Bitcoin was created as a trustless and censorship-resistant currency in which the holder has complete control over his funds. It gives people the ability to be their own bank and to transact directly with one another. Centralized exchanges, despite providing a valuable service, remove this control from their users.
“A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.” Satoshi Nakamoto, Bitcoin whitepaper, 2008
Hacks, fractional reserve systems, or plain theft can lead to the loss of user funds as we’ve seen over and over again with centralized services like Mt. Gox, Cryptsy, and most recently Bitfinex, that have lost millions in user funds. Furthermore, centralized exchanges employ KYC/AML policies that, combined with the transparent nature of the blockchain, strip the user of his privacy, and may cause fungibility issues. Centralized exchanges may also be subject to order book manipulation by corrupt operators. Ironically, every problem that Bitcoin solves can be found in these exchanges.
There are however some alternatives that employ blockchain technology to allow users to exchange cryptocurrencies, and even fiat currencies among themselves without the need to trust a centralized third party service.
BitSquare – Bitcoin Exchange
Bitsquare is an application that allows anyone to buy and sell Bitcoin in exchange for national currencies or alternative cryptocurrencies. Bitsquare runs on a peer to peer network, much like Bitcoin itself, meaning that there is no central server to hack as the application is hosted by the nodes running it. Using Bitsquare, users retain control of their funds until the exchange takes place. Furthermore, Bitsquare network operates using Tor hidden services, and all the private data sent over the wire is end-to-end encrypted.
When a user wishes to sell or buy Bitcoin, he broadcasts an offer to the network and pays a security deposit. Another user can now take that offer and start the trade by depositing the security deposit himself.
The Seller’s Bitcoin, his security deposit, and the buyer’s security deposit will be held in a 2 out of 3 multi-signature wallet, in which the key holders are the seller, buyer and a randomly appointed arbitrator.
Now that the Bitcoins are in escrow, the buyer can send the fiat or altcoin payment via traditional methods like bank transfer or a simple cryptocurrency transaction. Chargeback friendly methods are not available on Bitsquare.
After the payment is made, the buyer signals it and authorizes an outgoing transaction in the multi-signature wallet to himself. When the seller receives the payment, he confirms it thus completing the 2 out of 3 signatures required, and the Bitcoin is sent to the buyer. If the transaction goes according to planned, both users keep their security deposit.
If the transaction is contested by one of the parties (because the buyer did not send payment or a seller falsely claims to have not received it), the randomly assigned arbitrator will step in and resolve the issue according to the evidence provided by the traders. The arbitrator will keep the security deposit of the party that has misbehaved, while the other security deposit will be returned to the customer.
Bitsquare applies a trading and a tx fee that is put in place to avoid spam orders and market manipulation and to pay for transaction fees.
Everything in Bitsquare is decentralized, including the order books which means that the user must be online for their order to be broadcast and for the trade to take place.
Although Bitsquare may be a bit hard to get used to for less experienced users, it is the only decentralized exchange that offers direct Bitcoin to fiat trading.
Bitshares is a platform with it’s own blockchain and native currency (BTS) It allows decentralized exchange of Market Pegged Assets (MPA) and User Issued Assets (UIA).
A Market Pegged Asset or “Smart Coin” is a crypto asset that always has 100% or more of its value backed by the BitShares core currency (BTS), to which they can be converted at any time. Smart Coins are created on the BitShares blockchain when a BTS holder asks the network for them by handing over collateral to the network, essentially locking them in a contract for difference (CFD). Smart Coins include assets like BitUSD, BitGOLD, and even BitBTC.
User Issued Assets are different, they can be issued by anyone and are valued according to the reputation of the issuer, meaning that there is a trust element. User Issued Assets like open.BTC and open.ETH are used to represent cryptocurrencies (Bitcoin and Ethereum) and are issued by the Openledger exchange, which is the web version of the Bitshares exchange.
When a user wants to fund his Bitshares account, he can send BTS to his wallet normally, or use a gateway or bridge service like Openledger to convert cryptocurrency funds into User Issued Asset. A Gateway converts funds into the user issued asset they represent, while bridges are a shapeshifting service that allows users to exchange a cryptocurrency for na UIA that represents another cryptocurrency. These assets are kept in the user’s wallet and can be traded freely in the Bitshares exchange, and withdrawan as BTS or the cryptocurrency they represent.
Users can not withdaw smartcoins like BitUSD directly to their bank accounts, but they can enjoy all the advantages of cryptocurrency, while holding a price stable asset like bitUSD or bitGOLD, and they can trade user issued assets that represnet other cryptocurrencies without the risk of that asset being stolen.
Users can also withdrawal fiat User Issued Assets like open.USDT or open.EURT to their bank accounts through Openledger, but this requires users to verify an account with CCEDK.
Of course, when trading User Issued Assets, one must be aware that the cryptocurrency funds that back the assets are entrusted to a third party, much like in a centralized exchange, and that they are subject to theft or neglicence, so only smartcoins (MPAs) are fully decentralized.
Bitshares can be used as a desktop or browser application and it is very intuitive and, unlike Bitsquare, it does not require users to be online for a trade to take place. Bitshares only supports trading of its native currency BTS, and Market Issued Assets or User Issued Assets, meaning that when trading in UIA that represent other fiat or crypto currencies users must trust a third party service.
Counterparty (XCP) is a meta-coin smart contract layer that embeds data into regular Bitcoin transactions. It allows anyone to issue assets or tokens inside of the Bitcoin blockchain, these are separate from Bitcoin the currency itself but exist entirely inside ordinary Bitcoin transactions. Counterparty allows users to exchange assets for bitcoin or other assets within the Bitcoin blockchain.
When trading assets for other assets, the Counterparty protocol acts as a decentralized escrow service that holds the funds until the orders are matched. When trading na asset for Bitcoin, the asset is held in escrow and the other user must make a manual bitcoin payment using the Counterparty wallet. Although the Counterparty DEX only allows users to trade Bitcoin, XCP and assets, there are a varity of popular cryptocurrencies that were issued using Counterparty like BitCrystals and FoldCoin.
Steemit, the Blockchain-based blogging platform, employs the technology used in Bitshares to provide its users with a decentralized exchange where they can trade Steem, the cryptocurrency that fuels the Steemit platform, for Steem Backed Dollar, smart coins that are backed by Steem and are pegged to the value of the USD. This system allows users to keep their Steem as a stable asset that is pegged to the dollar, or as a cryptocurrency that is exposed to volatility, Steem.
The NXT cryptocurrency platform also allows users to exchange assets on the blockchain without a third party involved. These assets, however, can only be traded for NXT and not among themselves, which greatly reduces the functionality of the exchange.
More projects with the intent of creating a decentralized exchange service for users are currently being built. Waves is building a platform that will allow users to trade fiat and cryptocurrencies without the need to trust a third party, and to withdraw fiat currencies directly through fiat gateways. EtherEX is also developing a decentralized exchange that will run on Ethereum Smart Contracts. In time as the technology progresses, decentralized exchanges may come to replace centralized ones, thus ending the era of “Getting Goxed” once and for all.