The quick growth of cryptocurrency exchanges has led to many hiccups. Lost funds, hacks, delayed support, and higher fees are just a few of the problems that centralized exchanges have struggled with over the years, and these problems were crystallized in 2017. The solution could be a natural extension of cryptocurrencies: decentralized exchanges.
THE MANY PROBLEMS OF CENTRALIZED EXCHANGES
Cryptocurrency had a banner year in 2017, but there are clear-cut issues in the space heading into 2018. As the market cap swelled and numerous coins hit all-time highs, a wave of new money flooded into exchanges like Coinbase. And exchanges have hiccupped considerably. Lost funds, hacks, delayed support, and higher fees are just a few of the problems that centralized exchanges have struggled with over the years, and these problems were crystallized in 2017. The solution could be a natural extension of cryptocurrencies: decentralized exchanges.
Since its origin, cryptocurrency has been bought and sold through centralized exchanges. Coinbase is one of the most popular, and the one new investors likely use. Bittrex, Poloniex, Binance, and Kraken are other big names in the space. These exchanges are easy to use. They have high liquidity, and offer most coins. But they’ve had inherent problems for years, and many new investors learned this the hard way in 2017.
Exchanges are a gigantic target for hackers. When coins are left on exchange, which many new investors do, the exchange holds your private keys. If a hacker gets them, the coins are as good as gone. Mt. Gox, an early Bitcoin exchange, was hacked in 2014, and 850,000 Bitcoins were stolen. Those coins would be worth around $12 billion today. Bitfinex, another exchange, had 120,000 Bitcoins stolen last year. Exchanges have improved their security, but the more money comes in, the more motivation there is for hackers.
There are also day-to-day problems. Exchanges have had trouble scaling up in 2017, which is understandable given the huge increases in volume many are seeing. Coinbase notoriously crashes whenever its coins move drastically, which is often just when people want to buy or sell. Deposits are taking longer and longer to clear, and fees have shot up. Coinbase even saw accusations of insider trading, after Bitcoin Cash saw drastic movement before it was added. Centralized exchanges can be regulated or outright banned, like in China. Investors are searching for a better way.
ENTER DECENTRALIZED EXCHANGES
Bitcoin was created as an alternative to centralized banking. It’s only natural that decentralized exchanges have sprung up to replace centralized exchanges. Decentralized exchanges are exchanges hosted on blockchain networks. They offer the same services as regular exchanges. But private keys and coins aren’t stored on centralized servers, making them tougher targets for hackers. They aren’t hosted in a specific country, so they can’t just be banned. Decentralized exchanges are appealing for many of the same reasons cryptocurrencies are.
EtherDelta, BitShares, Kyber, and Airswap are a few decentralized exchanges. More are springing up everyday, and some of them target a niche by offering tiny coins, that aren’t on the radar of big exchanges yet. One of the more interesting exchanges is offered by the team behind NXT and Ardor, coins we’ve profiled extensively in the past. NXT and ARDOR allows users to buy and sell almost anything you can think of. Patents, bonds, stocks, movie tickets, legal licenses, and commodities are just a few of the use cases listed on their site.
Another big innovator in the space is Loopring. Although not technically a decentralized exchange, the Loopring protocol offers many of the same advantages to decentralized trading. We’ve written an in-depth article about the Loopring protocol here.
THE DEBATE AROUND DECENTRALIZED EXCHANGES
One of the big appeals of Bitcoin and cryptocurrencies is that they’re significantly more difficult to regulate than fiat. Crypto investors in China were left high and dry when the country shut down exchanges. Coinbase is an American-based company, and the government could easily demand user information or financial records. In fact, recently the IRS ordered Coinbase to hand over user data and the IRS won. Whether or not a government should be able to interfere with an exchange is a debate we won’t get into. But users who value their privacy and freedom have been drawn to decentralized exchanges.
Like cryptocurrency, decentralized exchanges aren’t perfect, and they’ve had growing pains of their own. Decentralized exchanges don’t yet have the trading volume big exchanges do, so liquidity is considerably less. Cybersecurity expert John McAfee recently cautioned that decentralized exchanges could make it difficult for governments to track and regulate cryptocurrency purchases. Again, to some this may be a plus, but it could also lead to more governments attempting to blanket ban any use of cryptocurrency. We’ve already written on some of the most crypto-unfriendly governments out there.
Decentralized exchanges may be safer than centralized. But that doesn’t make them risk-free. Just ask users of EtherDelta, who had some $260,000 stolen from them just before Christmas. 308 Ether and an unknown number of smaller tokens were stolen, a considerable sum given the smaller total volume of decentralized exchanges. A hacker replaced EtherDelta’s site with a fake but identical version, duping investors into sending funds. Decentralized exchanges clearly still have some kinks to work out.
Despite the warts, decentralized exchanges are a groundbreaking change in the crypto world. Scaled up and made user-friendly, they could pose the same threat to traditional exchanges, that cryptocurrency does to traditional banks. Watch out, Coinbase.
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