To understand the concept of decentralized exchange (dex) and we need to dwell on the idea of what is a centralized exchange. A centralized exchange is a service where one can buy cryptos from centralized authorities in exchange for fiat or other cryptos. These centralized exchanges are generally custodian in nature and control the funds of users on their behalf. Since being a custodian in nature they provide hackers sweet honey spots to hack into and history is great evidence for it. Ok let's discuss the problem related to them
Vitalik Buterin: “I definitely hope centralized exchanges go burn in hell as much as possible”
John McAfee: Centralized Exchanges Will Disappear, DEXs Will Drive Crypto
Irresistible Hacks and dark past
Most of the centralized exchanges are hold the funds of users on their behalf. They store these funds in the centralized hot and cold wallet, This design principle accumulates lot value at single place providing honey spots which is hackers paradise.
- $500 million worth of NEM stolen from Coincheck — The 2nd largest exchange in Japan
- $31 million dollars of cryptocurrency was stolen from bithumb
- the famous $472M Mt. Gox security breach
- $195 million hacked from BitGrail — Italian exchange
- $72M Bitfinex hack
- $45 million hacked from Binance — One of the largest global exchanges
- $40 million stolen in Coinrail hack — A boutique exchange in South Korea, including $19.5 million of Pundi X tokens (NXPS), $13.8 million of Aston X tokens (ATX), $5.8 million Dent tokens (DENT) and $1.1 million of Tron tokens (TRX).
- $60 million hacked from Zaif — Exchange in Japan
- record-breaking $530M Coincheck theft,
They not only hold your funds but your identity too
Since they are central authorities managing the funds they are forced KYC/AML requirements to comply with government regulations and restrictions. Governments or regulations can anytime compel them to reveal identities or close their shutters.
What happens if they disappear overnight?
I am sorry pal, everything you invested are gone up with them. These events are not hypothetical but have actually occurred in past.
- Poland’s oldest exchange Bitcurex disappeared all of sudden. Around 2,300 bitcoins went missing, although it remains unclear what has happened exactly. All of the company’s social media accounts have been deleted in the process as well.
- China-based bitcoin centralized exchange GBL in November of 2013 suddenly went offline. Many people initially anticipated this was due to some hack, but it became evident the operators simply ran off with US$4.1m worth of bitcoin.
I am the boss
Since centralized exchanges control your funds, they can any time freeze your account for no valid reasons. Not only this they many time will set up a withdrawal limit on crypto or fiat. If freezing also doesn't suffice you got to maintain a minimum deposit with them and will charge unrealistic fees on both sides of trades.
Custodian Nature Problems of a centralized exchange
QuadrigaCX exchange lost $190 million dollars ($145 million) in digital assets, following the death of its founder who had access to the private keys on Feb 1, 2019
Crypto Exchange QuadrigaCX Missing $145 Mln After Death of Founder
Why decentralization is the answer?
We have seen there are tons of problem that are associated with a centralized exchange. They come usually with good UI/UX and speed which is basically wolf in sheep clothing. All these problems can be sorted if we leverage the power of blockchain technology and apply it to centralized exchange yielding us decentralized exchange, a true boon. Let's discuss why humanity require decentralized exchanges.
1) Privacy — one of Dex’s ornament
Since most of the decentralized exchange operates on protocols, sidechains or layer2 scaling solutions they typically do not require any form of sign-up process and thus do not collect any of your personal data. Since there are no centralized agencies that qualify as a money transmitter, meaning government regulations and restrictions cannot compel KYC/AML requirements.
In future the current regulatory environment will adapt to this new kind of exchanges, the only possibility could for its malfunction would be smart contract design flaws and bugs. As of now, it is possible to trade anonymously on decentralized exchanges.
2) Security(Dex) >>> Security(Cex)
We have already seen how centralized exchanges are prone to attacks due to their design flaws. Peoples and investors have lost their hard earned money to hackers. Although there are many reasons for various hacks but these can be rooted to their custodian nature (ie hold user funds on their behalf).
Most of Dexs operate on some form of smart contracts which do atomic swaps between the market maker and taker via their respective wallets. Since dex does atomic swaps internally in their smart contracts or protocols, even smart contract do hold any user funds. Therefore Dex does not provide any honeypots for hackers to hack into. Trading takes place from the wallet which is secured by mathematical functions and mnemonics
3) Dex enforces user empowerment
In Dex trading take from wallet and trade directly from the other peer. This design principle allows a user to give complete freedom and power over their funds, so account freezing, withdrawal limit, and denial are not possible with decentralized exchanges
Advantages of Dex are endless but they too have their drawbacks. Dexs does not match the UI/UX, speed and liquidity of centralized exchanges. But soon these will be thing of past as Bitcoin, Etherium and other cryptos are working on their scaling solutions, interoperability and on chain liquidity options.
I(SUSMIT) and Kuldeep Grewal are developing a decentralized exchange based on 0x protocol under Oc2 drive crypto adoption efforts further.
Wanna get in touch with us? Write to us at susmit9370@gmail.com