Custodial vs Non-custodial: Why Negative Is Positive

The world of cryptocurrency is rife with terms that often create confusion, and the distinction between ‘custodial’ and ‘non-custodial’ is a prime example. While ‘non-custodial’ might suggest a lack of something or even a deficiency, in the realm of Web3, this negative prefix, in fact, signifies a highly positive attribute. 

This article explores the misconception surrounding ‘non-custodial’ solutions and explains why, in the digital asset space, negative may indeed be positive.

What Is a Custodian?

The word ‘custodian’ comes from the Latin ‘custos,’ which translates to ‘guardian’ or ‘watcher.’ This root word has since then entered many languages in various contexts, but it always suggested being entrusted with something.

In ancient civilizations, such as Rome or Greece, the role of custodians was integral to society. These custodians, known as φύλαξ (phylax) in Greek, were often responsible for safeguarding public and sacred treasures. In Roman law, the ‘custos’ was a slave or freeman appointed as a guardian of minors or lunatics, entrusted with protecting their assets and managing their affairs until they could do so themselves.

In medieval times, custodians might be castellans, often members of the nobility, entrusted with guarding castles on behalf of their suzerains. In the religious context (especially in Christianity), custodians were tasked with safekeeping relics and church property. Notably, during the Crusades, Knights Templar offered custodial services to pilgrims: they were to protect their valuables for a fee. Later, during the Renaissance, bankers in cities like Florence and Venice acted as custodians of their clients’ funds, securing their gold and valuables in vaults. This meaning of custodianship directly transitioned from traditional finance to crypto.

A custodial service in Web3, then, is a service that actually receives assets from their customer and then uses them on their behalf. In particular, custodial staking solutions, often offered by centralized and decentralized exchanges, involve the exchange gaining control of customers’ tokens by getting their private keys. This means the tokens, initially owned by the customer, end up controlled by the exchange, allowing them to stake or use the tokens as they want.

How Negative Becomes Positive

Custodial services certainly have their advantages. They include ease of use and accessibility, as these services manage all the technical complexities. That said, the cons are significant: users lose direct control over their assets, become vulnerable to the security practices of the custodian, and often forfeit governance rights that come with token ownership.

Non-custodial staking, on the other hand, allows users to stake their cryptocurrency directly from their own wallets. This ensures they retain complete control over their assets, reduces counterparty risks, and typically provides governance participation depending on the particular blockchain. While it usually requires users to be more crypto-savvy, it transcends and surpasses custodial solutions in terms of security and benefits for the ecosystem.

This is where the confusion around ‘custodial’ and ‘non-custodial’ stems from. In common parlance, the prefix ‘non’ often suggests that something does not exist or the word it is attached to has a negative meaning. Still, as we saw, ‘non-custodian’ in Web3 describes a system where users retain absolute control over their assets rather than rely entirely on third parties. So, while it looks negative at first glance, it actually denotes a positive alternative to a solution that assumes control over its customers’ assets.

Here is how custodian and non-custodian staking compare.

The Impact of Custodial Solutions on Crypto Ecosystems

The impact of custodial solutions on an ecosystem may be adverse, primarily due to the combination of massive token accumulation by such services and the fact that they often handle those funds in a questionable manner. In particular, major CEXs that offer staking solutions rarely participate in governance voting, thus impacting the respective blockchain networks’ development, all on behalf of their delegators.

Thus, validator data as of November 24, 2023, indicates that approximately 28.2% of all staked ETH resides with custodial services like CEXs and DEXs. This concentration poses a potential risk, as users are effectively sidelined from governance decisions and remain at the mercy of the custodial service’s security measures. Effectively, this means that more than a quarter of all staked ETH is not under the control of their owners, who paid for them.

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Additionally, the transparency of these platforms is often called into question, as they may underreport their holdings to downplay their influence.

Non-custodial staking is generally more profitable than custodial one as there are typically lower fees and there are fewer of them. For instance, Everstake’s recent pooling solution allows users to stake as little as 0.1 ETH in a non-custodial manner. This massively lowers the entry threshold for ETH staking and thus benefits the ecosystem by distributing control and reducing centralization while remaining profitable to end users. In addition, it offers one of the highest APRs among top-tier providers and is very easy to use.

Embracing Non-Custodial Solutions for a Decentralized Future

While the term ‘non-custodial’ might instinctively feel like something negative, it, in fact, implies autonomy and security and is, therefore, quite positive. 

Using non-custodial services is beneficial not only to the users who retain complete control over their assets but also to the ecosystems since their governance becomes more efficient and they can continuously improve. For that reason, staking your crypto with a non-custodial service, such as Everstake, is always a wise choice.