D(arwen)

how exchanges are evolving

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Today we have some thoughts on Arwen and the balance between self-custody and efficient trading from Messari analyst Jack Purdy.

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Despite repeated hacks, it seems crypto exchanges still cannot figure security. In 2018 alone hackers made off with over $800 million, representing over half the total amount ever stolen. Already this year we’ve seen one of the most prominent exchanges Binance get taken for $40 million. Security is hard, especially when millions of dollars in cryptoassets are up for grabs.

One solution has been migrating from the centralized exchange model altogether, opting instead for decentralized exchanges (DEXs). One of the immediate advantages offered by DEXs is to eliminate the centralized honeypot that hackers look for, since users are able to custody their own assets.  

However, DEXs come with their own problems. One being the inherent latency issues since messages need to be sent to a distributed set of nodes making it physically impossible to reach the speed needed to satisfy many professional traders. Others include poor UX due to the infancy of the tech, scalability problems of underlying blockchains, and front-running since it is possible to see executed trades in the mempool and then set your gas cost higher to have your trade mined first. 

But who said you can’t have your cake and eat it too? 

Enter Arwen a novel approach that combines the two approaches and allows self-custody along with the speed and liquidity of centralized order books. Arwen created a layer-two blockchain protocol that enables users to trade on exchanges without having to trust them to secure their funds. 

This is accomplished via an escrow mechanism where the user sends funds to a Hashed Time-locked Contract (HTLC). They then ask the exchange to do the same and pay a fee in order to compensate the exchange for locking up their tokens. The user can then trade across the escrows with each individual trade being executed atomically. 

Whenever the user wants to withdraw their tokens they can, and so long as the escrow is closed before the time expires their tokens are safe. If time expires before the user closes the escrow their funds face the same security risks as any other tokens on an exchange. However, at any point in time the user can re-escrow the funds or withdraw them altogether. 

Arwen is currently launched on KuCoin and enables trading for BTC, BCH, LTC, XRP, ETH, and ERC-20 tokens. This is a major development for Bitcoin as it is a new way to trustlessly participate in the emerging DeFi space.

Pathways for DeFi in Bitcoin

Like everything that is cool in crypto Arwen is currently unavailable to U.S. residents. The idea could also face headwinds from the new FATF recommendations since exchanges would have no longer have the power to control who users send funds to. 

Regardless, Arwen is tackling a pressing issue in crypto in a unique way. The ability to self-custody while trading on a centralized order-book is a game-changer and something we expect to be widely used in the future. 

-Jack

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