The cryptocurrency ecosystem has continued to take some major hits lately, causing many investors and holders to rethink the way they trade their crypto assets. Several high profile cryptocurrency hacks have made the news in the past few years. In one of the most recent hacks, the Japanese cryptocurrency exchange, Coincheck lost more than $500 million dollars worth of digital coins, adding to a growing perception that cryptocurrencies are particularly vulnerable to hackers.
Yet, as the total market capitalization of cryptocurrencies continues to increase (now above $4 billion), the most recent Coincheck hack may finally be a wake up call for crypto investors and holders.
As the vulnerability of centralized cryptocurrency exchanges is becoming more and more apparent to the cryptocurrency community, some are looking to alternatives in the form of decentralized exchanges.
Unlike a centralized exchange system that handles the trading of cryptocurrencies for its users, decentralized exchanges allow users to control their own funds within their own wallets. Decentralized exchanges do not rely on a third party service to hold a user’s funds, making them less vulnerable to large hacks. This also means that trades on a decentralized exchange happen directly between users in a peer-to-peer manner. These features make decentralized exchanges less vulnerable and much more transparent than centralized exchanges.
Decentralized exchanges such as AirSwap, Bisq, EtherDelta and Hodl Hodl — the newest player to enter the scene — have sparked the interest for crypto enthusiasts looking to control their own assets with little hand holding involved. Users on these decentralized exchanges keep their own private keys and transact directly with each other, demonstrating a truly decentralized form of trading crypto assets.
“We believe that there will be a huge liquidity migration from centralized exchanges to decentralized exchanges when it comes to token-to-token trading,” AirSwap strategist, Sam Tabar, told Bitcoin Magazine. “AirSwap’s mission is to let people trade crypto assets without a middleman involved and blockchain technology allows for just this.”
He pointed out that AirSwap doesn’t hold any user assets. The platform uses the Ethereum blockchain and atomic swaps based on smart contracts to make sure assets cannot be traded without another asset coming to a user.
“In a way, centralized exchanges act as a bank, broker and clearing house because they hold all your money and charge fees. This is problematic though, and hacks are happening quite often because of this model,” said Tabar.
What About Crypto to Fiat Trades?
Most decentralized exchanges allow for crypto-to-crypto trading. While this model is common, Bisq is one of the few decentralized exchanges that lets users buy and sell bitcoins in exchange for national fiat currencies as well as alternative cryptocurrencies.
“Crypto-to-fiat exchange transactions are inherently difficult to decentralize, because fiat itself is under the centralized control of banks and governments,” Bisq co-founder, Chris Beams, told Bitcoin Magazine. “This means that any system designed to automate the process of trading crypto for fiat must get permission from these gatekeepers, and all too often they choose to close their gates to Bitcoin and cryptocurrency-related transactions — just as we saw last month with Visa shutting down all Bitcoin-based debit cards on its network.”
Bisq, however, solves this problem by coordinating out-of-band, manual fiat payments. It’s important to note that Bisq does not directly integrate with banks or other national currency payment systems in any way. Rather, Bisq’s trading protocol orchestrates the process of buyer and seller working together to settle fiat payments outside of the Bisq application — for example, via normal person-to-person SEPA payments in Europe or via a person-to-person payment system like Zelle in the U.S.
Bisq is also impressive in that their peer-to-peer network ensures a high level of user security.
“Centralized exchanges require users to ‘deposit’ cryptocurrency and fiat funds, putting them in the control — or custody — of the centralized exchange. Bisq is entirely non-custodial, meaning that you, the user, stay in control. You never hand over your private keys to a third party, meaning that they cannot be lost or stolen by that third party. This makes Bisq a fundamentally more secure way to exchange,” said Beam.
Most recently, the beta version of Hodl Hodl was launched. Hodl Hodl is another peer-to-peer crypto exchange that allows users to trade directly with each other, without holding user funds.
Instead, funds on Hodl Hodl are locked in multisig escrow.
Each time a contract is created between two parties, a multisig escrow cryptocurrency address is generated. The seller sends cryptocurrency from his wallet to this account and when the cryptocurrency is locked in escrow, the buyer sends fiat to the seller. The seller then releases the locked cryptocurrency from escrow and the buyer receives it directly in their wallet.
Furthermore, because decentralized exchanges do not hold funds and because the exchanges are all peer-to-peer, there are no AML/KYC requirements for users to set up accounts.
“AML/KYC type of compliance, in combination with the transparent nature of Bitcoin's blockchain, represents a significant loss of privacy,” said Manfred Karrer, founder of Bisq, when it first launched as Bitsquare.
“By piecing together the data collected by these exchanges, it can become trivial to figure out how much someone earns, or saves, or spends, and often even what the money is spent on. That’s not just inconvenient; it really makes Bitcoin unsuitable for all sorts of transactions ‒ including perfectly legal ones.”