By now, every one of us has almost certainly heard the news about the supposed death of Gerald Cotten, the founder of QuadrigaCX, which left about $147 million in crypto on the exchange inaccessible by its owners. There were speculations that the founder is not really gone and that this was an elaborate ruse to make off with a part of the money. However, whether or not he is setting up a new life on some little-known beach somewhere is beside the point for most of the people. The real problem behind the event is that the use of centralized exchanges which hold onto the cryptocurrencies and private keys of people for them. If the exchanges are controlled by one entity, they operate under a system where just one individual can access the crypto. So, there is actually no obtaining the exchange when he or she dies. Also, if the exchange decides to shut down or maintenance or is breached, its users will be out of luck and money of course. Keeping the keys and cryptocurrencies of people secure requires a shift from centralized to individualized key management. However, how are users expected to satisfy and store seed phrases for dozens of cryptocurrencies properly, when they cannot even manage their Apple ID passwords?
The answer, as well as the real future of the crypto exchanges, lies in the right peer-to-peer decentralized exchanges or DEXs, but much of the infrastructure has to be built before they can even scale.
Here we are going to explain why it is critical to solving for security, as well as key management problems, and move forward with DEX adoption.
The intrinsic issues of centralized exchanges regarding crypto
In the United States, people believe in centralized institutions such as banks to hold onto their money and data, to make transactions seamless. A tradeoff is made, and they are going to trust institutions enough to handle all of their transactions, but they also want to guarantee in the form of FDIC insurance and regulations to guide behavior.
However, for the most part, people trust the system. Such trust tends to bleed over the centralized crypto exchanges, although these have none of the traditional safeguards like the federally-insured bank has. Usually, people realize too late that the custodians of their crypto may not have the ability to care for it in the proper way. Remember that, if it is not your key, it is not your crypto either.
Unsurprisingly, centralized exchanges became the primary target for hackers. In 2018, Coincheck was the prey of the largest crypto hack ever, losing about $400 million in tokens on its blockchain. Of course, they were just breaking the record held by the infamous Mt. Gox hack, which came at the cost of about $340 million. And, by October the same year, almost $1 billion worth of crypto were stolen.
Sometimes, hacks can be foul play, while sometimes, they may be honest mistakes. However, over and over again, centralized exchanges have still not proven to be the best place to store cryptocurrency.
Risks to the new cryptocurrency users
The reason why people still utilize centralized exchanges is as personal key management is relatively complex.
For example, when you choose to store your own key, you are going to be given either the hash of date or a seed phrase – 16 random words which are representative of the key. You should also store those in the hot wallet without danger of it being compromised. The safest way of storing it is putting it in cold storage, writing down the seed phase on paper and then putting it in a safety deposit box or an individual safe. Some people even burn the phrases on metal for added security.
However, as we saw, if someone dies, the key may be lost for good. It is also unsafe to leave instructions on how to find it; still, people apparently don’t want to miss our on the part of an estate only as no one but the deceased knows how to access the money.
Even though individual key management is the ideal scenario, it is now a lot more cumbersome to hold onto your private keys and lead them to a DEX to exchange crypto on a peer-to-peer level. So, people utilize centralized exchanges as right now, they are faster and much more convenient than DEXs. They will even continue to do so until those problems are resolved.
Decentralized exchanges are the most secure option
If DEXs become anything more than a niche tool for the ones most adamant about their security, they are going to have to become more comfortable to use. One of the solutions may be to obtain a third-party, self-sovereign identity which you use on the exchange in mixture with a key management solution.
Another thing important to remember will be that right now we have a generation that reaches maturity that was immersed in the digital world since birth. There is also a generational gap when it comes to crypto use, and indeed, older generations will be more comfortable with centralized entities handling their crypto – if they are comfortable with the concept at all.
However, we can also put the infrastructure in place for people to start utilizing DEXs, and there is going to be an essential population of younger people prepared to utilize them. And, once their use becomes normalized, we can finally have the secure and widespread peer-to-peer exchange crypto users were waiting for.