There has been a new many startups that have been raising funds through Initial Coin offerings (ICOs). These are a great new way of financing where a startup will offer their coins or “tokens” on sale for retail investors to fund their blockchain projects.
These allow start-ups to fund their investments without the cumbersome need for Venture capital or other more restrictive methods of financing. This is the reason that there has been an explosion in the amount of ICOs over the past 3 years. In 2014, there was only $26m that was raised via this method. However, in 2017 we are already at $1.3bn. This increase in funding does however, create a number of challenges for all of the centralised exchanges.
Problems for Centralised Exchanges
As more and more of these tokens are raised and end up on the free float of the market, this creates a number of challenges for the exchanges where they are traded. There are not that many options when it comes to being able to liquidate these investments which creates a number of problems for those who hold them.
The reason that a number of centralised exchanges may find it hard is because they require a certain amount of the tokens in reserve for traders to handle them effectively. If these buyers want to transact with tokens that are not very common, they could have a hard time finding the right exchange given the requirements for liquidity.
There is also the requirement when someone places a trade that they have to wait a certain period of time before they are cleared and there are also certain withdrawal restrictions. This means that certain traders may have to wait a certain period of time before they can realistically expect to take out their funds.
Security is a Problem
Most of the volume on these exchanges is indeed in Bitcoin and Ether but there are also a number of newer tokens that are sometimes only a year or two old. The main issue that these exchanges do face is their security. There are a number of exchanges that were hacked and they are indeed ripe targets. Despite the decentralised nature of crypto, when there is a centralised exchanges there is a target.
These exchanges keep all of their user information in their servers which means that it could be easy enough for a hacker to try and breach that and get access to their coins. They are meant to keep most of their user’s private keys in “cold storage” but as we saw in the Mt Gox case, this is not always the result.
This was also echoed by a well-known investor, Arif Akhtar. He said that when you make use of a centralised exchange, you are fully trusting in that entity. You are also trusting not only that they are completely honest but that they have the best security practices in place from security perspectives.
Decentralized Exchanges to the Rescue
There is another option which should satisfy most trader. Decentralized and trustless exchanges that offer a unique way to trade all of these tokens as well as the more traditional coins. This would not be such a large step given that these decentralized exchanges are just using the technology that is underlying the actual currencies.
This exchange would also be trustless because you, as the trader, do not have to place your trust in one central body. All of the transactions on the exchange would be open to all participants. Moreover, the decentralised exchange will be secure with the most advance cryptography. This means the people could not fake the transactions.
You, as the user, could also see the technology in terms of security and protocols that held the exchange up. This is because it would all be available on the public ledger. Hence, you could determine whether this exchange is indeed one that you would like to work with and trade on.
Using Peer to Peer technology, there is no need for this centralised exchange to hold all of the funds. The exchange could handle of the transactions from user to user. The funds would flow from one user to the other over the network. This further strengthens the security. This would also be safer than having the coins in one location.
Trade requests could also take place almost instantly if there is enough liquidity on the system. Users would not have to wait a large period of time for their trades to be met with corresponding matches. Another great benefit of a decentralised exchange is that the user does not have to send their information like private info etc. There would be no need for this unless money is taken out in physical Fiat.
Safer Token Trading
The benefits of a decentralised exchange are no doubt plentiful. There is no doubt that this would be the most appropriate move for the future and that all traders should be making the move. However, why has that not happened yet?
This is mainly down to the fact that these decentralised exchanges are not well known and their interfaces are not as friendly as the large centralised exchanges such as Coinbase or Bitstamp. They are also not the most user friendly of platforms for your mainstream users. They would have to get more used to the technology that underlines the networks etc.
Yet, there is no doubt that this will be the eventual result. There is no reason to still be using outdated client / server technology for centralised exchanges when blockchain technology is making waves in the world. As more hacks happen and news spreads of dishonest exchanges, so too will the demand for decentralised solutions. We will no doubt see it eventually.