One of the major trends that appears to be on the horizon for 2020 is a migration to non-custodial exchanges.
As the industry starts to grow up (and the young HODLers and traders mature as well), people are starting to realise the risks of custodial solutions.
If the seven major hacks of 2019 taught us anything, it’s that centralised exchanges (CEXs) are a major target for bad actors. Not only that, but they can’t necessarily always be trusted.
Centralised entities may become insolvent, pull an exit scam, or simply disappear with your private keys.
The rise of non-custodial exchanges
That’s why Nash co-founder Ethan Fast foresees more users making the leap toward non-custodial exchanges.
He says: “Non-custodial exchanges offer a user experience much more aligned with the original promise of cryptocurrencies: user control of funds.”
Remember the Proof of Keys event coming up on January 3? This is an initiative started by industry player Trace Mayer. He wants cryptocurrency users to withdraw all funds from centralised exchanges on this day in order to prove their solvency.
Proof of Keys is also a good exercise for reminding users how to store their crypto-assets safely and how to make transactions.
If you get “withdrawal accepted”, remember it could have as easily been rejected.
Not your keys, not your coins.@TraceMayer’s #ProofOfKeys is coming. Better do it sooner than later.
— PA₿LO F7z (@pablof7z) December 20, 2019
As of Q3 2019, $4.4bn worth of crypto-assets have been stolen already. While not all that sum is the fault of centralised exchanges, opting for non-custodial exchanges can greatly reduce the risk of cryptocurrency theft.
Fast comments: “Users are beginning to understand more clearly the security risks of holding their funds on custodial exchanges, where there may be no recourse if the operators are untrustworthy or the exchange is hacked.”
To be clear, it’s not impossible for a non-custodial exchange to be hacked, but the attack surface is infinitely smaller.
Fast remarks: “It isn’t true that non-custodial exchanges have not been hacked. For example, EtherDelta was hacked in 2017 with a DNS-level attack that tricked users into interacting with an independent malicious website.”
However, he explains: “It is much harder to hack non-custodial exchanges because control of funds is distributed across the users of the service. You won’t see the same sort of spectacular attacks that occur on CEXs where attackers exit with hundreds of millions of dollars of user funds.”
The difference between a non-custodial exchange and a DEX
Since we’re used to talking about “centralised” and “decentralised” exchanges (DEXs), is “non-custodial” just a fancy way of saying DEX? What’s the difference between non-custodial exchanges and decentralised ones (in fact, is there one)?
Moreover, do non-custodial solutions suffer from the same issues as DEXs, such as high latency, low liquidity, and poor user experience?
Fast explains: “’Non-custodial exchange’ is a more precise and accurate description than ‘DEX’, as it focuses on what matters: user custody and control of funds. By contrast, it’s easy to argue over whether a system is decentralised enough to warrant the DEX label.”
Don’t be fooled! Not every exchange calling itself a “DEX” is decentralized. Pegged tokens leave your assets with custodians while you trade only IOUs. Read more about fake DEXes here: https://t.co/uGCHbf62Rf #TrustYourselves #Nash pic.twitter.com/oX4geVnaha
— Nash (@nashsocial) November 15, 2019
He continues: “Every exchange that calls itself a DEX today has some centralised components. By centralising our matching engine while keeping user accounts non-custodial, Nash’s APIs provide low enough latency to enable market makers and liquidity providers to operate on the platform – a first for any non-custodial exchange.”
So, non-custodial isn’t the same as decentralised, but as Fast points out, the key point is that users control their own funds. This makes them far less susceptible to hacks and out of the control of malicious central actors.
But are they easy enough to use for your beginner-to-intermediate cryptocurrency user who struggles with 35-character alphanumeric addresses?
How non-custodial exchanges can gain a substantial user base
Fast admits there’s still work to be done before moving the masses to non-custodial exchanges – from improving the user experience to removing the burden of looking after their own funds.
He says: “Non-custodial exchanges need to provide just as good a user experience as centralised exchanges before we will see mass adoption. This means fast APIs, support for mobile and desktop platforms, a wide range of assets (including Bitcoin), and a best-in-class UI for funds management.”
Just this week, in fact, Nash released a series of updates for its mobile app with a “number of UI improvements”.
The latest Nash Mobile release adds a number of UI improvements, including faster loading times and a USD toggle. Get it now! #Nash #TrustYourselves #Wallet pic.twitter.com/TgnTLtDfd5
— Nash (@nashsocial) December 17, 2019
Non-custodial exchanges reduce the risk of hacks and fraud. But it’s still a very scary prospect for many people being in charge of their own funds. What happens if they lose their backup seed, for example? Their funds disappear forever along with it.
Fast concedes that using non-custodial solutions does imply a lot more responsibility for the user.
He says: “Putting the burden of key management on the user is dangerous because people often do not engage in best practices and either lose their keys or store them improperly.”
When looking at mass usage, he says: “This is one of the biggest UX challenges for non-custodial systems. We try to remove this burden as much as we can at Nash, backing up an encrypted version of user keys that we cannot access to make it harder for users to lose the key material.
“However, we still ask users to maintain a private backup of their keys to protect themselves. We’re working to improve this aspect of the system for the future.”
And in fact, this is the very goal of Nash: “To make joining and interacting with a non-custodial exchange just as easy as interacting with a centralised one.”
As we enter a new year, it will be interesting to see the role of non-custodial exchanges and whether they can truly go head to head with the centralised solutions currently on offer.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.