Last week a crypto exchange manager was kidnapped outside his office.
Reportedly ransomed for over $1 million of Bitcoin, this marks the latest event in the turbulent history of centralized exchanges.
From hacks to scams, centralized exchanges have cost the community billions of dollars. We need change, and the solution may already be here.
But what is a decentralized exchange? And how would it help?
Centralized exchanges provide a service. Users send their crypto to the exchange wallet, trusting that they will get it back. Good exchanges offer a broad range of cryptocurriences to trade, and are often user friendly. They draw enough users to build up liquidity, meaning that cryptos can be exchanged easily, avoiding high volatility. In exchange for this service they often charge fees both for individual transactions, and for withdrawing crypto from the exchange.
But, in providing this service, centralized exchanges present an irresistible target for hackers and criminals. Even with the bulk of user funds in inaccessible ‘cold storage’, there can still be pots of crypto worth billions that hackers can walk off with. We don’t need to look far back to see the chaos centralized exchanges have caused -the infamous Mt Gox hack cost users 850,000 Bitcoins ($12.7b at todays price).
Decentralized exchanges remove the target. They allow users to exchange cryptocurriences without having to trust a third party. You are solely responsible for your crypto (private keys). At all times.
They achieve this through smart contracts that send tokens peer to peer, without the need for a trusted, central third party.
Early decentralized exchanges are gaining popularity, however they have not been free from controversy.
Last month popular exchange EtherDelta was compromised by a hacker. The attacker managed to phish a small number of users private keys, manipulating the DNS to create a replica site that directed funds to a private wallet.
Whilst unfortunate, the fact that EtherDelta was decentralized, without third party ownership of private keys, reduced the scale of the damage significantly. The hacker was only able to access the funds of a small number of uses, making away with 308 Eth, worth an equivalent $300,000 today. A small sum, relatively speaking. The lesson to be learned here is to always bookmark an exchanges URL, and never click an unverified link to an exchange. Attacks have not been the only limitation.
The Low liquidity issue
Whilst it has enabled users to trade any ERC20 (ethereum) token they wish to add, EtherDelta’s design and perceived difficulty to use has led to low adoption. This has meant low liquidity, preventing the exchange from competing with high resourced centralized exchanges.
Fortunately, new developments in smart contract technology are overcoming this barrier.
The 0X Project have created a protocol that can connect multiple decentralized exchanges, relaying buy and sell orders off-chain. Through this, the order books of all decentralized exchanges using 0X can be pooled, meaning high liquidity and easy trading. There are several decentralized exchanges in development, including the long awaited Ethfinex, RadarRelay and Paradex. Open betas are currently ongoing, with working products in sight.
Whilst this protocol is currently only for ERC20 tokens on the ethereum network, the team plan to add compatibility for all cryptocurrencies. They envision a tokenized future where all stocks, and even physical assets such as gold, are exchanged through decentralized exchanges.
Decentralized exchanges promise a future where the danger of malicious attacks can be severely reduced, if not completely eradicated. And, with the total market cap of cryptocurrencies nearing $1 trillion, we need to know our cryptocurrency is always safe, now more than ever.