Custodial or Non-Custodial Bitcoin-backed lending? Which is right for you?
Bitcoin-backed loans allow you to borrow fiat currencies using your Bitcoin as collateral. The ease of accessing funding is making it an increasingly popular tool in financing, both for retail and institutional customers. A critical decision, though, when choosing a lending platform that offers Bitcoin-backed loans, is whether to opt for a custodial or non-custodial model. (This is also among the most overlooked factor!)
Custodial platforms, like Nexo, for example, hold your Bitcoin, offering convenience but requiring complete trust in their business model. Non-custodial platforms, such as Firefish, on the other hand, let you retain control of your Bitcoin, prioritizing security and transparency.
This article explores the differences between custodial and non-custodial Bitcoin lending, comparing their pros and cons.
What are Bitcoin-backed loans?
Bitcoin-backed loans let you access funds by pledging Bitcoin as collateral without selling it. Collateral is a core component of any kind of financing. However, the role of Bitcoin as a collateral is still getting realised.
BItcoin-backed loans, in most instances, offer access to liquidity with comparatively easier terms, lesser paperwork and a more seamless process as compared to traditional loans. Firefish, claims to have processed a loan in 15 minutes and 23 seconds!
So, what is custodial Bitcoin lending?
Custodial lending platforms, such as Ledn and Nexo have grown in popularity. The way these platforms work is they take custody of your Bitcoin during the loan term, allowing them to rehypothecate it, for example. You transfer your Bitcoin to their wallet, and they manage the collateral, loan issuance, and repayment. This is akin to a bank holding your assets for a secured loan.
Here's a look at the terms and conditions from Nexo:
This is one of the biggest difference between custodial and non-custodial platforms. As you see above, in the case of Nexo, the platform gets the right to “convert, exchange, swap, pledge, re-pledge, hypothecate, re-hypothecate, sell, lend, stake, or otherwise transfer, dispose of, invest, or use any amount of any Digital Assets” in users Nexo Account.
Pros of custodial lending
Ease of use: These may be viewed as easy to use, and comfortable for beginners with intuitive interfaces, taking the onus of holding your assets.
Additional services available: Given some of them have had a long period of operations, a platform like Nexo, for example, provides a comprehensive bouquet of products, savings accounts, crypto trading, or insurance on deposits.
Fiat integration: Seamless connections to banking systems for fiat loans in a wide range of currencies.
Cons of custodial lending
Trust dependency: This is one of the biggest criticism of custodial lending platforms. You rely on the platform’s security and solvency. Past failures like BlockFi and Celsius highlight risks of hacks or insolvency.
Rehypothecation risk: Some platforms may reuse your Bitcoin for other purposes, increasing risk if they fail.
Limited control: Your Bitcoin is inaccessible during the loan term, restricting trading or other uses.
Then, what is non-custodial Bitcoin lending?
Non-custodial lending platforms, like Firefish, and Hodl Hodl let you retain control of your Bitcoin’s private keys. Your Bitcoin maybe locked in a multisig escrow on the Bitcoin network. Staying true to the ethos of Bitcoin, these platforms do not take control of your Bitcoin through the process of lending.
Pros of non-custodial lending
Enhanced security: You control your private keys, eliminating risks of platform hacks or insolvency affecting your Bitcoin.
Transparency: On-chain multisig contracts are publicly verifiable, ensuring trustless or trust-minimized operations.
Resilience: Features like pre-signed recovery transaction allow collateral recovery if the platform ceases to exist.
Cons of non-custodial lending
Technical complexity: Platforms may require understanding multisig or blockchain transactions, and can seem intimidating for novices.
Fewer features: Non-custodial platforms are increasingly becoming mainstream. However, given they are relatively newer, some may lack extra features that custodial platforms may extend.
Comparing Custodial and Non-Custodial Bitcoin Lending
Aspect | Custodial Lending | Non-Custodial Lending |
|---|---|---|
Control | Platform holds private keys | User retains private keys |
Security | Relies on platform’s security | Typically secured by code (the Bitcoin network) |
Ease of Use | User-friendly, ideal for beginners | May require some technical knowledge |
Risks | Hacks, insolvency, rehypothecation | Smart contract errors |
Transparency | Limited; depends on platform disclosures | High; on-chain transactions are verifiable |
Recovery | Dependent on platform’s solvency | Possible via multisig (e.g., Firefish.io’s feature) |
Which model is right for you?
Non-custodial lending suits Bitcoin holders who prioritize security and control, especially those comfortable with basic blockchain concepts. Custodial lending may appeal to beginners. Consider your risk tolerance and technical skills. For example, if you’re wary of platform failures like BlockFi’s, non-custodial model offers peace of mind.
Conclusion
Choosing between custodial and non-custodial Bitcoin lending depends on your priorities. Custodial platforms like Ledn and Nexo may offer convenience but require trust, while non-custodial platforms like Firefish provide security and control at the cost of some understanding of minor technicalities. As always, DYOR!
Disclaimer: This blog is for informational purposes only, not financial or legal advice. Bitcoin-backed loans carry risks like price volatility and loss of collateral. Do your own research before deciding.
