Decentralized Exchanges Are The Future Of Crypto

Throughout 2017 and entering 2018, everyone was jumping aboard the cryptocurrency bandwagon. In fact, over 900 ICOs launched in 2017 alone, raising an estimated $5.6 billion. A sizable portion seems to be coming from student loan funds.

It didn’t take long for the noobs to realize it’s a lot harder to buy, sell, and exchange cryptos than it looks. More than half of the ICOs launched just last year are already worthless today. And many early adopters are finding difficulty withdrawing their money, especially from more obscure altcoins. The confusion and complications drew the ire of regulators worldwide.

Popular crypto token exchange Bitfinex found itself in hot water with the U.S. Commodity Futures Trading Commission after Bitcoin’s meteoric price rise. There’s a reason legislators are so worried about crypto exchanges — the storied shutdown and subsequent bankruptcy of Mt Gox is one example. But financial markets have always drawn theft and other forms of greed.

The CFTC was barely created in 1974 in response to massive growth in commodity futures and options, something that wasn’t a big issue prior. Even America’s major investment watchdog, the Securities and Exchange Commission (SEC) was only created in 1934 after lack of financial regulation led to the historic Wall Street crash of 1929.

It’s estimated that over $50 billion in new securities was offered in the 1920s as the First World Warcame to an end. Half of those became worthless, just like what we’re seeing with today’s ICOs. History is, indeed, repeating itself.

Except this time, the public is pushing another solution alongside the government — decentralized exchanges.

The Centralization of Cryptocurrencies

The problem with centralized crypto exchanges like Binance and Coinbase is the exchange itself holds your money. You could be worth a billion dollars in crypto, but it’s not worth anything until withdrawn from the exchange. And if governments like the U.S., China, and Japan shut down an exchange, you may lose your fortune forever.

It’s the exact opposite of what Satoshi Nakamoto envisioned when creating Bitcoin. Early supporters of cryptocurrency wanted to pull financial power away from banks and governments, and in doing so, they learned why these institutions were created in the first place. Crypto exchanges are demons every bit as evil as the devil they were created to destroy.

These exchanges are subject to the same problems found in traditional banks and currency exchanges. We’ve already seen government shutdowns (Mt. Gox), and allegations of market manipulation (Bitfinex), theft (Coincheck), and embezzlement (3 anonymous South Korean exchanges). It all happened in the first decade of the crypto industry’s existence.

All fraudulent, or incompetent, behavior aside, centralized exchanges are still susceptible to an exchange run, in which more people withdraw from the exchange than it has money to pay out. Stable coins like Tether (which backs Bitfinex) promise to back up its crypto supply with fiat currency, but regulators doubt these claims. Based on its current market cap, Tether would need to hold over $2.2 billion in liquid fiat assets to back its supply, and that’s not counting all the other cryptos it holds for Bitfinex users.

Decentralized Exchanges Are The Future

A lot of decentralized crypto exchanges (DEX) have popped up over the past year or so in hopes of resolving these issues. Some, like EtherDelta and 0x support only Ethereum. Others, like CryptoBridgeand Bisq, support more altcoins, although these decentralized exchanges still rely on their own proprietary crypto tokens. Even the larger exchanges, such as Binance and Bitfinex, are exploring decentralization. The most-anticipated ICO of recent times, is a decentralized exchange — NEX.

In China and other jurisdictions in which centralized exchanges are banned, a roaring trade in OTC (over the counter) trading has sprung up — often using Skype and other messaging tools to facilitate P2P trading through an intermediary. Some OTC offerings are even seeking to decentralize this aspect of trading, and aim to fully decentralize even OTC deals.

A decentralized exchange cuts out the third party, relying on decentralized smart contracts to track all transactions. This makes them much faster, as centralized verification can take several days to weeks to complete. In addition, the user maintains control of his or her own finances. There’s no deposit into the exchange and no centralized servers, so they’re theoretically immune to the types of cyberattacks and regulatory problems plaguing centralized exchanges.

While decentralization seems like a better option, it still leaves you financially exposed in the event of a market crash. March 2018 was a rough month for cryptocurrency values, losing nearly $500 billion in value during this crash. And the flood of ICO scams is only further shaking investors’ confidence.

These scam ICOs have government watchdogs focused intensely on cryptocurrencies themselves, regardless of the exchange used. The bad eggs are ruining the entire basket, as ICO ads are blocked from Google, Facebook, Twitter, and MailChimp. While decentralized exchanges are hoping to make cryptos operate more like fiat currencies, some organizations like Polymath are going a different route by issuing Security Token Offerings (STO).

Bringing Security to Crypto

Many companies are treating their ICOs like an investment round, but the difference is buying a crypto token doesn’t give you stock in the company. Shareholders of common stock have legal rights that owners of cryptocurrencies (which are regulated as a commodity) and currencies do not.

Shareholders are the true owners of companies, and their rights include a degree of control over company management, voting rights, a share of the company’s profitability, income, and assets, and preemptive rights to newly issued shares. In the crypto world, miners are the only parties with somewhat similar rights, and that sector is increasingly being centralized.

As we move through 2018, it’s becoming clear that the ICO and centralized cryptocurrency exchange are being replaced by the STO and decentralized exchanges.

We’ll have to wait and see if that’s enough to stabilize the crypto-economy.

Decentralized Exchanges Are The Future Of Crypto was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.