Exchange wallets are convenient, but they come with several important drawbacks. The biggest disadvantage is a lack of control. When funds are held on an exchange, the user does not control the private keys. This means access to assets ultimately depends on the platform, not the individual.

Security risk is another major concern. Exchanges are attractive targets for hackers because they hold large pools of funds. Even well-known platforms have suffered breaches in the past, and users may lose access to their assets during investigations or recovery periods. While some exchanges offer insurance, coverage is often limited.

There is also counterparty risk. If an exchange faces financial trouble, freezes withdrawals, or shuts down, users may be unable to access their funds. Regulatory actions can make this worse, especially when accounts are suspended due to compliance reviews or regional restrictions.

Operational limitations are another downside. Exchanges may delay withdrawals, suspend wallet services during maintenance, or restrict transfers during periods of high volatility. Users must also comply with KYC and AML requirements, which can lead to frozen wallets if documentation issues arise.

Finally, exchange wallets are less suitable for long-term storage. Convenience often comes at the cost of sovereignty. For traders who value full ownership and security, self-custody solutions like hardware or non-custodial wallets offer stronger protection and independence.