Imagine a square peg in a round hole. The outcome is unfavorable in every sense of the situation, and that is what happened precisely.
Blockchain configuration stands on a decentralized order without a third-party engagement in any activity whatsoever. In other words, the technology guarantees Peer-to-Peer (P2P) interactions to deliver faster, cheaper, transparent, and immutable transactions.
Unfortunately enough, the first application of the Blockchain, which is Cryptocurrency or Digital Assets, has its major infrastructure standing on centralization with intermediaries running the show. Completely contradictory, right?
It is more or less like when a country claims it is decentralized, although, in reality, all the decisions come from the top hierarchy of the government. In such a nation, corruption, despotism, and stagnation are likely what the citizenry has to live through.
And to compare and contrast this with Cryptosphere, the results have been no different. Decentralization as a concept, whether in governance or technology, centers on the transfer of control of any pursuit or structure to various civic agencies than a single entity or individual.
Centralized Exchanges In Focus
In Crypto, a private key is a complex design of cryptography that permits a user to access his/her assets. Hence the often used term: Not your keys, not your coins. The security design serves to defend the user from hacks and unapproved accessibility to funds.
Centralized Exchanges (CEXes) operate with third-parties steering affairs were the initial platforms built to facilitate the trading and exchange of Crypto. This arrangement means users have to give away control of their funds or private keys to the exchange administrators.
Users of exchanges of this nature have a large portion of their funds in so-called hot wallets with a single private key. The norm defeats the cardinal basis of the Blockchain, hence, Cryptocurrency.
Simply put, a hot wallet is an online Crypto wallet connected to the Internet. It opens a can of worms for all sorts of undesirable situations for users, investors, and sometimes exchange owners themselves.
Though CEXes offer speedy transactions and higher liquidity but are insecure for the reasons outlined above. The inconsistency with the Blockchain/Cryptocurrency fundamentals is distinctly outstanding, and that is where its vulnerability originates.
Undoubtedly, the pioneers got it wrong by running a decentralized system on a centralized medium, causing the ecosystem irreversible damages.
The result has been immensely disastrous, slowing down Crypto adoption and undermining trust while fuelling misconceptions.
Centralized Exchanges have no reputation when it comes to security breaches. Malicious actors exploiting their vulnerabilities have stolen large sums of money in Cryptocurrencies running into billions and user data.
Between 2011 to early 2020, hackers stole over $11 billion from CEXes around the world. From Africa to Asia, America, and Europe to LATAM, security breaches of exchanges littered newspaper headlines.
In 2014, the Japanese exchange, Mt. Gox, was in charge of approximately 80 percent of Bitcoin trading. Alas! It ended up in tears for many people, followed by lengthy lawsuits when hackers in the most eventful Crypto heist stole $450 million, the equivalent of 850,000 Bitcoin.
All the compromised exchanges, the Coincheck hot wallet security breach in 2018 stands out in terms of value stolen. The platform, which is also a Japanese entity, tops the ranking with $530 million going to ill-disposed actors.
Even market leaders like Binance went through such anguish when in 2019, $40 Million of traders’ funds went missing. Although these incidences are gradually going down a bit, in 2020 alone, investors and users lost over $200 million of their funds on exchanges.
It became ridiculous for a currency that prides itself on security and solid protection to lose that much funds to bad actors in the industry. Accordingly, it is one of the most significant barriers to Crypto adoption even to this date.
A critical look at these security failures indicates how a centralized system is irresistible to abuse and manipulation by insiders and outsiders. For instance, most of the violations occurred with the cooperation of some exchange staff.
A case in point is the hacking of the Korean Exchange Bithumb in 2019, which resulted in $13 million worth of EOS stolen. The exchange categorically stated that the hack emanated by an insider since no evidence of external exploit was at play.
Decentralized Exchanges (DEXes) Weren’t Enough
Amidst all the losses, DEXes were evolving in the market with a unique proposition ideal for a decentralized environment. This approach of employing Ethereum Smart Contracts via an immutable Blockchain network to process trades in a peer-to-peer fashion appears sound.
Based on the Ethereum Smart Contract, funds don’t move out of users’ wallets except trade goes through execution and is permanently recorded on the Blockchain. With such a mechanism, funds are not at risk to the outside and non-existing insider attacks. Decentralized exchanges are guarded against hacking efforts and security risks since hackers can’t breach a peer-to-peer network.
Non-custodial Wallets, which ensures that users don’t give away their private keys and funds to third-parties when trading, is a prominent feature of DEXes, lowering counter-party risk. Thus, traders have total authority over their money and decide when to connect or disconnect their wallets to an exchange.
Private data getting into the wrong hands whenever exchanges suffer external attacks is a worrying concern for many users. Another breakthrough of DEXs is that traders are not required to produce their data to third parties, with no signing up obligations for using the platform.
Given all the benefits of DEXes and the risks regarding CEXes, you would think it was a no-brainer to use the latter. Why are then so many investors and traders still using CEXes?
The reason for slow adoption is due to limitations hindering the convenient use of DEXes, especially by mainstream and institutional traders. The drawbacks include lower liquidity, lack of speed, unsatisfactory user experience, absence of customer support and Crypto to fiat gateways, and scalability concerns.
DeFi Is changing The Narrative
Decentralized Finance, in short DeFi, in the past two years is gradually altering the deficiencies of DEXes, providing better alternatives to CEXes. At the end of 2020, the cumulative volume of DEX was hovering around $23.3 billion.
Market leaders like Uniswap, Sushiswap, or Curve have been instrumental in leveraging tools like Automated Market Makers (AMM), Liquidity Providers (LP), Yield Farming, and others to solve speed and liquidity issues in the decentralized exchange market without relying on buyers and sellers.
These automated liquidity protocols aided by Smart Contracts perform pertinent roles in ensuring an autonomous decentralized system devoid of any central involvement. Though the sector is still young, its influence on DEXes in guaranteeing financial freedom is pretty tremendous.