As a seasoned analyst with a background in consulting at McKinsey and extensive experience in the crypto industry, having played a significant role in the development of various crypto products and leading the Crypto Operations at Revolut, I firmly believe that the future lies in hybrid crypto exchanges.
With cryptocurrencies experiencing a resurgence, as values approach record peaks and key figures in the field are actively engaged in discussions about it, constructing a reliable and efficient crypto trading platform has become crucial.
Today’s crypto traders demand more than ever before from an exchange platform. They seek a seamless user interface, infrastructure that can handle large volumes quickly and with minimal delay, and unmatched security features. Security is crucial at this time, considering the recent collapse of FTX and its subsequent impact on various other businesses within the industry.
Centralized exchanges are known for creating attractive interfaces and user-friendly experiences. However, they handle users’ assets by taking custody of them, which allows them to operate swiftly. Unfortunately, history has shown that when users don’t hold the keys to their own assets, there’s a risk of mismanagement due to fraudulent activities. Furthermore, these exchanges have the power to restrict account access, such as freezing funds or preventing withdrawals. Following the crypto mantra: If you don’t control the keys, you don’t truly own the coins.
Instead of centralized exchanges where you entrust your funds, decentralized exchanges give users full control over their assets through self-custody. Utilizing blockchain technology and smart contracts, they facilitate peer-to-peer transactions without the need for intermediaries or trust. However, this setup may present a learning curve for some users due to its complex nature. It’s important to note that this architecture has limitations, such as lower transaction speeds, higher latency, lack of sophisticated trading tools like advanced order types and conditions, and potentially high gas fees for blockchain settlement.
A fresh wave of cryptocurrency innovators is considering exchange structures in unique ways. Instead of sticking strictly to either centralized or decentralized models, they aim to blend their advantages – this novel approach is called a hybrid cryptocurrency exchange.
A better trading engine for a better crypto trader
As a seasoned crypto investor, I’ve noticed that exchanges like Coinbase and Binance from the previous market cycle modeled their platforms after broker platforms, emulating their mechanics and user interfaces (UI). They prioritized creating intuitive UIs, robust mobile apps, competitive fees, and an extensive variety of coins and tokens. Their aim was to provide a seamless, fintech-app-like experience for users.
The centralized trading infrastructure offers high throughput and low latency, which is what the world demands for crypto trading. Going deeper, high throughput and low latency enable better liquidity, as market makers can reprice quicker. They also allow for more efficient margin usage, as a centralized risk engine enables the exchange to offer higher leverage. Centralization enables advanced trading features and logic, such as advanced order types and conditions.
Beyond just improving performance, it also enhances the control exchanges have over regulatory compliance matters. These CEXs (Cryptocurrency Exchange Systems) regulate who can access their platform, with the ability to limit certain users based on comprehensive blockchain analysis, financial crimes (Fincrime), and compliance measures. In recent times, particularly following the FTX incident, authorities and legislators have been tightening the screws on the crypto industry, imposing heavy penalties and even imprisonment for businesses and individuals caught flouting regulations.
To put it simply, the hybrid exchange model combines the advantages of centralized exchanges (CEX). The trading infrastructure remains largely centralized. This design also borrows the user-friendly interface from CEXs, as decentralized exchanges (DEXs) often lack features like easy account creation, which means users don’t need a wallet before using the exchange. Additionally, DEXs have limitations in terms of onboarding and offboarding (on- and off-ramps), fee handling, and advanced trading analytics. As more crypto traders join during what seems to be the start of a bull market, it’s essential to have a robust set of features along with an intuitive user experience.
So far, it appears centralization is winning without a hitch. However, the crucial question arises: What traits do hybrid exchanges adopt from their decentralized counterparts? Primarily, they inherit the fundamental aspect that fosters trust in cryptocurrency trading. On the other hand, centralization has its share of drawbacks.
Give users the keys
In simpler terms, hybrid exchanges borrow ideas from Decentralized Exchanges (DEX) by employing blockchain technology to safeguard users’ funds. Users keep their own funds, and trades are confirmed on the blockchain at different intervals. A significant aspect is that the trading rules are verified directly on the blockchain, reducing the possibility of operator fraud. This means trust and transparency are verifiable and unchangeable.
Operator fraud is one of the most significant risks in crypto. CEX’s control over funds is beneficial for compliance reasons; however, it grants the authority to limit access to accounts, such as freezing funds or halting withdrawals. The collapse of FTX certainly heightened concerns over an operator’s access to user funds. Yet, FTX wasn’t the first or only exchange to mishandle user funds and call into question the CEX model. One of the first-ever crypto exchanges, MtGox, completely shut down and filed for bankruptcy in early 2014 because of an undetected theft over many years that drained the exchange of more than 850,000 Bitcoin (BTC). In 2018, Canadian exchange QuadrigaCX went dark and was later revealed to be a Ponzi scheme, causing the loss of roughly $190 million in user funds.
Regular occurrences underscore the significance of personally safeguarding digital assets and using peer-to-peer, on-blockchain transactions. In this setup, individuals maintain control over the access codes for their own digital funds, rather than relying on a centralized service that may not fully disclose its key management practices.
Scaling tech for cutting costs
In the world of derivatives trading, large transactions commonly incur hefty fees. It’s essential to note that there is no such thing as fee-free trading. Centralized and Decentralized Exchanges (CEXs and DEXs) levy charges for trades, but users of decentralized exchanges face an extra expense to process all their transactions on the blockchain. These costs can vary based on the current level of blockchain usage. Notably, Ethereum transaction fees soared to a two-year peak in March 2021, primarily due to heightened interest in meme tokens and increased speculation.
By combining both centralized and decentralized trading methods, the hybrid exchange model streamlines fee structures. This is achieved by relying on layer-2 technology, which enhances scalability without significantly increasing transaction fees. Rollups are a prime example of such scalability solutions. They process transactions on a distinct network, accumulate data from these transactions into groups, and then submit and settle the groups to the main blockchain.
Now’s the time to go hybrid
Choosing a hybrid system, combining aspects of both centralized and decentralized exchange structures, seems like the logical solution as the market matures and competition increases.
The speed, usability, and design of CEX help users of all levels of technical know-how trade crypto easily. And the security provided by implementing aspects of DEX will create an ecosystem of trust and reliability that gives users peace of mind.
In the upcoming cryptocurrency market surge, a mix-type crypto exchange is expected to emerge victorious. This is because success isn’t primarily about inventing something brand new, but rather about skillfully combining existing elements in innovative ways. It’s important to remember that this industry doesn’t conform to a standard solution; instead, it demands creative and adaptable approaches.
Ruslan Fakhrutdinov, previously a consultant at McKinsey and the Head of Cryptocurrency Operations at Revolut, played a crucial part in creating multiple cryptocurrency products. He held profit-and-loss (P&L) accountability for one of the company’s biggest and most lucrative divisions, contributing £220 million in gross profit to the 2021 earnings. In 2023, he chose to depart from the fintech powerhouse to initiate his own endeavor, X10 – a unique crypto exchange platform.
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2024-08-17 14:34