As the cryptocurrencies are making their way up in the technological reign, two breeds of people are broadly associated with them:
- Who believes that cryptocurrency is the future and can be the potential medium of exchange. This group has already started to stash important cryptocurrencies in their wallets and are just looking for the right gateway to treat them as the mode of exchange.
- Who thinks that blockchain opens up a cornucopia of opportunities for the investment and aspires to get quick returns in the form of fiat currencies.
In this section, we will solely talk about the second group and problems faced by them while exchanging their currencies. The trading of cryptocurrencies is same as trading shares, commodities, and fiat currencies, i.e., the modus operandi is based on generating sell order or purchase order and orders are matched and trade is accomplished. However, there are certain flaws with the crypto exchanges (both centralized and decentralized exchanges). Let’s inspect these flaws.
- It is Exchanged on a Central Exchange: The Purpose of Decentralization is Diluted
We all know that the birth of cryptocurrencies is credited to the manipulative nature of central bodies like banks. Cryptocurrencies are run on a blockchain network. This network connects everyone to everyone. Each node of the network has a complete ledger of all the transactions. Hence, there is no central body which accounts for maintaining the ledger/database. They are maintained by the people who are involved in the transactions. But is the purpose of decentralization served when you can exchange your cryptocurrency through the central exchanges like Coinbase and Binance?
These are the privately owned third-party exchanges and no one knows how long will they exist. They might look authentic today, they might default tomorrow. Who knows?
For every exchange investors or traders make, they have to store their cryptocurrencies on the central server of these wallets. These wallets are controlled by whom? HUMANS. What’s the point? They are vulnerable to hacking, cyber threats, authority snatching, etc.
Now, there is an option where you could avoid exchanging or trading of these currencies on the third-party portals. And that is decentralized exchange on the blockchain network itself. Yes, you can transfer your BTC or ether through the decentralized channel of the blockchain itself, but it has its own execution problem.
- Decentralized Exchange has Greater Risk of Execution
If you are trading bitcoins or ethereum directly on the decentralized trading exchange, you have got to understand that you are not going to get the same manner of trade in terms of speed, quality, and in terms of knowing your position in the trade. You can compare it with the forex exchange where you can go to the counter dealer and complete the trade. In the case of crypto, it can take a long time to fill, it may take a high cost to complete the trade. Surely, it is not as busy and active as the level of forex exchange but it is yet to reach the point where you feel that all the transactions and trades are homogenous or at least look like that.
Why is execution poor?
There are various flaws which make the decentralized exchange weaker. The first and the primary concern revolves around the validation of the transaction. The validation of the transaction takes time. Here is why verification takes time:
The concept of the cryptographic puzzle in a blockchain network is used to bridle down mining rate of the coins. The transaction happening on a block is not executed until the cryptographic puzzle is solved and miners give a consensus to the transactions. What does it mean? If it takes 22 minutes to solve the block, the completion of the transaction will take place after that.
One of the major challenges faced by the decentralized systems taking place in the chain is that blocks are not mined fast for a high-frequency trading. The mining of the blocks is dependent on the hashing power and cryptographic puzzle solving skills. So, in some of the decentralized exchanges, to carry a high-frequency trading, the semi-centralized system is devised. This semi-centralized system is an off-chain service where you don’t trade in the blocks. If you want to sell or buy or trade something of high frequency, you sign your order and submit it to the off-chain solution and not the block. Since it is out of the block, where is transparency?
Decentralized exchange doesn’t work like any other stock exchange. It only supports resting orders. Resting orders are those orders whose prices are set and are not executed automatically. Generally, the automatic matching in the stock exchange makes it easier for the seller and the buyer to trade.
When you want to sell n number of tokens on the centralized exchange system, you just have to mention the number and create a sell order. You can then forget it and the automatic trading engine will automatically match your order with the optimized buyer but the decentralized exchange is too manual to identify such buyers based on your sell order. When you feed your sell order in the network, it won’t be picked up by the system. A buyer would have to click on the link and notify you that he is interested in buying your sell order and in return you will have to keep on checking if any buyers have shown interest in purchasing your order. Now, this is a tedious job.
With the number of complexity hanging in with the on-chain trade, you can cancel the order. But another problem which occurs while canceling the sell order is Front Running. It can be explained by a simple example,
Since every trade is happening on-chain, miners have a complete visibility of your sell orders. Let’s say you submitted an order on the network yesterday and today is not just a good deal and you want to cancel the order, but because you have signed the order, a miner can actually execute your order. The process is called front running when you wish to cancel the order but miners execute the signed copies of your order.
- Custody Problem in Cryptocurrency exchanges
Who are the custodians in traditional trading?
Consider a situation on the stock market where X buys 1000 shares of Samsung stock to Y. In this case, they don’t meet and transact directly as per the deal. But in custodian trading, both X and Y have a common custodian who manages both the accounts (of X and Y) and sets the respective balances after the transaction is made. The responsibility of these custodians is enormous as they hold securities and assets in billions for both side parties. Hence, they are in the form large firms.
But there is a custody problem when it comes to cryptocurrency exchanges. They need two custody to execute the transactions.
Fiat custody is one of the primary issues linked to the investors who are exploring the cryptocurrency market. Even the large fiat custody fears of transferring the large sum of fiat currencies. Generally, fiat custody firms demand certain proofs like storage of their money and what guarantees are put on these funds. Banks usually guarantee these criteria. And it doesn’t seem possible that bank would guarantee anything with cryptocurrency exchanges.
As the name suggests, Crypto custody is completely in the digital form. This makes them vulnerable to cyber-attacks and theft.
However, Legolas Exchange will be the first third-party cryptocurrency exchange to offer both the custody services, i.e., a fiat and crypto custody services complying with investors security. The prominent feature of this exchange is that custody of the cryptocurrencies is completely alienated from the exchange. This makes the funds secure.
As a trader or investors, if you ever faced this issues or expect some improved exchange for better trading experience, there is one survey to collect the real-time information from the members of crypto community conducting by , Encrybit. Its primary goal is overcome these issues faced while using currency trading platforms and provide the Crypto lovers with a highly improved and secured trading platform. Browse the link (http://encrybit.io/#open-modal1) for details about the survey.
The Final Call
Yes, there are problems linked to both the systems, that is, centralized and decentralized exchange system of the cryptocurrencies, but the acceptance of cryptocurrency as a medium of exchange still speaks about the volume of influence it has produced.
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