Can someone explain to me a way of doing two-way encryption with a custom key that is used to encrypt and decrypt something like a password?

Something along the lines of this, but don't expect this to be perfect.

PHP Code:

function key_encrypt($text, $key)
{
    $iv_size = mcrypt_get_iv_size(MCRYPT_XTEA, MCRYPT_MODE_ECB);
    $iv = mcrypt_create_iv($iv_size, MCRYPT_RAND);
    $enc = mcrypt_encrypt(MCRYPT_XTEA, $key, $text, MCRYPT_MODE_ECB, $iv);
    return $enc;
}

function key_decrypt($enc, $key)
{
    $iv_size = mcrypt_get_iv_size(MCRYPT_XTEA, MCRYPT_MODE_ECB);
    $iv = mcrypt_create_iv($iv_size, MCRYPT_RAND);
    $crypttext = mcrypt_decrypt(MCRYPT_XTEA, $key, $enc, MCRYPT_MODE_ECB, $iv);
    return $crypttext;
}

// 16 char keystring
$key = '9a8fy29hf97ewhfd';

// String to encrypt
$string = 'Only a life lived for others is worth living.';

// Encrypted string
$encrypted_string = key_encrypt($string, $key);

// Echo output
echo '<b>Encrypted:</b> ' . $encrypted_string . '<br />';
echo '<b>Decrypted:</b> ' . key_decrypt($encrypted_string, $key) . '<br />'; 


Also read: http://us2.php.net/manual/en/ref.mcrypt.php