The Spotty History of Central Exchanges
Exchanges play a pivotal role in the cryptocurrency marketplace. They enable investors to exchange fiat money for cryptocurrency, exchange one type of cryptocurrency for another, or turn cryptocurrencies back into fiat money. Most of the first generation of cryptocurrency exchanges, such as Binance, Coinbase, Bittrex, and others, are centralized, meaning that they use a centralized architecture to implement their business.
When you read about huge cryptocurrency losses due to hacking, they never occur within the distributed blockchain architecture of the cryptocurrencies themselves, which was designed to be essentially unhackable. With few exceptions, these huge losses have occurred within exchanges. Given that total market capitalization of cryptocurrencies has reached as high as $750 billion, they are not an altogether surprising target for cybercriminals.
The sole successful hack of bitcoin code occurred in 2010 when, due to the exploit of a number overflow error, 92 billion bitcoins were created suddenly as if by magic. Fortunately, the bitcoin community was able to cancel all these transactions and rollback the bitcoin blockchain to its original state. Needless to say, the coding problem was quickly rectified.
Since then, most of the damage has been done to centralized exchanges. One huge loss was experienced in 2016 on the Bitfinex exchange, when 120,000 bitcoins were stolen. At the time, that was a loss of about $72 million. At today’s valuation, the loss would be nearly ten times that amount. As a result, bitcoin immediately lost 20% of its value.
The largest exchange hack to date is the infamous Mt. Gox attack. This crypto exchange was the world’s largest, handling nearly 70% of all bitcoin transactions. In 2014, it was discovered that hackers, over a period of three years, had stolen 750,000 bitcoins from this exchange. Sadly, this was not the first time Mt. Gox had been the victim of a hacking attack, having experienced an initial and significant loss of bitcoin back in 2011.
Numerous other exchange hacks have made the news in recent years, including the DAO in 2016, which victimized Ethereum and their Ether currency; 2017’s NiceHash hack which occurred on this Slovenian exchange; and 2018’s Tokyo’s Coincheck exploit, which occurred just this last January and involved the popular coin NEM.
It could be said that centralized exchanges violate the basic tenets of the decentralized crypto economy. In contrast, decentralized exchanges, called DEXs, use an underlying architecture that is very similar to that used successfully by blockchain to permanently secure and make transparent all its transactions. As with blockchain networks, control is distributed out to all the users of the network, eliminating the single point of failure inherent within centralization. The most important aspect of a DEX is, of course, its security. Every transaction is protected against intrusion, hacking, or unwanted oversight, just as with the cryptocurrency networks themselves.
A good example of this is ZeroX or 0x. This is an open source protocol that sits on top of the Ethereum blockchain. It was modeled after one of the first Ethereum-based decentralized exchange implementations called EtherDelta. 0x is essentially an improvement of EtherDelta code and capabilities, and includes documented smart contracts, off-chain order management, and more available trading mechanisms.
IDEX is another popular decentralized exchange. It allows its users to easily trade ERC-20 compliant tokens (a technical standard on the Ethereum blockchain network) and provides a much friendlier user interface than EtherDelta or EtherDelta-based systems.
Waves Dex is somewhat of a hybrid system, using both centralized and decentralized functionality in an attempt to provide the best of both worlds. It is built on top of the Waves blockchain, enabling users to deal in bitcoin, Ether, and other tokens supported on the Waves network.
Cryptobridge Dex is one of the newer decentralized blockchain networks. It runs on top of the BitShares blockchain network. It makes use of a decentralized blockchain-based order book with a multi-signature gateway network. It’s web-based wallet is also decentralized, thus offering an additional layer of security to its currencies. Another advantage is that it accepts dozens of different tokens, both the well-known and the obscure.
OpenLedger Dex, which also runs on the BitShares network, is another good example of a decentralized exchange, though in some ways it’s much more than just an exchange. It is actually a collection of ecosystems, with OpenLedger Dex at the center. OpenLedger Dex permits users to store, trade, and send BitShares, and also allows for converting bitcoins to fiat-pegged SmartCoins, which can be withdrawn directly to cash through a money order. However, surrounding the exchange are an advertising technology called HubDSP (demand side platform), tokens called OBITS, and a crowdfunding system called ICOO, and many others. Together, these services are known as the ecosystems of OpenLedger DC.
State of the State
Numerous problems have been reported with many of these distributed exchanges. User interfaces are often overly complex, difficult to understand and use, and poorly documented if at all. Customer support can also be spotty and unsatisfying to users who encounter difficulties trying to use the exchange. System downtime, which prevents users from executing their transactions on the network, can be infuriating and disheartening. However, it’s important to remember that at this point this is more of an emerging technology than a tried-and-true solution, so problems should be expected, even as those exchanges that stay the course will be successful in correcting them.
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Should Exchanges be Decentralized? was originally published in Data Driven Investor on Medium, where people are continuing the conversation by highlighting and responding to this story.