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Bridging the hole between sovereignty and efficiency


Again in 2019, an estimated 99% of crypto-asset transfers befell on centralized exchanges (CEXs), in keeping with the quantity that was utilized by predominant crypto critic Nouriel Roubini. CEXs are more likely to stay a central fixture of the crypto buying and selling panorama for the foreseeable future. CEXs are quick and handy, however sometimes require merchants to deposit funds in an account managed by the alternate. Sadly, historical past illustrates that this lack of sovereignty over a consumer’s digital belongings may be an excessive and dear compromise. 

Decentralized exchanges (DEXs) provide an intriguing various and are gaining momentum, however are nonetheless not but prepared for prime time. Due to this fact, there should be a solution to bridge the hole between consumer sovereignty and alternate efficiency.

Associated: DeFi proved resilient through the March 2020 and Might 2021 market crises

In terms of custody, management is healthier than belief

The nightmare state of affairs for merchants utilizing CEXs is that they could fall sufferer to hacking or fraud and lose their deposited funds. Though seven years have handed because the collapse of Mt. Gox in 2014, its identify nonetheless stays synonymous with the risks of cryptocurrency fraud. As soon as the world’s largest Bitcoin (BTC) alternate, it filed for chapter in 2014 after Bitcoin of an estimated 650,000 prospects went lacking. The victims are nonetheless making an attempt to obtain partial compensation from the insolvency course of in 2021.

Sadly, this type of counterparty threat stays a risk to this present day. In April, the founding father of Turkish alternate Thodex absconded with $2 billion of investor belongings unaccounted for. A yr earlier than that, China’s FCoin and Australia’s ACX each closed with out warning. Whether or not these failures had been as a result of fraud, a hack, or issues with the enterprise mannequin, it doesn’t matter a lot to the traders neglected of pocket. In a really perfect world, the alternate operator (or a hacker who has compromised an alternate) ought to be denied the power to maneuver consumer funds discretionarily between accounts.

Associated: Belief remains to be a should within the trustless world of cryptocurrency

The established order: Managing threat brings higher prices

For well-capitalized or well-connected merchants, there are methods to mitigate these dangers, however the options include their very own drawbacks.

Credit score is one solution to keep away from having to pre-fund an account. Sure, that’s potential if you’re keen to pay excessive charges to a dealer or if you may get a credit score line with a selected alternate by establishing your self as a prime buyer. Both method, it’s costly (and within the latter case, sluggish), and solely the largest of spenders stand any probability of growing such an excellent relationship with a number of exchanges.

Off-exchange settlement networks present an alternative choice to loading funds instantly onto exchanges. These intermediaries maintain the dealer’s funds and tackle the counterparty threat for every alternate. Within the present atmosphere, such intermediaries present a worthwhile service for establishments, however they nonetheless characterize an added layer of expense. A lot for frictionless buying and selling.

DeFi and the difficulty with transparency

If the issue is the lack of asset sovereignty on CEXs, may DEXs be the answer? Sure and no. By utilizing sensible contracts and decentralized liquidity swimming pools to allow asset swaps, DEXs take away intermediaries and allow merchants to retain sovereignty over their belongings. Nonetheless, DEXs additionally contain heavy compromises, notably for bigger merchants.

On a DEX, as an alternative of consumers and sellers being paired by means of a centralized matching engine, a sensible contract performs the trades. Contributors referred to as “yield farmers” can lock their belongings right into a liquidity pool and earn yields in return. Every liquidity pool facilitates buying and selling for a selected pair of belongings, corresponding to Bitcoin and Tether (USDT), for instance. The sensible contract will alter yields in keeping with the relative quantity of belongings within the pool, with the intention to entice extra of the scarcer asset and keep a wholesome steadiness. On the identical time, the transaction payment a dealer pays will differ relying on the relative shortage of the belongings concerned.

Though progressive, this method doesn’t scale nicely. Relying on the scale of the liquidity pool, giant trades can instantly have a robust impact on buying and selling charges. As well as, DEXs are extremely inclined to frontrunning. Frontrunners are merchants (typically bots) who scan for info that implies a giant commerce is coming, then soar in with their very own transaction to revenue from the anticipated worth transfer. After all, these exploitative trades have their very own impact in the marketplace worth, decreasing the revenue of the initially deliberate transaction. On CEXs, the chance is that if prefunding is carried out on-chain, third events might be able to infer {that a} large commerce is about to occur. Nonetheless, these dangers are drastically magnified when utilizing a DEX.

Because of the networking delay when processing transactions, pending transactions might flow into amongst validating nodes earlier than they’re lastly dedicated to a block. Certainly, on smart-contract-based DEXs, bids are despatched transparently, so a frontrunner merely wants to watch incoming bids and place their very own bid with larger charges or with much less networking delay with the intention to revenue. Moreover, as validators resolve on the order of transactions for the blocks they produce, it may introduce one other alternative for manipulation.

Thus, whereas DEXs are a tantalizing thought and current the chance to earn passive yield, they’re at present not nicely suited to the wants of most merchants.

Associated: Yield farming is a fad, however DeFi guarantees to alter the best way we work together with cash

Can we construct a greater DEX?

So, can the pursuits of merchants be higher protected with out the downsides of current DEXs?

One potential method right here can be to make use of blockchain because the supply of belief and mix it with off-chain confidential computing {hardware} to deal with order matching. For instance, trusted execution environments (TEEs) can set up an remoted space inside a pc processor, operating individually from the usual working system that’s not accessible to the system admin.

The matching engine and commerce execution software program for an alternate might be positioned inside a TEE, eradicating it from the management of the alternate proprietor. Every dealer may then decide an allowance that the TEE may spend to settle trades on their behalf, eliminating the necessity for prefunding or intermediaries. As well as, as matching can be carried out off-chain, the chance of frontrunning would even be diminished.

Considering extra long run, a mix of different rising strategies corresponding to multi-party computation or zero-knowledge proofs would possibly have the ability to be used to attain related outcomes, however these approaches are at present much less mature and can be troublesome to implement in actual world eventualities.


The necessity for prefunding on cryptocurrency exchanges introduces issues and dangers that pose a major barrier to the adoption of digital belongings. Whereas DEXs provide an progressive various that leaves the dealer in charge of their funds, additionally they entail vital trade-offs. To drive the mainstream adoption of digital belongings and acquire a aggressive benefit, cryptocurrency exchanges must discover methods to protect consumer sovereignty with out compromising on efficiency.

This text doesn’t include funding recommendation or suggestions. Each funding and buying and selling transfer includes threat, and readers ought to conduct their very own analysis when making a call.

The views, ideas and opinions expressed listed here are the writer’s alone and don’t essentially replicate or characterize the views and opinions of Cointelegraph.

Alain Brenzikofer is a co-founder of Integritee AG, a hardware-enabled confidential computing answer that mixes blockchain and trusted execution environments. Lively in blockchain since 2013, he contributed to the Quartierstrom peer-to-peer power markets initiative and based Encointer, a crypto-based common primary earnings venture. In 2020, he led the crew that received the Vitality Net Innovation Problem for a venture that used trusted execution environments for off-chain computation.