Latest news about Bitcoin and all cryptocurrencies. Your daily crypto news habit.
Not all noncustodial exchanges are true to the terms, but they may still provide a safer service than centralized exchanges.
Despite centralized cryptocurrency exchanges suffering nearly $300 million worth of hacks during 2019, many digital currency traders continue to hold significant sums of capital on centralized exchange platforms.
While many noncustodial crypto services have launched in recent years, few platforms have been able to garner significant liquidity. Cointelegraph reached out to several industry experts to discuss the promise of noncustodial exchanges.
Are noncustodial platforms safer?
Erik Voorhees, CEO of the noncustodial cryptocurrency exchange ShapeShift, told Cointelegraph that, âNoncustodial exchanges provide a fundamentally safer way for individuals to trade digital assets.â He went on to add:
âTraditionally, exchanges are custodial (and almost all of them still are today), and thus they hold user funds. Some exchanges literally hold billions of dollars worth of crypto on behalf of their customers. This crypto can get lost, hacked, stolen, mis-accounted, etc. [...] Often, this destroys the exchange and the customers are out of luck â they bear the risk of these losses.â
Despite his preference toward noncustodial platforms, Voorhees noted that many noncustodial exchanges exhibit some limitations, such as cultivating a âmore complicated user experience,â or exclusively operating âwith Ethereum and Ethereum-based tokens.â
However, Jack Tao, co-founder of digital currency derivatives platform Phemex and a former Morgan Stanley executive, is less certain about which is the safer option. He told Cointelegraph that both custodial and noncustodial exchanges cater to different needs:
âI donât believe itâs possible to determine which type of exchange is âsaferâ in absolute terms, both answers to different tradersâ needs.â
Tao suggested that the successes of noncustodial platforms may be contingent on the popularity of centralized exchanges, arguing that, âthe success of noncustodial exchanges would be a sign that conventional exchanges are failing to remain trustworthy and transparent with their customers.â
The Phemex co-founder emphasized that noncustodial exchanges expose traders to different security risks, asserting his belief that, âAsset security should be a burden carried by the exchange rather than the user.â He added that Phemex developed a cold wallet system that stores âusersâ funds in independent deposit addresses, to be insured in the event of any emergency.â
Are centralized exchanges âhoney pots for hackersâ?
Alan Curtis, the CEO of the noncustodial ERC-20 token wallet Radar Relay, told Cointelegraph that centralized exchanges currently comprise âthe foundation of the cryptocurrency industry,â despite the security risks associated with such platforms:
âProblem is, thereâs a chance users of those exchanges could never see their funds again! Since 2011, there have been 50+ disclosed hacks of centralized exchanges accounting for billions of USD and private user information lost. Somehow, ten years later, most digital asset users are still funding honey pots for hackers!â
Curtis argued that recent âincremental improvements in custody solutionsâ made by centralized platforms are âinsufficient,â urging the cryptocurrency sector to transition toward noncustodial solutions at large.
The term ânoncustodialâ is being misused
Curtis Spencer, the managing partner of Electric Capital â an early stage venture capital firm focused on cryptocurrencies and distributed ledger technology â offered Cointelegraph a balanced appraisal of the strengths and weaknesses offered by both custodial and noncustodial exchange platforms.
Drawing from experience in trading cryptocurrencies across various venues, including âcentralized exchanges, noncustodial exchanges, OTC, and smart contract-based exchanges,â Spencer detailed several risks associated with centralized and noncentralized exchanges:
âThe simple formula of custodial risk = (amount x time) / size of balance sheet can be useful in evaluating the risk of trading on a particular venue. In a traditional centralized custodial exchange, you take bigger risks by storing large amounts of cryptocurrency there for a long period of time, but that can be mitigated by using exchanges with larger balance sheets than can absorb a multi-million dollar hack. Unfortunately, the balance sheet strength of an exchange is usually not very transparent.â
Spencer argued that the term ânoncustodialâ is regularly misused, claiming that many purportedly noncustodial platforms would more accurately be described as temporarily custodial. According to Spencer, noncustodial exchanges decrease their usersâ risk by shortening the time frame during which they hold onto the assets, however:
âUsers are still subject to being censored and the lack of transparency in what the noncustodial exchange does with assets once they are received.â
Despite such, Spencer stated that said noncustodial platforms âencourage better crypto hygiene by having users actually manage their private keys as opposed to relying on bits in a centralized exchangeâs database.â
Spencer asserted that smart contract-based exchanges are the only platforms that can be truly noncustodial. He described these platforms as being relatively new, typically hosting âlower liquidity than their centralized counterpartsâ and having a steep learning curve. However, he concluded that smart contract-based exchanges are a step in the right direction, as they âpreserve both the privacy and safety of assets of the users trading on them.â
Noncustodial exchanges decentralize trust
Steven Quinn, a product manager at cryptocurrency exchanges Eosfinex and Bitfinex, shared his view that ânoncustodial solutions eliminate the need to trust a third-party with precious assets,â offering numerous benefits to both consumers and the industry.
Despite arguing that noncustodial exchanges have the potential to drive a ânew paradigmâ in digital currency trade, Quinn identified several major challenges to the widespread adoption of decentralized exchange platforms.
âThroughput and speed are limitations of decentralized exchanges. These exchanges often rely on a blockchain network for settling trades. So, exchanges that are built on Ethereum for example are at the mercy of Ethereumâs maximum transaction throughput of about 15 transactions per second. Even if millions of users were to switch to a decentralized exchange today, some exchanges wouldnât be in a position to adequately handle the demand.â
Quinn also mentioned that noncustodial platforms require users to experience an entirely new learning curve to adjust to such platforms, emphasizing that âusers need to learn how to keep custody of their own funds while connecting their wallets to the platform.â
Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.