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Decentralised exchanges (DEX) have always been able to compete and beat centralised platforms when it comes to reliability and security because of their superior design.
Yet, despite countless exchange hacks, frozen assets as a result from government bans, and opaque operations, most of the crypto trading volume we’ve seen in the past few years has gone through centralised exchanges.
Trading volume has always been the advantage centralised platforms have over decentralised exchanges. That’s about to change as recent findings have uncovered some centralised exchanges have been artificially inflating those numbers.
Centralised exchanges faking trade volumes
Following the investigation led by the Crypto Exchange Ranks research team, it seems like some of the centralised exchanges have been faking trade volumes on a mass scale. The team investigated how relatively new crypto exchanges like BitForex, FCoin and CoinEx were able to surpass established names like Upbit and Kraken, breaking into the CoinMarketCap list of Top 10 Exchanges based on daily trading volume.
The team analysed the rapid rise of the three trading platforms exploring their social media engagement, website traffic and overall demand. They uncovered what appeared to be a lack of active users, traffic and engagement which led them to believe the crypto trading platforms were inflating trading volumes with wash trade methods. The dishonest practice can be carried out in several different ways, but typically uses large trading orders made by bots that trade their own coins to inflate volumes.
A separate investigation into OKex conducted by Sylvian Ribes concluded that the trading platform was in fact a ghost town largely populated by trading bots with up to 93% of its volume being non-existent.
These and other reports have led crypto data tracker CoinMarketCap to issue an announcement involving how they intend to counter fake volume concerns.
Pointing to a bigger problem: lack of transparency
The findings in the reports point to a bigger problem that exists with centralised exchanges. Because centralised exchanges are run by a central authority, their operations, business models and revenues are opaque which makes it cheap and simple to engage in wash trading to pump up volumes artificially.
On a decentralised exchange, it is much harder to fake volumes and easier to filter out suspicious trades. Instead of opaque operations, all DEX activity occurs in a transparent manner. Counterparties find each other and trade directly on-chain or off-chain using smart contracts. This increases transparency and auditability levels and makes DEX trading volumes far more reliable than their centralised counterparts.
Decentralised exchanges provide better security
Besides dishonest practises, users on a centralised exchange are subject to increased risks of fraud and theft coming from bad actors inside the companies running the platform or from outside attacks. In comparison, decentralised exchanges have a fundamentally different design which provides an edge in terms of security.
Protection from misconduct internally
Users connected to a centralised trading platform don’t actually hold the coins they trade in their own wallets. Instead, the coins are credited to their accounts, but stored in a wallet owned by the exchange. The private key necessary to access the wallet is held by the exchange and they often refuse to release the key to the account holder. In a way, it requires users to trust centralised exchanges as though they were banks.
This dependency creates tremendous risk to the users as illustrated by the infamous Mt. Gox incident. In 2014, the Japanese exchange accounted for 70% of all bitcoin transactions when it abruptly shut its doors and filed for bankruptcy. An independent audit determined the coins had been stolen over time, soon after Mark Karpeles became CEO.
Of the missing 850,000 bitcoins belonging to Mt. Gox customers, Karpeles acknowledged 200,000 coins have been recovered after they were found in a “forgotten wallet”.
This could never happen with a decentralised exchange because customers keep their own coins in their own wallets. Trades don’t go through the central authority but are conducted on a peer-to-peer basis and effected by smart contracts. The exchange of funds is mediated by the blockchain itself and every transaction is constantly audited and validated by cryptographic proofs.
Protection from outside attacks
Additionally, centralised exchanges are far more vulnerable than DEXs when it comes to exchange hacks because all the funds are held centrally. For hackers, centralised crypto trading platforms are nothing but large honeypots waiting to be exploited.
Hacking a DEX is a lot less lucrative, because there is nothing to steal from the platform itself. All the funds are held by the users themselves in their own wallets. Funds traded on the DEX are distributed and fragmented across the network, so there is no central target for hackers to break in to.
Hacking a centralised exchange is like a well-planned bank heist, whereas stealing from a decentralised exchange is more like random pickpocketing.
DEXs own the future of crypto trading
Despite offering a more transparent and safer services, the growth and mainstream adoption of DEX has been somewhat limited. One of the key reasons is likely a suboptimal user experience. But as bigger players such as BitShares, Kyber Network and Etherdelta have begun to focus more on delivering a seamless and user friendly experience, decentralised exchanges are poised to take over the crypto trading market this year and will ultimately initiate the downfall of centralised trading platforms.