Monday, 13 July 2020

The Need for Decentralized Exchanges

As we know, Binance, the largest cryptocurrency exchange by trading volume, was hacked this week. Nothing like a major hack to remind us why the crypto world needs a Decentralized Exchange (DEX) now more than ever.
Below, I address some of the glaring problems associated with a market that is too dependent on centralized entities.

Perhaps one of the most compelling arguments for a decentralized exchange is empowerment. Specifically, the empowerment of individual investors, not centralized authorities. As of this moment, if an individual is interested in accessing some of the more popular digital asset exchanges, they are forced to relinquish a great deal of the power digital assets are supposed to confer.

Think about it. One of the animating features of the Bitcoin protocol is to allow people to transact in a trustless, peer to peer manner. Unfortunately, when you are trading on a conventional exchange, the idea of trading peer to peer all but evaporates. What is left is an illusory promise of payment for whichever asset one is trading.

For example, when one submits an order to a centralized exchange, they aren’t actually submitting a buy or sell order bid in Bitcoin, Ethereum, or any other digital asset. Instead, they are signaling to the platform that they wish to meet a certain bid price or asking price that may or may not accurately reflect the market conditions. In fact, the entire methodology by which maker and taker books set prices is pretty much up to the exchange. Basically, the user is trading in intermediated IOUs rather than an actual order for a digital asset.

Often, the illusory nature of this “IOU” arrangement is not appreciated until investors try to withdraw their funds. Why is it that some exchanges have relatively low withdrawal times while others can take days? Do these exchanges actually have the amount of Bitcoin on hand that their order books require? I shudder to think about how the market would react if major exchanges were found to be taking orders in this IOU setup, and then only buying “real” assets once a withdrawal is initiated. In other words, the solvency of these entities is up for debate, and by extension, the health of the cryptocurrency ecosystem as a whole. Does any of this sound a lot like the legacy financial system?

Another major issue with these centralized entities is that they demand that users cede their privacy in exchange for access. For instance, entities such as Coinbase or Kraken demand identification documents for Know Your Customer (KYC) rules. Speaking personally, I once had my account frozen by an exchange, only to find out that my account had been frozen until I provided the requisite documentation. Goodbye, privacy! My assets were being held hostage. What else was there to do?

Lastly, I think we need to have a frank discussion about scalability. During the last epic bull run, a number of exchanges were nearly broken by an onslaught of new users. I hate to think that the explosive growth that we celebrated was actually being constrained by the fact that a few exchanges lacked the manpower or server capacity.

Fortunately, it is not all doom and gloom when it comes to centralized entities. A number of exchanges are improving and streamlining their signup and support systems. Furthermore, I am optimistic about the very real possibility that DEXs and centralized exchanges can happily co-exist, compete, and bring improvements to both sets of users. In the same way that one blockchain is unlikely to reign supreme or “rule them all”, it would be foolhardy to say that one type of exchange will completely dominate the market.

What is likely to emerge is a constantly evolving collection of DEXs, Centralized Exchanges, and Semi-Centralized Exchanges. Members of the world’s various diasporas will likely use DEXs for their privacy and negligible fees. Meanwhile, legacy financial institutions will inevitably begin to embrace the blockchain via tokenized securities of the fungible and non-fungible variety. Ideally, whenever one type of exchange implements a feature that empowers the user, the other exchanges will do the same.

On behalf of the Stakenet team, I hope that you are as excited as I am about our decentralized future. Please keep an eye out for updates and announcements regarding Stakenet DEX, a truly peer-to-peer exchange.

Thank you to Sandy, a long-term community member of Stakenet, for the following article.

By Stakenet Team
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