The long-awaited Bitcoin bull market and all signs of the recent wave of corporate and institutional investors allocating most of their reserves to Bitcoin (BTC) indicate that the mainstreaming of cryptocurrencies is accelerating: but the path to mass adoption Is it at the cost of privacy and decentralization?
KYC (Know Your Customer) and AML (Anti-Money Laundering) laws force most cryptocurrency exchanges to make the identities of their users more transparent, while those that refuse to exchange have to limit the scope of services they can provide.
In order to operate legally in many countries, many exchanges have no choice but to comply with strict “anti-money laundering” procedures. Except for Monero (XMR), most major exchanges have delisted a large number of privacy tokens.
Recently, regulators have begun to strengthen supervision, and jurisdictions around the world continue to promote further measures to ensure that investors disclose their cryptocurrency holdings and pay taxes on their profits.
This is happening with the U.S. Department of Justice arresting the co-founder of BitMEX and the CFTC accusing its owner of operating an illegal cryptocurrency derivatives exchange.
About a week later, the Financial Conduct Authority, the UK’s largest regulator, even banned investors from trading derivatives on all cryptocurrency exchanges.
All of these measures are designed to force encryption service providers to comply with the rules, and although they may eventually help further mass adoption, many encryption thinkers are looking for alternative ways to gain financial autonomy.
Decentralized transactions may be the solution
More and more investors believe that centralized cryptocurrency exchanges basically operate in the same way as traditional banks. In response to this, throughout 2020, decentralized exchanges such as Uniswap, 1inch, Curve Finance and Balancer have become more and more popular.
For more sophisticated investors, decentralized exchanges that provide derivatives trading are already available. Similar to traditional derivatives, the crypto exchange that provides this service essentially acts as a broker, but in a decentralized exchange, the process is slightly different. This is because they use smart contracts instead of brokers, and derivative contracts will not settle until the contract terms are met.
At present, Synthetix is one of the most popular decentralized derivatives exchanges. In 2020, its total locked-in value (TVL) rose to 1 billion US dollars, and subsequent major adjustments in the entire industry led to TVL and most decentralized transactions The number of daily active users decreased.
Synthetix Exchange allows users to create a tool called “Synth” of synthetic assets, which can track gold, fiat currencies and cryptocurrencies. It also allows the creation of assets that track asset prices in reverse.
Platform users can also use native SNX tokens as collateral to mint new synthetic assets. Similar to Uniswap, the liquidity provider will earn part of the exchange’s transaction fees in return.
Those familiar with decentralized exchanges such as Uniswap will know that it is no exaggeration to say that anyone can list a new asset. In terms of derivatives, this means that any underlying asset can be converted into a derivative tool.
These platforms allow users to trade derivatives without depositing funds in any centralized platform and do not require them to complete any KYC process.
Although some investors have avoided KYC and tax compliance, this is a serious problem for crypto service providers. According to Molly Wintermute, the anonymous developer who created Hegic DEX, compliance issues are more of a centralized encryption service provider than a DEX.
When asked how DEX maintains compliance with financial regulators, Wintermute explained straightforwardly in a unique way:
“They can’t. This is a new financial infrastructure layer, not a supplement to the existing financial system. It is similar to TCP/IP or FTP, not just a decentralized encrypted trading platform. You cannot ban code or the Internet . Unless the public blockchain is open and permissionless, it is almost impossible to ban decentralized derivatives agreements.”
Wintermute further explained that decentralized derivatives have attracted a certain number of investors due to:
“Non-custodial transactions (the agreement/person does not hold the funds because the funds are allocated to the smart contract). Verified on-chain settlement (there is no low-cost ability to manipulate derivatives, and there is no closure where only exchange owners know how Source trading algorithm). Higher liquidity (the new point-to-pool/point-to-point contract model may provide lower spreads and better terms to users).”
According to Wintermute, the number of investors who actually use DEX is very small compared to the total number of cryptocurrency investors. For Wintermute, this means that the FCA derivatives ban and recent legal actions against BitMEX are completely irrelevant and do not apply to decentralized financial agreements.
Wintermute said:
“Decentralized derivatives are part of the cryptocurrency world. There are more than 100 million cryptocurrency holders worldwide. Of these, about 5-10 companies may be actively engaged in crypto derivatives trading (on a global scale). I think the FCA ban is not It will bring any new and interesting opportunities. Nothing has changed.”
After being asked to elaborate that the SEC, FCA or other regulatory agencies may not attempt to shut down platforms such as Uniswap and arrest their founders, Wintermute said:
“They may arrest one or two CEOs who are like the founder of BitMex. They have some improper behavior within them, but only two arrests will make others feel scared. They cannot arrest everyone. They also Compare decentralized derivatives with cryptocurrencies used for drug transactions. If decentralized derivatives are toys, then drug dealers who use cryptocurrencies to trade are guns. Decentralized derivatives are not a crime.”
Wintermute seemed to have gotten rid of the recent BitMEX scandal and replied sharply:
“I don’t think anyone cares about DeFi or DEX. BitMEX people have a lot of disgraceful things. This may be a good target for attack. And the DeFi/DEX protocol has 100% transparency. The website sent a person to jail, and the numbers on this website are transparent to everyone in the world”
In the end, Wintermute believes that “Bakkt/CME and other obstructors are angry because no one uses their junk products and they are now trying to send crypto entrepreneurs to prison.”
The anonymous developer later explained that, in her view, “the overall response is to ban all cool encryption products and try to use compliant products to gain their user base.”
Although some of Wintermute’s bold assertions may be justified, it takes some time for the law to work, and as we have seen in the now-defunct ICO era, it takes time to bring those who violate securities laws to justice. .
In 2020, the total value locked on the DeFi platform has risen to US$12.6 billion, and data from Dune Analytics shows that Uniswap’s transaction volume in October was US$11.2 billion. These huge numbers will definitely attract the attention of U.S. and international regulators, so it is only a matter of time before legal action against DEX is taken.
Decentralized exchange is a testing ground for second-tier solutions
In addition to solving privacy issues and restoring decentralization in the cryptocurrency field, DEX also provides a sandbox for second-tier developers. As Cointelegraph reports, scaling in the Ethereum network has always been a persistent challenge.
When the network becomes congested during periods of high demand, gas fees will increase exponentially and transaction speed will stall. With the development of Ethereum 2.0, many DEXs have begun to try to integrate second-layer solutions to provide cheaper and faster options for users who are willing to give up the Ethereum network.
For non-Ethereum-based DEX, Project Serum may be one of the most famous success stories.
This decentralized derivative-based project is built on the Solana blockchain, not the default Ethereum network for most DEXs, but it can also be fully interoperable with ERC-20-based assets and Bitcoin.
FTX CEO Sam Bankman-Fried and his team are the masterminds behind Project Serum. According to Bankman-Fried, the project aims to circumvent the privacy and security issues of centralized exchanges and provide users with a permissionless way to Invest in leverage and swap assets.
This project also provides a cheaper alternative to solve the high gas fees and slow transaction speeds that often plague the Ethereum network during periods of high traffic.
Bankman-Fried said:
“In order to build a product that can provide fast and cheap order matching, you need a high-throughput chain. This demand for non-standard market transactions and processing risks or liquidation has further increased. Serum chose to build on Solana because Solana focuses on a unique and powerful expansion vision.”
Bankman-Fried believes that technical issues such as congestion and high fees may determine the success or failure of investors. Regarding the high cost, he said:
“They are fatal: you basically cannot use derivatives on Ethereum due to scaling issues. If there is a growth opportunity for decentralized derivatives, they are either on the new L1 or on L2.
Bankman-Fried also agrees with Wintermute’s statement, because “the vast majority of derivatives are on centralized exchanges, so almost no one uses DEX.” But he suggested that, theoretically, “composability and self-custody” should It is the motivation for more users to use DEX.
A user-friendly DEX will dominate
Currently, as the price of Bitcoin, a digital asset, is pursuing record highs, investors’ attention has turned back to Bitcoin. Data from Cointelegraph and Digital Assets Data show that DEX trading volume and daily active users continue to decline.
Although this may disappoint investors, it at least provides some quiet time for developers to focus on how to properly integrate second-layer solutions into the DeFi protocol.
The trend of major cryptocurrency exchanges becoming more centralized is unlikely to change in the short term. This means that once investors choose to invest in decentralized finance and decentralized derivatives again, the first decentralized exchange that successfully provides a platform with low prices, privacy protection and fast user-friendly interfaces will dominate.
