each user of this BTCPay server can receive their own Lightning wallet and have access to their own Lightning transactions. LNbanks is an account and Lightning wallet system with the ability to create a variety of Lightning wallets that can be used for a variety of different applications. If you have your own Lightning Node at home, you can install the Zeus Lightning Wallet on your smartphone. Zeus is then connected to your own Lightning Node and you can use Zeus to make payments via your own Lightning Node at any time while on the move.
Node Management Lightning Wallets
As a Node Operator, you have to manage your own Lightning Node in the form of opening and closing channels, liquidity management and, of course, sending and receiving Lightning payments.
This is where appropriate node management software such as Thunderhub or Ride the Lightning (RTL) can help.
Lightning Wallet fees
What fees and costs are incurred when using a Bitcoin Lightning Wallet? For the fee analysis, we will take a closer look at the most widespread and most frequently used Bitcoin Lightning wallets.
For beginners, the two Bitcoin Lightning wallets from Wallet of Satoshi and Alby.
And for advanced users with some experience, the Bitcoin Lightning wallets from Phoenix and Breez.
We look at the costs for sending and receiving Lightning payments and for sending and receiving Bitcoin payments.
For the self-custodial Bitcoin Lightning wallets, we also look at the costs for opening a channel.
Fees: Receive Lightning payments
Receiving Lightning payments is generally always free of charge or fees. This applies to all types of Lightning wallets. The routing costs via the Lightning network are always borne by the payer and are free of charge for the payee.
Fees: Send Lightning payments
When sending Lightning payments, no fees are charged by the Lightning wallet provider for Custodial Lightning wallets. As already mentioned, the costs for Lightning payments are borne by the payer. Even if the Lightning wallet does not charge any fees, external costs are incurred for the routing of Lightning payments, which are charged by the Lightning nodes on the payment path.
These fees depend on the fees charged by the individual Lightning Nodes, the number of hops, i.e. Lightning Nodes, between the sender of the payment and the recipient, and the amount to be paid.
These are external routing fees that are passed on by the wallet provider.
With Custodial Lightning Wallets, there is no payment channel between the Lightning Wallet and the wallet provider’s Lightning Node.
A Custodial Lightning Wallet is like an account or database entry on the wallet provider’s Lightning Node.
Fees: Receive Bitcoin payments
With the self-custody Lightning Wallet, there is a channel between the Lightning Wallet and the provider of the Lightning Wallet. The provider of the Lightning Wallet acts as a kind of Lightning Wallet provider that offers a Lightning payment service. Because there is a channel between the Lightning Wallet and the Lightning Wallet provider, this Lightning Wallet provider is the first external node in a payment path and charges a separate routing fee for its forwarding. Phoenix charges a basic fee of 1 Sat plus 0.05% as a variable fee depending on the payment amount. In addition, there are external routing fees for the other Lightning Nodes on the way to the payee. Phoenix tries to find a favorable way that amounts to a maximum of 12 Sat and 0.5% of the payment amount.
Breez only charges 1 Sat for its own routing and no variable share. The external routing fees of the other nodes are added to this. The balance on a Bitcoin Lightning wallet is denominated in Lightning. If there is a deposit via Bitcoin, this on-chain credit must first be converted to off-chain credit. This exchange takes place via the Bitcoin blockchain and Bitcoin network fees are incurred accordingly. Wallet of Satoshi charges a fee of 0.5% of the amount for the exchange and crediting to the Lightning Wallet. Alby works together with the external service provider Deezy. For the exchange from Bitcoin to Lightning, these external fees as well as the external blockchain network fees are charged to the payee. With self-custody Lightning wallets, the payment received via Bitcoin is credited to the Bitcoin wallet and then used to open a payment channel between the Lightning wallet and the provider of the Lightning wallet. As a Lightning balance, the equivalent value in Bitcoin is available to the user of the Lightning Wallet as a local balance for Lightning payments. Phoenix requires 1% of the Bitcoin amount and at least 3,000 sats. Breez requires slightly less, namely 0.75% and at least 2,000 sats.
Fees: Send Bitcoin payments
If you want to make a payment in Bitcoin from your Lightning Wallet, each Lightning Wallet charges the external Bitcoin network fees incurred by the Lightning Wallet provider itself.
Wallet of Satoshi charges a flat rate of 0.5% of the Bitcoin amount and Alby and Breez each pass on the fees of their exchange service providers.
Only Phoenix does not charge any exchange fees and is limited to passing on the external network fees of the Bitcoin blockchain.
Fees: Channel opening
In order to participate in the Lightning network, you must be connected to the Lightning network via a payment channel. In the case of custodial Lightning wallets, the connection to the Lightning network is provided by the provider and operator of these Lightning wallets. Each of these Lightning wallets is actually just a database entry with this provider and uses the wallet provider’s Lightning node. With a self-custody Lightning Wallet, each Lightning Wallet is independent of the wallet provider and connects to this Lightning Node. The costs incurred are charged as costs for opening a channel with this node.
Recommendation for Lightning Wallet
We are often asked which Lightning wallet would you recommend? There is no general answer here, because the wallet has to suit the user. For a beginner who wants to gain their first experience with Lightning without any prior knowledge, we recommend the Satoshi wallet. As with all Custodial Lightning wallets, only a minimum amount should be deposited here. I myself have installed the Wallet of Satoshi on my smartphone and like to use it as an emergency Lightning wallet. Sending and receiving Lightning payments via this Wallet of Satoshi has always worked so far. I also have my own Lightning address, can use Lightning Login and there is a Point of Sale function to accept Bitcoin and Lightning payments as a merchant in the store. I like to use the Wallet of Satoshi when I want to pay with Lightning on the go. I installed the Alby Wallet as a browser extension to make Lightning payments online and receive donations. You get an individual Lightning address and can store it in other applications. But Alby has also piqued my interest, as new functions are constantly being added that allow you to pay conveniently online with Lightning. However, it is very important to me to promote self-custody Lightning wallets at this point. The rule for Bitcoin is “Not your keys, not your coins” and this rule applies not only to Bitcoin, but also to Lightning. Anyone who has had their first experience with a custody wallet should definitely set up a self-custody wallet. Some Bitcoiners are of the opinion that even beginners and newcomers should only be taught and install a self-custody Lightning wallet. Here I refer again to my statement that the wallet must suit the user, and in an individual discussion I then decide which wallet is more suitable for my counterpart. I recommend the Phoenix or the Breez wallet for experienced users and users of the Wallet of Satoshi who want to take the next step. Anyone who has read both parts of the types and functions of Bitcoin Lightning wallets up to this point should have gained enough knowledge to understand how a Lightning wallet works and be able to use Phoenix or Breez without any problems.
Otherwise, there will soon be detailed videos in which we explain how these wallets work in more detail.
