Kirill

Blockchain enthusiast developer and writer. My telegram: ksshilov

All Cryptocurrency Exchanges Fail for the Same Reason

There’s a major contradiction in the cryptocurrency world right now. The invention of Bitcoin was supposed to bring about the new age of finance; one with trustless transactions, frictionless cross-border transactions, and censorship-proof Internet cash. 
However, a quick look at the market history of cryptocurrency trading only shows a messy trail of thefts, extortionate fees, scams, government crackdowns, and seized funds. Weren’t these the exact problems cryptocurrency was invented for to demolish?
Source: howmuch.net
The excitement of a growing market has lured traders to crypto, however, technological problems have all but forced traders to use the central cryptocurrency exchanges. But the veil is quickly lifting on the majority of the centralized cryptocurrency market. And what is replacing it will truly change the world. 

Centralized exchanges at first glance

On the surface, the big centralized exchanges seem like they do a great job. Many have good transaction volume, great user interfaces, a wide array of cryptocurrencies, and beginners can get started without much hassle. The larger ones, like Coinbase and CEX.IO, allow you to buy cryptocurrency with multiple payment options and they offer integrated tools and metrics dashboards to make trading easier and more productive. At a glance, everything looks great. 
This is especially true when compared to their decentralized counterparts. In fact, decentralized exchanges haven’t even been a serious option for most traders. The lack of useability alone is enough to deter all beginners. 
Then there are the aspects of traditional finance that traders love. Things like insurance for exchange funds, fund custodial services for organizations, and trading tools like margin trading and leverage. All these aspects add up to what seems like an easy choice for crypto traders. Until you dig a little deeper... 

A quick look at the history shows repeated, persistent problems

An estimated $1.7 billion in funds were stolen in 2018 alone, followed by the multiple hacks of hundreds of billions of dollars in 2019. 
Below is a quick timeline of the major cryptocurrency exchange loss events and the estimated value at the time. (Yes, this is indeed the “quick” version).
  • Bitcoinica 2012 - $430,000
  • Mt. Gox 2014 - $450 million
  • Poloniex 2014 - 12.3% of Bitcoin funds
  • Bitstamp 2015 - $5.1 million
  • Bitfinex 2016 - $72 million
  • YouBit 2017 - 17% of all crypto assets
  • Nicehash 2017 - $60 million
  • Coincheck 2018 - $400 million
  • Bitgrail 2018 - $195 million
  • Coinsecure 2018 - $3.3 million
  • Coinrail 2018 - $40 million
  • Ziaf 2018 - $60 million
  • Bitrue 2019 - $5 million
  • Gatehub 2019 - $10 million
  • Cryptopia 2019 - $16 million
  • CoinBene 2019 - $45 million
  • Bithumb 2019 - $13 million
  • Coinbin 2019 - $26 million
  • Binance 2019 - $41 million
Some were direct hacks of the exchange platform, some were exploits of external tools (e.g. wallets), some were internal issues that lead to theft, and some are seizures by government entities. These loss events seem to be getting worse, and exchanges repeatedly fail to learn from the past mistakes of others. 
Looking at the list above, it's easy to see the stark contrast between Bitcoin’s original promise of cheap, secure, anonymous transactions and reality. Add to the fact that most of these exchanges now require identity verification and fees, this vision seems completely lost. 

There’s a fatal flaw

All of these problems can be traced back to the same root. The infrastructure for true cryptocurrency trading has been slower to develop than the media hype and excitement of traders.
Cryptocurrency is attractive to FOREX traders because it’s a relatively immature market. Prices and market movements are heavily influenced by news, sentiment, panic, etc., and this is a big opportunity for experienced traders who can keep their cool. 
Source: news.bitcoin.com 
However, the scalability of blockchain technology and decentralized infrastructure has been slow to develop. In order to satisfy the global demand for fast crypto trading, centralized exchanges had to take the vast majority of transactions “off-chain”. 
In doing this, they inadvertently created the “Frankenstein” model of cryptocurrency exchange; where the currencies themselves are decentralized, but the trading of those currencies is anything but. You have to hand over your identity and funds to central actors, which then also brings you under the purview of regulators as well. Funds accumulate in the millions and even billions on these trading platforms, creating irresistible honey pots for thieves and even the operators of the exchange. 

Things can only get worse

As cryptocurrency trading is going to get more popular, more funds will flow into the system. As they do, the current flaws of crypto exchanges will become even more exposed. 
As tens of billions worth of currency accumulates in the hands of a few, regulators will start to come down... hard. Hackers will have the most alluring targets that have ever existed, but luckily, as mentioned earlier, funds on Coinbase are insured. However, if you look a little deeper, you’ll see that only the 2% that is stored in their “hot wallets” is actually insured. The rest is stored offline on USB drives and on paper, completely uninsured. Sure, offline storage is much safer, but are you willing to bank your own cash that a sophisticated criminal organization or insider won’t find a way to steal hundreds of millions of dollars worth of crypto stored on a few USB drives?
Founder of Ethereum Vitalik Buterin summed up the problems perfectly when he said, “I definitely hope centralized exchanges go burn in hell as much as possible.”

Decentralized exchanges: the emerging way forward

True decentralized exchange platforms don’t suffer from having a central point of failure. There’s no pool of millions of Bitcoins to target. There’s no point where a founder can decide to jump ship and take off with user funds, and there is no central group of organizers for regulators to target, or even a physical place that’s running the servers for an exchange. 

Infrastructure: The Hold Up

Decentralized currencies are built to be traded on decentralized exchanges (DEXs). The problem has been that the infrastructure (DEXs and their networks) haven’t been able to scale to meet demand. Yet. 
It’s a similar story to making phone calls on the early Internet. Back then, the Internet was impossibly slow, unreliable, and couldn’t deliver the same level as service as the phone company networks. People said it was unusable and would never compete with traditional telecommunications. But, of course, the Internet eventually did overtake the phone networks in performance and reliability. Now there is no point in even comparing the power of the modern Internet to the old telecom infrastructure. 
Source: stateofthedapps.com
But that’s all starting to change now. Decentralized exchanges are gaining traction in the market. The viability of the technology is catching up with demand. Partial decentralized exchanges like IDEX are offering faster trading experiences for traders. Binance, one of the largest centralized exchanges is also getting in on the action. It has launched its own decentralized exchange, Binance DEX, that they say aligns with the “industry’s long-term vision of peer-to-peer trading.” 

Coherence of trading tools

Another key reason holding traders back from using decentralized exchanges is the lack of coherence in the tools. Traders are used to logging in to their trading account to see their current trades, their funds in the relevant currencies, and the market metrics all in front of them on their trading dashboard. This kind of integration is common with centralized exchanges that control the whole platform, but not with DEXs. 
One very interesting solution to this problem is coming from Volentix.io. It’s an ecosystem of disparate development teams across the world, all working toward the common goal of a decentralized exchange complete with an exchange platform, multi-currency integrated wallet, a metrics dashboard, and a community platform all designed to work together. 
The way they are pulling it off is with an innovative decentralized form of governance and Distributed Autonomous Organization (DAO). The Volentix platform’s native currency, VTX, incentivizes contributors to the platform to work together towards the common goal of increasing the value of VTX and bringing new users to the ecosystem. For traders, this means better integrated trading tools without centralization. 

There will be no going back

For now, centralized platforms still has the upper hand when it comes to speed, volume, and day-to-day usability. But it’s becoming increasingly clear that they are just a band aid solution while the true decentralized infrastructure is being built. 
Soon, all traders will be forced to ask themselves:
  • Why pay for insurance when I don’t need to? 
  • Why pay a middleman when I don’t need to? 
  • Why risk high-profile theft when I don’t need to? 
  • Why risk handing over my identifying documents when I don’t need to?

True crypto trading is coming

The cryptocurrency market has certainly exploded in popularity, evidenced by the fact that the market valuation is now in the hundreds of billions of dollars. But so far, what has cryptocurrency really added to the world of trading other than some new currencies, wild news headlines, and insane losses for millions of victims? 
Source: xkcd.com
The answer is not much yet. But with decentralized exchanges becoming faster and more complete every day, that is bound to change soon. Just like how the right infrastructure brought out the best in our digital devices, decentralized infrastructure is about to bring out the true purpose of our decentralized currencies. And it’s going to be epic. 

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