Custodial vs Non-Custodial Staking
The growth of the staking economy has created a lot of competition for consumer attention. There are numerous custodial and non-custodial staking products available. Let’s dive into the pros and cons of both approaches to key management. If you’re not familiar with “key management” take a look at our guide on the subject.
First off, what does “custodial” even mean? The Balance defines custody as:
“…In financial services, a custodian is a company that has physical possession of your financial assets. It’s often a brokerage, commercial bank, or other type of institution that holds your money and investments for convenience and security.”
For most people, custodial management of financial assets is normal! It’s the standard option for banks, brokerages, trusts and even personal credit. In staking, we have companies like Coinbase and Binance offering “custodial staking solutions.” At Lunie, our offering is “non-custodial”. Think of it as DIY (do-it-yourself) key management and security. You have control over your private keys and how they are stored. You get to design and build the security model that works for you.
Does this sound intimidating? Let’s break down how custodial solutions compare to non-custodial solutions.
Your Keys, Your Crypto
If you practice good privacy and security hygiene and you take care of private your keys (seed phrases) you can use any app / wallet / network you want. Non-custodial options are typically very portable in this regard, providing flexibility and freedom for stakers.
If you outsource your key management to someone else (custodians) you are trusting them to take care of money and security of it on your behalf. Many of the industry leading custodians are trustworthy providers — but many are not and from a distance it might be hard to tell which are which. As we see again and again many of the key management providers and big exchanges become targets because they are honeypots for hackers and do not always have the ability to make their users and customers whole after a hack.
You Choose How You Stake
With non-custodial solutions, you almost always have the ability to choose exactly the way you want to stake on any given PoS network, depending on the protocol’s rules and tooling you have access to. You can choose exactly which validators you want to stake with and for how long. On custodial services you usually don’t get to choose which validator to support and reward percentages are capped.
How To Manage Those Keys
Custodians handling keys for customers is a huge selling point especially for people who are not tech savvy or do not have any background knowledge about cryptocurrency, like Dave Portnoy in his quest to learn about Bitcoin from the Winklevoss Twins. Frankly, managing keys safely and properly is often a huge factor in how people get their funds stolen, so having professionals do it for you certainly can provide peace of mind if you’re ok with the trade-offs of having a centralized party control your funds.
Abstracted Networks, Abstracted Returns
When you log into a custodial dashboard and see a chart or progress ticker showing you your rewards balance going up at an arbitrary rate, you’re beholden to take the provider of that information at their word. It can be beneficial to someone who does not have a ton of interest or experience with cryptocurrency who just wants to know that professionals are fairly and accurately distributing any and all rewards they are entitled to.
For example, some major exchanges start symbolically accruing rewards for users immediately upon deposit with cryptocurrencies such as XTZ for staking, when in fact it takes many weeks for initial staking rewards to begin accruing and being deposited into the balance of a staker who self custodies.
Other networks that offer staking for ATOM might not require a 21 day un-bonding period for un-staking and withdrawal, even though it is required on a protocol level. So, if you think about it, the centralized exchanges offer users advertised convenience without really disclosing what’s going on behind the scenes. For some people that’s enough!
You Get What You Pay For (Maybe)
Should you pay fees to a custodian to manage your keys, your staking choices and subsequent rewards for you? Even a couple percentage points over a long enough time period can make a difference in compounding returns that would make anyone take pause at how much they’re paying.
This is a business model that clearly works for custodians such as exchanges! Now the question is, do you get what you pay for? That entirely depends on a case-by-case basis.
Factors to evaluate this include security, customer service, added value and loss-mitigation. If you’re paying extra for really valuable services and products from a custodial solution, that may be worth it.
Really Rock The Vote
On-chain governance participation is extremely important to the future of any given blockchain that implements it. We’ve seen countless examples of non-formal governance causing a political mess in other blockchains. Therefor it is of the utmost importance that holders of cryptocurrencies which represent some share of voting power in a network participate in how the protocol evolves.
With non-custodial on-chain governance, you can be sure your vote counts as you cast it and that peace of mind should only gain in importance as these networks evolve and grow.
Motives and Accountability
In the world of on-chain governance there are some gigantic players in the node operator space that wield a lot of influence on networks if they so choose. Some of these are backed by VC funds and some are run by cryptocurrency exchanges and even custodial divisions of traditional asset management firms.
This is not inherently bad on any given day — it’s not common to see a hostile takeover or pirating of a PoS network via on-chain governance collusion or cartel formation (but not unheard of), however it’s assumable that undue influence could be used to sway networks in one direction or another in the future.
Will newcomers to the staking space really give this a lot of thought? We hope so! Even those of us who have been involved in the PoS space for some time don’t fully understand the ramifications of validators acquiring on-chain influence through delegations with tactics such as 0% commissions or otherwise. However it is important for both the long term value of these networks and the individual holders of the staking tokens associated with them to ask hard questions of their custodians when it comes to how their massive stake in these networks will play out.
Despite advantages and disadvantages of the custody debate, it’s clear that the best solution for each person is a very personal decision. The risks and benefits for each side are not black and white. Security and sovereignty are on a spectrum. Have questions if non-custodial staking is right for you? Feel like we left something out? Get in touch with us on our Telegram channel!
Lunie is a platform that allows users to safely store, manage and stake crypto assets in Proof of Stake (PoS) networks. We assume that because you have landed here you are interested in learning more about Proof of Stake and trying it out. We’re here to help!
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