Can You Trust Your Exchange? Fighting Fake Volume, Centralization, and Hackers on the Crypto Frontlines

Cryptocurrency may be one of the most significant technological developments in recent history, but it has also caused a significant amount of grief. The “be your own bank” promise of Bitcoin and other cryptocurrencies places the security of stored value solely in the hands of a cryptocurrency owner, which has inevitably resulted in large-scale hacks, losses, and scams.

Blockchain technology holds the potential to create a truly transparent, decentralized, and open financial ecosystem free from centralized control and abuse. While Bitcoin and other cryptocurrencies may be decentralized, however, the way in which cryptocurrency investors and holders interact with them is not. Almost all cryptocurrency trading is currently performed on centralized exchange platforms, which have been consistently proven to be susceptible to fraud, hacking, and less-than-honest business practices.

The core technology that drives crypto is inherently immutable and transparent, but centralized exchanges aren’t. The cryptocurrency ecosystem currently sufferers from a series of major problems, which negatively impacts the growth of the industry itself.

The Wash Trading Epidemic

Cryptocurrency exchanges currently facilitate the largest volume of cryptocurrency trade volume. Outside of extremely large-scale over-the-counter trades, the vast majority of crypto is traded on major cryptocurrency exchanges such as OKEx, Binance, and Huobi, or purchased through platforms like Coinbase.

The presence of cryptocurrency exchanges in the crypto market ecosystem is a net positive — these platforms facilitate retail and professional trading and are the vehicle through which most trade occurs. The issue with most exchanges, however, is that they are often governed by little to no regulatory oversight and are susceptible to the actions of bad actors in a manner that does not affect traditional financial markets.

Fake volume, caused by wash trading, is one of the biggest issues in the cryptocurrency market right now. An in-depth analytic report published by Bitwise Asset Management in mid-April 2019 revealed that as much as 95 percent of all volume in the cryptocurrency industry is fake.

By collecting data from the top 81 cryptocurrency exchanges by volume, BitWise discovered that only 10 exchanges are currently keeping honest records regarding trade volume. The data collected by BitWise indicates that Binance, Bitfinex, Kraken, Bitstamp, Coinbase, BitFlyer, Gemini, itBit, Bittrex, and Poloniex are the only cryptocurrency exchanges that possess “real” volume, while the 71 other exchanges assessed all artificially inflate trade volume.

Countering the widespread use of wash trading in order to inflate trade volume is a difficult task — crypto market data aggregator CoinGecko has recently announced the launch of a new analytics platform that will identify and track order book action in order to prevent volume inflation. CoinGecko’s new “trust score” initiative may help trader’s identity fake volume, but unfortunately can’t prevent it — the centralized nature of cryptocurrency exchanges allows bad actors to approach major exchanges with offers of wash trading services, which are available for as little as $1,000/month.

Exchange Hacks Keep Happening

Fake volume isn’t the only problem affecting the cryptocurrency market — despite more than a decade of cryptocurrency trading, exchange hacks keep occurring. To date, large-scale cryptocurrency exchange hacks have resulted in the loss of billions of dollars in investor capital, with major cryptocurrency hacks such as the infamous Mt Gox disaster still affecting cryptocurrency market prices years later.

New initiatives designed to counter the actions of hackers in the cryptocurrency ecosystem are able to minimize the negative effect of exchange hacks, with many exchanges holding reserve funds intended to compensate exchange users in the event of a hack.

The recent Binance hack in which hackers stole over 7,000 BTC from Binance by accessing API keys and two-factor authentication information demonstrates that even the “safest” of exchanges can still be hacked by enterprising bad actors. It’s possible to secure a centralized platform against external threats, but hacks such as the one executed against Binance recently demonstrate that any centralized platform that holds cryptocurrency on behalf of users is susceptible to attack.

The Problem of Centralization

The core tenet of blockchain technology is decentralization. The Bitcoin network, by design, is not operated by a single third party. Bitcoin exists as a collaborative effort performed by thousands of node operators across the world. Centralized exchanged, by design, are not. The future of the cryptocurrency market relies heavily on the application of blockchain technology to the manner in which cryptocurrency is traded — through decentralized exchanges.

The Dex as the Future of Cryptocurrency

Exchange platforms that are built on blockchain technology already exist, and have done so for some time. Decentralized exchanges, or DEX, exist as decentralized applications on top of existing blockchain networks or on top of purpose-built blockchains.

Decentralized exchanges are designed to operate in a peer-to-peer manner and don’t require users to deposit funds into a centralized platform. Instead, trades are made between platform participants, with no need for third party management of funds.

IDEX, Waves, OpenLedger Dex, and CryptoBridge are all examples of operational decentralized exchanges that can be used right now to trade cryptocurrency without third party risk. Some Dex platforms are more decentralized than others — with some still retaining a centralized decision-making team when it comes to token listing — but are overall far less likely to be impacted by wash trading and don't present the same broad risk profile as centralized exchange platforms.

Ultimately, cryptocurrency is driven by decentralization. Until the exchange ecosystem reflects the technology that drives it, it will remain susceptible to wash trading, volume tampering, and hacks.