The concept of centralization is not foreign to humans. All 7.9 billion of the people who exist on the planet are put in check by governments, leaders, bosses, parents, etc. The different levels of centralization that humans exist in cuts across all spheres of life, including finance. We have conducted financial transactions under the guidance of banks, clearinghouses, insurance, investment companies, etc while subjected to extended exorbitant fees and regulatory checks.
In 2008/2009, Satoshi Nakamoto birthed bitcoin (BTC) to solve this problem and make freedom from the clutches of centralized finance available to the average man. After looking at the Bitcoin white-paper, one would surely conclude that truly Satoshi Nakamoto envisioned a world of pure decentralization for financial transactions. A world where individuals could truly explore a ‘peer-to-peer’ relationship with no centralized authority calling the shots on how and when to transfer money.
After the launch of the leading cryptocurrency that year, BTC was first priced on Bitcoinmarket.com (now defunct) for the value of $0.003 per BTC. Later on, Mt. Gox, a Tokyo-based exchange launched in 2010, monopolized the bitcoin(BTC) exchange market controlling about 70% of BTC transactions worldwide. From that time, as other forms of cryptocurrency were born, other exchanges like Binance, eToro, Huobi, Poloniex, Gemini, Coinbase have sprung up as well to struggle for a share of crypto transactions in the market enabling users to buy, sell, exchange and store cryptocurrencies.
Centralization Finds a Home in Decentralization
However, despite Satoshi’s dreams of decentralized finance, centralization still thrived amid it all. In the bid to mitigate the complexities of the system for new users and introduce a sense of order, these cryptocurrency exchanges that sprung up adopted a centralized modus operandi. Here, tiered-level KYC (Know-Your-Customer) /AML (Anti-Money Laundering) checks were put on intending users, funds held by the exchange on behalf of the user. Cryptocurrency available to users were only those listed on the exchange platform, and the exchange management still fixed transaction fees.
Centralized exchanges (CEXes) offer the benefit of what we can describe as a soft landing for enthusiasts into the crypto market. These platforms provided a home away from home for new users by maintaining a familiar ground and bridging a gap between traditional finance and the world of cryptocurrency.
Not only are new users not bothered with the nitty-gritty of ensuring the security of their private keys, but the platforms also provided easy fiat gateways through the conversion of various cryptocurrencies in minutes to the local fiat of the user. Users can also to a large extent that cryptocurrency bought, sold, exchanged, and stored on the platform is trustworthy.
But as much as these platforms promise a sense of security in transactions through rigorous preliminary checks on intending users, the disadvantage of single-point failure still looms like a dark cloud. This weakness makes the exchanges subject to the whims and conditions of anyone in power as well increases the risk of loss of users’ funds through hacking. This has led to the fall of many exchanges.
Mt. Gox, earlier mentioned, suffered several hack blows before the final blow in 2014 where 840,000BTC (worth around $460 million at the time) was stolen from the platform leading it to file for bankruptcy. That single debacle alone diverted the attention of regulators towards the cryptocurrency industry. Other centralized exchanges like Bitfloor (now defunct), KuCoin, Bitfinex, and even the exalted Binance have all had their due pound of flesh of this menace.
Also, the plight of QuadrigaCX (now defunct), Canada’s largest cryptocurrency exchange is also a typical example of the dangers of having a centralized custodian of cryptocurrency. They lost here $190 million worth of crypto assets belonging to users on the platform after the death of the exchange’s founder, Gerald Cotten. The founder had sole custody of private keys needed to access the funds in the exchange’s wallet. It was later also revealed that there was proof of mismanagement.
The Journey to Attaining True Decentralization
Although the biggest cryptocurrency exchange today is centralized, many crypto thought leaders still groan at the thought of how centralized cryptocurrency exchanges blatantly defy the laws of decentralization and seem to shake the very foundation upon which cryptocurrency was born. This view led to the launch of decentralized exchanges (DEXes), the staunch champions of the decentralized dream.
Decentralized exchanges (DEXes) are not built on a single server but are decentralized applications (DApps) running on a decentralized server. DEXes thrived around 2014, and awareness of it in the crypto space grew as well. These exchanges truly place the power of finance in the hands of the people with no intermediary. They require no form of login or KYC to trade any volume of crypto assets. Users need only to open the platform and proceed with the intended transaction. Examples of popular DEXes include Binance DEX, PancakeSwap, UniSwap, Blocknet, OasisDEX, EtherDelta, SwapDEX, etc.
Besides the previously mentioned benefits, users also maintain full custody of their crypto assets through various individual crypto wallets that simply need to be connected to be used to start transactions on the space. Most DEXes are also run with governance tokens. The possession of these tokens simply allows the user to be a part of those who make crucial decisions that affect the well-being of the exchange. In this way, ownership of the platform is for all and not for one alone. An example is Maker (MKR) used to run the DAI stable coin network.
With dominant power, however, comes great responsibility. They place the user with the onerous burden of ensuring the security of their private keys. This often leads to loss of funds and has left dormant wallet addresses in the record of bitcoin. The lack of proper KYC channels also made DEXes a suitable spot for the sale of stolen cryptocurrencies. Other issues arising include unfriendly user experience. As DEXes involve a lot of technicalities, the user experience is not as friendly as that of centralized exchanges. They display all information at a go to the user. Some DEX platforms like PancakeSwap are already trying to bridge that gap by making the interfaces playful and enjoyable for every user.
The Way Forward
For any user, new or old in the crypto game, the power to decide what type of exchange to use and the cryptocurrency to buy is totally inherent in the person in question. Centralized and decentralized exchanges have their benefits and their flaws. The adoption rate for truly decentralized finance has grown in leaps and bounds since 2020 with Total Locked Value (TVL) currently at the time of writing at $51.64 billion.
As the tentacles of decentralized finance keep spreading, so would the love for decentralized exchanges in the hearts of crypto lovers as well. All crypto lovers are therefore enjoined to make the right decision of a suitable exchange after expert advice and due consideration.
The writer, Taiwo is a transactional legal practitioner in the Tech and IP space. She is glad to answer your questions and know your experience via the comment section below.
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