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Crypto exchanges: filling the space between supremacy and production

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Redakcja
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5 min reading

Crypto exchanges: filling the space between supremacy and production

The aim of crypto is to be possible to make the exchange of value global and frictionless, but security and extensibility concerns are brewing worries resulting in repeated trade-offs. During 2019, an estimated 99% of crypto-asset transfers took place on centralized exchanges (CEXs), based on the numbers used by main crypto critic Nounel Roubini. 

The aim of crypto is to be possible to make the exchange of value global and frictionless, but security and extensibility concerns are brewing worries resulting in repeated trade-offs. During 2019, an estimated 99% of crypto-asset transfers took place on centralized exchanges (CEXs), based on the numbers used by main crypto critic Nounel Roubini. CEXs mainly focuses on maintaining central fixture of the crypto trading landscape for the upcoming future. CEXs are rapid and appropriate but they need to deposit funds in an account which is handled by the exchange. But past requirements show that this loss of sovereignty over a user’s digital assets could prove to be very risky and expensive compromise.

Decentralized exchanges (DEXs) offer a very interesting choice and are slowly but steadily gaining momentum, but are not fully ready for prime time. Hence, there must be a way to fill the space between user supremacy and exchange performance. Traders who are using CEXs are facing a peril of probably falling victim to hacking or fraud and lose their deposited funds. Seven years have gone by since the collapse of Mt. Gox in 2014, its name still remains compatible with the dangers of cryptocurrency fraud. Once the world’s biggest Bitcoin (BTC) exchange, it filed for bankruptcy in 2014 after Bitcoin of an estimated 650,000 customers went missing. The victims are still trying to receive partial compensation from the insolvency process in 2021. 

Unfortunately, this type of counterparty risk is considered as threat even today. In April, the founder of Turkish exchange Thodex escaped with $2 billion of investor assets unaccounted for. During the previous year China’s FCoin and Australia’s ACX both shut down without any caution. Its still unknown whether those failures were due to fraud, a hack, or problems with the business model as it doesn’t make much difference to investors who were left high and dry. In normal situation the exchange operator (or a hacker who has compromised an exchange) should not be allowed to move client funds voluntarily between accounts.

For traders who are well-capitalized or well-connected there are plenty of ways to mitigate these risks, but the drawbacks come with their own drawbacks. Credit is one of the ways to ignore having to pre-fund an account. It is slightly possible if one is willing to pay high fees to a broker or if you can achieve a credit line with a particular exchange by establishing yourself as a top customer. One way or another it seems expensive and only the highest of spenders stand any chance of creating a very good relationship with multiple exchanges. Off-exchange settlement networks give an extra choice to load funds directly onto exchanges. These intermediaries hold the trader’s funds and accept the counterparty risk for each exchange. In this present situation these intermediaries give a very proficient service for institutions, but they still showcase an additional part of expense for easy trading. 

If the loss of asset sovereignty on CEXs is the issue then can DEXs be the solution?  With the use of smart contracts and decentralized liquidity pools to enable asset swaps, DEXs remove the usage of smart contracts and decentralized liquidity pools to provide asset swaps, DEXs remove intermediaries and enable traders to receive sovereignty over their assets. Nevertheless, DEXs also include heavy agreement especially for large traders. Normally, on DEXs instead of buyers and sellers being paired through a centralized matching engine, a smart contract performs these trades. Participants mentions these as “yield farmers” can lock their assets into a liquidity pool and continue earning yields. Every liquidity pool works out trading for a particular pair of assets such as Bitcoin and Tether (USDT). So basically, the smart contract will handle the yields based on the relative volume of assets in the pool, in order to attract more of the scarcer asset and manage to have a healthy balance.

Even though all of this sounds very profiting, this approach doesn’t help in reaching well. On the basis of the size of the liquidity pool large trades can immediately have a strong effect on trading fees. Also, DEXs usually allow frontrunning. Frontrunners are traders who look out for information that highlights the arrival of a big trade and these so-called trades have their own effect on the market price which decreases the profit of the originally planned transaction. Usually, in CEZs the risk is with prefunding conducted on-chain with third parties able to work out that a big trade is on the way. DEXs are basically transparent so a frontrunner needs to be on keen observation with incoming bids and place their own bid with higher fees or with less networking delay in order to profit. Therefore, even if DEXs are an alluring idea and gives options to achieve passive yield, they are at the present not the best for most of the traders.

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