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Decentralized exchanges make crypto unstoppable — so why aren’t they catching on? » Brave New Coin

Decentralization is key to the rise of cryptocurrencies. It’s a common refrain of blockchain professionals — one uttered at every conference and echoed throughout media coverage of blockchain. However, the on-ramps to the cryptocurrency economy remain centralized single points of failure. Though highly secure, even the most widely used exchanges exhibit the vulnerabilities present in all centralized systems.

Attacks, bans, and blocks have been widely publicized, with the resulting skepticism and suspicion acting as a barrier for new investors.

The cryptocurrency economy is currently worth $280 billion. Its growth has been fueled by the promise of a more secure and individualized form of value distribution. The key to this growth — decentralization — has the potential to eliminate any single point of vulnerability in the economy and return market power to individuals.

For the most part, this potential for a more robust economy has been fulfilled. Cryptocurrencieshave enabled users to store and transfer digital assets with confidence. Security breaches of cryptocurrency networks themselves have been rare. If networks like Bitcoin could be easily hacked, they simply would not have survived.

Cryptocurrencies have also shifted power back into the hands of individuals. The distribution of data across a complex web of participating devices (“nodes”) has created the possibility of eliminating the requirement for middlemen such as banks, brokers, and lawyers to act as trusted third parties, validating and recording who has what.

But in reality, these benefits have only been felt when sending tokens between trusted individuals on the same network (e.g., sending bitcoin from one friend to another). As transactions are irreversible, sending currency to a stranger’s wallet with the expectation of receiving assets in return can be risky. Nothing ensures the seller will provide these assets after you pay.

Reputation has been important — peer-to-peer (P2P) or over-the-counter (OTC) exchanges including LocalBitcoins have provided the backbone for a cryptocurrency retail market, enabling trust in wallet-to-wallet transactions through reputation-based review systems. Nonetheless, the inherent risk involved in P2P transactions increases fees and acts as a barrier to high-volume trade and investment.

Centralized exchanges have thus been essential to the formation of a widely functioning cryptocurrency market. These exchanges facilitate trust and enable liquidity by operating fundamentally as escrow services. Instead of sending coins directly to a wallet and waiting nervously, both parties make deposits to the exchange and can only gain access to what they are owed once a transaction has been finalized on both sides.

But while exchanges such as OKEx, Binance, and Bitfinex have been a vital onramp to investment in this burgeoning virtual economy, they suffer from the same core security weaknesses as any centralized system. Whereas cryptocurrency data is distributed and copied throughout the blockchain, all personal passwords (“keys”) to access funds stored at an exchange lie on a single bundle of centralized servers. This brings a single point of potential failure into an economy designed to eliminate such flaws.

The difference in the degrees of security that can be achieved by decentralized and centralized systems is significant. Centralized exchanges have shown susceptibility to hacking, corruption, government bans, and data loss. Though centralized exchanges are theoretically no more vulnerable than traditional centralized banks, the lack of regulation and insurance in the crypto space means if you lose assets, you are unlikely to retrieve them.

Not only is the security of the crypto economy compromised by centralized exchanges, but many see them as antithetical to its core culture and philosophy. Decentralization promised to give individuals increased control of their assets, taking power away from the typical market makers and breakers of the world. But exchanges are ultimately run by people.

At any time, those involved in maintaining and regulating a centralized exchange infrastructure could use their influence to bar access to funds, or worse. I’m not attempting to say that any of the major exchanges plan to do this, but it is a single point of failure that can be removed.

Of course, there are plenty of decentralized exchanges (DEXs) out there, even if they are heavily outnumbered by their centralized counterparts. But adoption has been problematic. The largest DEXs, including IDEX and Waves DEX, have struggled to achieve volumes to rival the top centralized exchanges. Although decentralization may solve the security issues faced by their commonly used alternatives, there have been other elements hindering the scalability of decentralized exchanges.

Primarily, the technical hurdles in the way of decentralization have been high. Computing power is a core issue with blockchain networks, as it is shared. Transaction data traditionally processed by a bunch of hard drives must be copied and verified by multiple computing devices to achieve secure distribution. This multiplies the power required to complete a single transaction exponentially across the network, which is why the current iteration of Ethereum struggles to handle more than 25 transactions per second (TPS).

And it’s not just transactions that must be hosted on the blockchain for true decentralization. To secure passcodes and assets, much of the complex programming that ensures the proper functioning of an online exchange must also be hosted and run on the blockchain. It is no understatement to say that reaching the speeds required for a distributed computing network to host and run entire decentralized exchanges has been the biggest technical challenge to developers since cryptocurrencies’ inception.

 

Category

Centralized or
decentralized?

Estimated Transactions
-per-second (TPS)

Binance

Exchange

Centralized

1,400,000

NASDAQ

Exchange

Centralized

1,000,000

Visa

Payment network

Centralized

56,000

Ripple (XRP)

Payment network / distributed ecosystem

Centralized

50,000

Internet of Services (IOST)

Payment network / distributed ecosystem

Decentralized

8,000

NEO

Payment network / distributed ecosystem

Decentralized

1,000

Internet of Things (IOTA)

Payment network / distributed ecosystem

Decentralized

800

Paypal

Payment network

Centralized

193

Waves DEX

Exchange

Decentralized

100

Bitcoin Cash

Payment network

Decentralized

61

QTUM

Payment network / distributed ecosystem

Decentralized

60

IDEX

Exchange

Decentralized

50

Bitcoin

Payment network

Decentralized

7

 This links into the front-end roadblock to attracting decentralized exchange users: market maintenance. To ensure liquidity (i.e., that there are enough buyers and sellers), centralized exchanges often employ temporary maintenance measures such as rewards for investors, even using their own capital to give the market a boost. For decentralized exchanges to achieve a competitive degree of liquidity will require complex automated market maintenance, further increasing demand on the network.

But the landscape is changing. The evolution of blockchains to support distributed apps (DApps) and self-executing contracts (smart contracts) may soon provide the complex functionality for decentralized exchanges to compete with their centralized counterparts. Ethereum has played a central role in this evolution, and focusing on speeding up the network has been its primary focus since 2017.

But Ethereum’s current scaling initiatives, which include running transactions “off-chain” (i.e., not on the blockchain), have been criticized for compromising on security. More recent projects on the rise, including IOST, NEO, and Qtum, offer promising alternatives to improving cryptocurrency infrastructure without such a compromise.

Rising venture capital support for future-first projects is also reassuring. With institutional investment comes market confidence, standardization, and positive regulation. Many blockchain startups lack the influence and market-making power these VCs are known for. With backing from established VCs such as Sequoia China it may not be long before we see some of these projects advancing blockchain technology beyond its current limitations, bringing forth further institutional investment, and securing and legitimating the virtual economy for the future.

It has long been clear to crypto fans, investors, and developers that high-volume, decentralized exchanges are needed for the cryptocurrency market to scale to mass adoption. There are those who have made predictions regarding this timeline — some say it will be 15 years until we see cryptocurrencies used widely, while others say 20.

At IOST, we are trying to shorten that timeline considerably by building an ultra-high TPS blockchain infrastructure to meet the security and scalability needs of the decentralized economy. Our mission is to be the underlying global architecture for the future of online service providers, with decentralized exchanges as a key feature of that future.

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