Custodial lending refers to the crypto lending, where the user does not control his assets (the platform has the user’s private keys). The user deposits his assets into the platform and the platform has access to the user assets. The user will receive interest payments on his assets.
The opposite is non-custodial lending, where the user controls his assets. This means that the platform does not have the user’s private keys. That’s more aligned with the philosophy of the blockchain, where every user should control his assets and only submit assets to specific transactions. However, the user should never give full control of his assets to third parties.
Custodial lending has 80% of the crypto lending market. A platform user has to deposit their crypto into the platform wallet. The platform will lend users assets either in the peer to peer mode or will consolidate them and will lend them via the OTC (Over The Counter) to the counterparties. Or the platform will lock these assets as crypto collateral and will lend fiat or stablecoins. The borrower will receive either crypto, stablecoins, or fiat on this platform. When the borrower is not paying his loan, then the collateral will be liquidated.