Cryptocurrency Exchanges Explained [ADB s1e10]

On this week’s episode of Ask Doctor Bitcoin, we talk about exchanges—where you go when you want to exchange one currency for another kind of currency. We’ll specifically cover centralized and decentralized exchanges.

What’s That

A cryptocurrency exchange is a place for you to take your money and turn it into other kinds of money. In a cryptocurrency transaction, one person initiates the transaction (which makes a record on the ledger), and the other person accepts the transaction (also making a record on the ledger).

In a centralized exchange, instead of the transaction going from initiator to blockchain to receiver, the initiator sends the transaction to a centralized platform to exchange the currency. For example, the initiator may send bitcoin (via the blockchain) to the centralized platform, which then converts the currency to Ether and records it on the Ethereum blockchain—which the initiator then reads. This process is the antithesis of blockchain technology, because with a centralized platform, you now have a central point of failure and are vulnerable to hackers.

In a decentralized exchange, you are making the transaction by yourself, using smart contracts to broker the process. For example, the initiator sends his bitcoin to a smart contract owned by a decentralized exchange and transfers it to Ether. If the transaction is not completed, the money is sent back to the initiator safely and securely.

How to

Mark shows users how to make a transaction using ShapeShift. In the example, he transfers Dash to Ether using the decentralized platform. Remember to fill in your sender address, so in the event that the transaction does not complete, your money will be returned. Choose the amount you want to exchange, type in the receiving address, and scan the QR code. The example transaction was completed in less than a minute. Changelly works similarly but has a diverse set of currencies it accesses. Both exchanges are decentralized, accessible through website or apps, and are equally secure and recommended for making cryptocurrency exchanges.

For more information on cryptocurrency and for all of your questions, join us each week on Ask Doctor Bitcoin.

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Ask Dr. Bitcoin: What does the Bitfinex Heist mean for cryptocurrency?

IMG_6069So last night, as my team was readying itself for one of the most well-attended #BigDNT presentations in memory, my attention was elsewhere, as one of the most precipitous price falls in Bitcoin history was underway. I posted to my Facebook account a quick update at the time:

So if you’re wondering why Bitcoin is dropping in price today (and why your other crypto portfolio is hurting as well), one of the leading American crypto exchanges has had a major hack, and has lost around $70-85 MM of user funds, according to reports on Reddit and Twitter.

Bitcoin will recover, but it’s unclear if Bitfinex (the affected exchange) will.

This further highlights the need for decentralized exchanges.

Technologies like Ethereum and OpenBazaar are the primary beneficiaries of today’s events (after the thieves themselves, of course).

Those are the hard facts. Here are some more:

  • Bitfinex was one of the highest volume crypto exchanges on the planet, and was based in Hong Kong.
  • They have temporarily ceased trading after the company reported a security breach that led to the theft of a large number of bitcoins.
  • The amount believed to have been stolen is 119,756 bitcoin, which at the time of writing is valued at $65.6 million.
  • Bitfinex said in a blog post that they were investigating the breach to determine what had happened, but they “know that some of our users have had their bitcoins stolen.”
  • Some of the blame almost undoubtedly rests with their security partner BitGo.
  • The theft itself is said to have been reported to legal authorities.

The market very quickly punished the Bitcoin price, dropping within hours of the news all the way to $465 per BTC before “dead cat bouncing” back well above 560. As of the time of this blog post, the price was steadily rising past $550 per coin.

Screenshot 2016-08-03 at 11.01.30 AM

What does it mean, though?

13876114_1718535025076699_4679288151748508142_nWhile this is certainly a highly significant event in the world of cryptocurrency, it’s not the most significant, it won’t be the last of its kind, and it will not kill cryptocurrency in general or Bitcoin in particular. The market capitalization of Bitcoin is nearly $9 billion, and $85 million only represents a small fraction of that.

There will certainly be many experts with very salient advice about what went wrong and how it could have been prevented, but the most fundamental thing to address in my opinion is the issue of centralization.

Bitcoin and most cryptocurrency was designed with many core principles in mind, and fundamentally these principles require decentralization. In the minds of the early founders of Bitcoin, decentralization represents the ability of Bitcoin to survive corruption, security threats, and “bad actors” like thieves and criminals (or more cynically, bad actors like regulators and administrators). Simply put, if you don’t have a central authority regulating and hoarding large pools of capital, you get rid of many of the existential threats that exist and threaten traditional monetary systems.

What’s interesting, though, is that while the means of decentralized transfer and maintenance of the system was built into the design of Bitcoin, one key piece was left out: the means of deriving market value or currency exchange. As such, to fill that gap, people and organizations started creating what basically look like traditional marketplaces – places where capital pools and becomes vulnerable in the typical ways that banks and other capital pools are vulnerable to bad actors and bad circumstance.

How does this benefit Ethereum?

This is why in my original post I said that this leaves Ethereum and OpenBazaar as the primary beneficiaries. Both of these technologies enable large-scale decentralized exchange. The technologies and digital organizations that enable this are still nascent and lesser known, but the concept is solid, and the outcome is real: trustless exchange of value in an environment less attractive to hackers. These large pools of capital are always going to be a honeypot for those that would like to make off with the money. In a decentralized exchange situation, you can store your own value in wallets that you control until it’s time to make an exchange, at which time the value exchange happens.

Any technology companies or cryptocurrencies that continue to adhere to the principles of openness, transparency and decentralization will be the primary beneficiaries of the natural evolution of this technology, and now is the tail end of the time to be considered a first mover in this space. It was in response to some of the large heists several years ago that OpenBazaar and other decentralized marketplaces were started. It won’t take too many more major heists like this to further push users towards experimenting and using as a natural course of things these decentralized technologies.

[Notes: A small portion of this post was quoted verbatim from a SiliconANGLE post by Duncan Riley, re-used under their published Creative Commons BY-SA license. -mrh]

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