Bridging the gap between sovereignty and performance


Again in 2019, an estimated 99% of crypto-asset transfers happened on centralized exchanges (CEXs), in response to the quantity that was used by main 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 usually require merchants to deposit funds in an account managed by the change. Sadly, historical past illustrates that this lack of sovereignty over a person’s digital belongings could be an excessive and expensive compromise. 

Decentralized exchanges (DEXs) supply an intriguing alternative and are gaining momentum, however are nonetheless not but prepared for prime time. Subsequently, there should be a option to bridge the hole between person sovereignty and change efficiency.

Associated: DeFi proved resilient during the March 2020 and May 2021 market crises

In terms of custody, management is healthier than belief

The nightmare state of affairs for merchants utilizing CEXs is that they may 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) change, it filed for chapter in 2014 after Bitcoin of an estimated 650,000 prospects went lacking. The victims are nonetheless trying to receive 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 change Thodex absconded with $2 billion of investor assets unaccounted for. A 12 months earlier than that, China’s FCoin and Australia’s ACX each closed with out warning. Whether or not these failures have been on account of fraud, a hack, or issues with the enterprise mannequin, it doesn’t matter a lot to the traders omitted of pocket. In a great world, the change operator (or a hacker who has compromised an change) must be denied the flexibility to maneuver shopper funds discretionarily between accounts.

Associated: Trust is still a must in the trustless world of cryptocurrency

The established order: Managing threat brings better 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 option to keep away from having to pre-fund an account. Sure, that’s attainable in case you are prepared to pay excessive charges to a dealer or if you may get a credit score line with a selected change by establishing your self as a high buyer. Both means, it’s costly (and within the latter case, sluggish), and solely the largest of spenders stand any likelihood of creating such a great 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 change. Within the present surroundings, such intermediaries present a useful 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 pools to allow asset swaps, DEXs take away intermediaries and allow merchants to retain sovereignty over their belongings. Nevertheless, DEXs additionally contain heavy compromises, significantly for bigger merchants.

On a DEX, as an alternative of patrons and sellers being paired via a centralized matching engine, a wise contract performs the trades. Members known 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, reminiscent of Bitcoin and Tether (USDT), for instance. The sensible contract will alter yields in response to the relative quantity of belongings within the pool, as a way to entice extra of the scarcer asset and preserve a wholesome stability. On the similar time, the transaction payment a dealer pays will differ relying on the relative shortage of the belongings concerned.

Though modern, this method doesn’t scale nicely. Relying on the dimensions of the liquidity pool, massive trades can instantly have a robust impact on buying and selling charges. As well as, DEXs are extremely prone to frontrunning. Frontrunners are merchants (typically bots) who scan for data that means an enormous 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} massive commerce is about to occur. Nevertheless, these dangers are vastly 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 look at incoming bids and place their very own bid with increased charges or with much less networking delay as a way to revenue. Moreover, as validators determine 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 presently not nicely suited to the wants of most merchants.

Associated: Yield farming is a fad, but DeFi promises to change the way we interact with money

Can we construct a greater DEX?

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

One attainable 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, working individually from the usual working system that’s not accessible to the system admin.

The matching engine and commerce execution software program for an change may very well be positioned inside a TEE, eradicating it from the management of the change 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 methods reminiscent of multi-party computation or zero-knowledge proofs would possibly be capable of be used to realize comparable outcomes, however these approaches are presently much less mature and can be tough 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 supply an modern various that leaves the dealer answerable for their funds, additionally they entail vital trade-offs. To drive the mainstream adoption of digital belongings and achieve a aggressive benefit, cryptocurrency exchanges must discover methods to protect person sovereignty with out compromising on efficiency.

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

The views, ideas and opinions expressed listed below are the creator’s alone and don’t essentially mirror or characterize the views and opinions of Cointelegraph.

Alain Brenzikofer is a co-founder of Integritee AG, a hardware-enabled confidential computing resolution that mixes blockchain and trusted execution environments. Energetic in blockchain since 2013, he contributed to the Quartierstrom peer-to-peer vitality markets initiative and based Encointer, a crypto-based common fundamental revenue undertaking. In 2020, he led the group that gained the Vitality Net Innovation Problem for a undertaking that used trusted execution environments for off-chain computation.