Custodial vs. Non-Custodial Apps: Which Side Are You On?

In 2020, we introduced two new developments to Stellar:

• CAP-27: First-class multiplexed accounts, which was included in Protocol 13, allows services to map a single Stellar account to multiple users. It could make custodial solutions a lot easier to build.
• SEP-30: Account Recovery: multi-party recovery of Stellar accounts defines an API that enables a user to regain access to a Stellar account after losing the private key without providing a third party control of the account

Although both developments make it easier for businesses to build either custodial or non-custodial solutions, there's still some missing infrastructure necessary to support CAP-27 and/or SEP-30, and building it out would require a lot of coordination, resources, and assistance from both the SDF and the ecosystem as a whole. As a result, SDF was curious to see which approach they should prioritize supporting.

Non-custodial solutions uphold a philosophy of financial sovereignty that many users find attractive about blockchain. Blockchain itself relies on the premise of trustless trust.

Moreover, businesses have a lot to gain from building non-custodial solutions. Meinhard points out how SatoshiPay, as a provider of a non-custodial solution, can move a lot faster in terms of releasing products to the market in various forms: a B2B cross-border money transfer service, a micropayment service for content, and the Solar Wallet (an open-source Stellar wallet). This in itself demonstrates the versatility and power of building on blockchain, as businesses are able to pressure-test use cases against markets and see where the appetite really is for financial products and services.

Meinhard also points out how, if users are responsible for their own keys, businesses are relieved of huge overhead in terms of potential regulation or obligatory regulatory requirements they’d have to fulfill with a third party partner. Because of the lack of these regulatory constraints, users are able to handle bigger transactions – a big plus for corporations.

As ideal as trustless trust sounds, another truth remains: if people find a product difficult to use, they won’t want to use it. Financial inclusion and equitable access to the global financial infrastructure are important to us, so it’s not hard to see the appeal of custodial solutions.

As an anchor, Saldo supports both non-custodial and custodial solutions. However, it also supports “SMX” – a custodial wallet service that allows Mexican workers in the U.S. to send money back to Mexico and hold it in Mexican pesos digitally. Since this audience is not tech-savvy or part of the crypto community at all, they care more about ease of use rather than holding financial sovereignty in blockchain.

While Marco from Saldo is philosophically aligned with non-custodial solutions and doesn’t see the need for custodial solutions for single-asset blockchains like BitCoin, he sees great market opportunity for representing real market assets and allowing exchanges and transfers in Stellar. This inevitably requires companies and regulated entities to hold value for their users to participate.

By removing the need to manage keys from the users, companies are able to provide a more seamless user experience. Additionally, participating in the ecosystem helps develop regulatory standards and benefits those building custodial solutions on the Stellar network.

Christian from DSTOQ illustrates what other factors contribute to whether a product will be more useful as a custodial vs. non-custodial solution, using DSTOQ as an example. There are two ways to use DSTOQ’s technology.

The first involves an API layer that DSTOQ is built upon according to the Stellar protocol. In this case, it doesn’t matter as much to DSTOQ how users protect their keys if they’re only using their Stellar accounts to trade assets. These users are presumed to be familiar with Stellar and practicing self-key management.

However, DSTOQ’s other product, a mobile app, is deliberately targeted towards emerging markets that have a mobile first approach. The app is not targeted towards crypto users, and are instead targeting non-crypto users who are new to investing, The concept of creating and managing a private key is not immediately intuitive, which means non-custodial solutions tend to see a drop-off when users go through onboarding and have to create an account.

Meinhard acknowledges that custodial and non-custodial solutions each have their pros and cons, and even a hybrid approach could work effectively.

After all, the biggest con of a non-custodial solution is that if users lose their secret keys, they effectively lose access to their accounts and assets. However, if a key recovery mechanism like SEP-30 or the new proposal CAP-35, which involves time-locked “asset clawbacks,” could be effectively deployed, businesses can quickly develop non-custodial solutions and allocate funds normally used for regulation towards other business costs such as distribution.

However, a hybrid solution will still require a robust legal and regulatory framework on top of changes to the existing technical framework. Many will still seek the best user experience possible for their needs, so education and good design are still of utmost importance when building a product for your audience, whether they are experienced with blockchain or not.

This roundtable session is just the beginning of an ongoing discussion. Whether you're looking to issue an asset, provide services, or start building a new application from scratch -- we encourage you to join the community. Stop by the Stellar Keybase team, check out the events page, and make sure you register for Meridian 2020!