Bitfinex has sounded the alarm on Bitcoin centralization. How can exchanges achieve decentralization?

The Bitfinex hack is fading with time, but the problems associated with operating a Bitcoin exchange are not going away.

On August 2, 2016, Bitfinex, one of the largest Bitcoin exchanges by volume, announced that it had become the latest victim of a major security breach. Accounts were hacked and customer funds were stolen. The ghost of Mt. Gox reappeared.

Yet despite their problems, exchanges remain the gateway to bitcoin, the interface with the world of central banks. With large exchanges like Coinbase and Bitfinex dominating bitcoin trading, commercialization has become a growing trend from a grassroots movement once fueled by anarchists and technologists.

These fast-growing companies provide convenience to users, but at the same time, the concentration of funds in a few exchanges also leads to the concentration of risks and creates single points of failure.

The Bitfinex theft represents another failure of a centralized system. Some are calling for more regulation, and it appears that new solutions are already emerging within the ecosystem.

Hope from the future

As Bitfinex begins to restore services, the disruption caused by the hack has encouraged community members to examine familiar scenes on centralized exchanges.

It may be helpful to recall the origins of cryptocurrency here.

The message embedded in the first blockchain block reads: 'The Times 03/Jan/2009 Chancellor on brink of second bailout The Times 03/Jan/2009 Chancellor on brink of second bailout for banks banks'. This could be seen as a warning of a worrying future, locked into a trajectory from the past.

Bitcoin presents an alternative that never existed. Its mysterious creator, Satoshi Nakamoto, describes Bitcoin as 'a distributed system with no single point of failure, where users hold the cryptographic keys to their own funds and can transact directly with others, with the help of a peer-to-peer network to check for duplicate payments.'

The Bitcoin whitepaper (full text download of Bitcoin whitepaper in Chinese) published under a pseudonym was a promise. Bitcoin (which began operating in 2009) is the fulfillment of that promise. That promise is to establish security through cryptographic proofs, replace trust in third parties, and create a resilient network that can withstand risks.

The 2008 financial crisis coupled with unprecedented institutional corruption began to give rise to resistance forces, and the creators of this technology have recognized these forces.

The assumption that governments protect us is increasingly being challenged. Trusted third parties are often actually the opposite.

Many credit companies charge predatory interest rates. Companies hide their large profits through service fees and refunds. They target the poor, migrant workers and now even the middle class with remittances and loan sharks. Central banks devalue their currencies while governments, using media propaganda, divert taxpayers’ money to finance resource wars.

A new vision for safety

This control doesn’t just exist in currency transactions.

This centralization for efficiency has sown the seeds for data mining and made the system vulnerable to censorship and espionage, the extent of which was revealed by Edward Snowden’s revelations about NSA mass surveillance.

In response to the demands for reform after the Snowden revelations, President Barack Obama quickly began defending the secret surveillance program. At the time, he told the American people, "You can't have 100 percent security and 100 percent privacy at the same time." He then noted that people must make a choice as a society. His solution was that the public just have to trust the government.

With most currencies already digital, central servers collecting information can have disastrous consequences when personal data is compromised. Contrary to Obama’s security claims, the reality is that citizens under indiscriminate surveillance no longer have privacy, nor can they protect themselves from a government that operates in secret and undermines basic rights.

Unlike the security promised by politicians in power, Bitcoin is built on a different vision of security. Cypherpunks, who advocate the use of strong cryptography as a form of social change, argue that 'we cannot expect governments, corporations or other faceless organizations to hand us privacy.'

Despite the recent Bitfinex setback, Bitcoin hashrate hit a new high following the attack.

Open Source Agreement

Bitcoin is a community-driven free software project.

The immutability of its network is supported by decentralization. Satoshi Nakamoto’s anonymity is at the core of the technology. By keeping the network parallel, from its origin to its development, it maintains an unprecedented security model, and its ecosystem grows in an organized manner.

At this point, decentralized exchanges could become an important link connecting many users to the Bitcoin network, however, such exchanges are lacking today.

Bitsquare is one of the few fully decentralized and censorship-resistant exchanges that is trying to fill this gap. Bitsquare was launched in late April this year and aims to creatively solve some of the problems inherent in centralized exchanges.

After the Bitfinex incident, an account of the BitSquare exchange said via Twitter:

“It’s time to expand the Bitcoin model of “be your own bank” to “be your own exchange” @aantonop — Bitsquare (@bitsquare_) August 3, 2016

Bitsquare founder Manfred Karrer explains how BitSquare achieves decentralization by removing trusted third parties from exchange transactions, allowing everyone to buy and sell Bitcoin using national currencies and alternative coins.

By having the server use the Tor Hidden service, the project attempts to bring stronger privacy protection, which can solve the weak anonymity of Bitcoin. What is special is that BitSquare is not only a decentralized exchange, but also a protocol designed to keep the network open. BitSquare is not a registered company. It is an open source project that can be studied, modified and shared freely.

BitSquare’s commitment to decentralization is demonstrated through its choice to prioritize security over convenience, as they do not hold user funds or collect data. This priority also extends to how they guide the organization, valuing community development over top-down management driven by rapid growth and profits.

BitSquare is gaining more attention since the Bitfinex security breach, and their client currently supports 73 altcoins. At this early stage of the project, it has some limitations, so there is room for improvement.

Bottom-up solutions

Centralization has been the dominant model of the society we live in today.

Corporate institutions are organized hierarchically, separating CEOs from employees and customers, and often turning people into cogs in a machine. This organizational style not only dominates the market, but also has a huge impact on political systems. As a result, governments are increasingly alien to the people they are supposed to represent, creating a huge gap between those who govern and those who are governed.

In the realm of trusted third parties, we have become “consumers” who are supposed to passively accept programs and apps that are not designed with our best interests in mind. Distributed systems, on the other hand, empower individuals and increase the role of users in the network.

One lesson learned from the Bitfinex incident is to realize our own power and responsibility in the incident. This can become a collective wisdom and make the community stronger.

Decentralization creates fertile ground for diversity. Platforms like BitMarkets and OpenBazaar create completely P2P markets, creating places for people to trade directly without the involvement of middlemen. The more decentralized exchanges and projects there are, the more dispersed the risks and opportunities will be.

The problems of centralization cannot be solved by the same thinking patterns that created them. Instead, solutions require innovation from below.

The security achieved through cryptographic proof is a commitment.

The network effects we participate in can deliver on that promise, making the system bulletproof; the system will be impossible to hack, there will be no more Mt.gox and Bitfinex, and the atrocities of past hacks will be left behind.