Crypto Concepts 101 - Non-Custodial

The central idea behind this phrase is that you don’t really have ownership or custody of the actual wallet address that holds your tokens, NFTs, etc on any given protocol’s blockchain when you use a centralized exchange. Your digital wallet’s private key is what is used to “sign” transactions and verify that the transfer is genuine with the assumption that you or your intended proxies/agents are the only ones that have access to that private key. When you maintain your cryptocurrency assets on a centralized exchange, the exchange acts as the holder or “custodian” of your cryptocurrency. In this capacity, you delegate the function of conservatorship to the exchange, in turn, making the exchange the custodian of your digital assets instead of yourself. This has its advantages – you don’t have to diligently maintain a record of wallet keys or be as up-to-date on online security threats that could breach your own digital asset controls.

Maintaining your crypto on an online exchange or brokerage is not without its risks. The 2014 collapse of the crypto exchange Mt. Gox is the most notorious failure of a custodial entity in the crypto world. In all, around 850 000 BTC had gone missing, a sum that amounts to 51 billion dollars at today’s prices. When these institutions fail, customers are left with little if any ability to recover their funds. Some exchanges, like Coinbase, are insured but this is the exception, not the rule.

Many of the largest DeFi platforms are custodial; the user has to hand over their crypto in exchange for their ability to participate on the platform. MELD has made the design decision to be non-custodial. Instead of a centralized entity holding all the crypto assets used on the protocol, lending and borrowing is made peer-to-peer between the lending and borrowing parties with the MELD protocol acting as a facilitator or matchmaker.

One has to ask, without a central entity to arbitrate between parties, how do the rules of a lending/borrowing agreement get enforced? Enter smart contracts. Smart contracts bring counterparties closer together by removing the traditional bank or exchange entity between them. The rules of an agreement are codified within the smart contract and once all the conditions of the smart contract have been met, it triggers an exchange. Smart contracts bring counterparties closer together. A borrower’s collateral has conditions placed on it by a smart contract, but the assets are still functionally in the custody of the borrower until a repayment or margin call event is triggered by the smart contract. Smart contracts are inherently more transparent than the EULA of a centralized exchange when it comes to terms, conditions, and risks. 

The non-custodial dimension of MELD goes beyond a technical decision and into a philosophical one. At its heart, cryptocurrency is about the reclamation of personal agency in a very centralized world where power – especially that of the financial and economic kind – is very vertically organized.  In a digitized financial world, centralized custodianship is more often than not a drag on the movement of currency. It can act not just as a financial drag in the form of fees, but a temporal one, too, where settlement can take hours, days, or in the most egregious cases, weeks. When you are the custodian of your own digital assets, the time it takes you to engage in a transaction is determined by the finality of the protocol you use for transacting. The cryptocurrency world moves very quickly, and not being held up by a centralized entity having to worry about the capitalization of all of its deposits (which include yours) is one less impediment to a world with greater personal financial agency. The more entities that stand between two parties in a transaction, the more capital inefficient a transaction becomes. Non-custodial DeFi protocols get to the heart of this problem by stripping away all the intermediaries that take a cut of your wealth every time you want to transact in the financial world. It’s your money, it should stay that way.