This Startup Is Fixing The Biggest Security Hole In Bitcoin Exchangesy Hole In Bitcoin Exchange
Throughout Bitcoin’s ten year history, one of the common issues has been the fact that the centralized exchanges where people are able to buy and sell the crypto asset are susceptible to hacks. In fact, research by hardware wallet manufacturer Ledger estimates more than $1.5 billion worth of crypto assets has been stolen from these exchanges over the years.
However, new crypto startup Arwen (formerly Commonwealth Crypto) thinks they’ve come up with a solution to this problem. Today, Arwen announced the launch of a testnet version of their platform, which allows traders to keep control of their crypto assets while they’re trading on exchanges via a layer-two blockchain asset transfer protocol.
A Lightning Network for Traders
Many Bitcoin enthusiasts have heard about the Lightning Network, which is a layer-two solution for making bitcoin-denominated payments in a decentralized manner. Arwen has designed a protocol built on some of the same technology used in the Lightning Network to create a separate network specifically for traders and exchanges.
The idea is to give traders the best of both worlds in terms of the liquidity and speed of centralized exchanges and the security of holding on to one’s own private keys.
Similar to the Lightning Network, users are able to leave this secondary network layer and go back to the base Bitcoin blockchain in a situation where something goes wrong. In this way, the blockchain is used as a sort of digital court for smart contracts.
In a situation where an exchange is hacked, the hackers will not be able to access the crypto assets held by those who are using Arwen’s software. Arwen users can simply broadcast a special transaction on the blockchain, which would allow them to regain full access to their digital assets. This same type of special transaction is used when users misbehave on the Lightning Network.
“We use something similar to Lightning revocation transactions,” said Arwen CTO Ethan Heilman when reached for comment. “We call them justice transactions.”
Having said that, there are notable differences between Arwen’s system and the Lightning Network. Some of these differences are due to a desire to support crypto assets based on blockchains that do not have a transaction malleability fix such as Bitcoin’s Segregated Witness (SegWit).
“Building a layer two protocol in face of malleability vulnerabilities is tricky but very important if your focus is to support as many coins as possible,” said Heilman.
Advantages Over Decentralized Exchanges
Decentralized exchanges (DEXs) are not a new concept in the crypto asset industry, but according to Arwen, their design offers advantages over the already available options on the market. A Medium post published by Arwenearly this morning discussed liquidity and latency as two key areas of concern for traditional DEXs:
“Today’s DEXs have too few users to produce a highly liquid market. Liquidity isn’t the only challenge for a typical DEX. Most DEXes require each trade to be executed on the blockchain. On-blockchain execution is slow, typically taking a few seconds to several minutes. In the trading world, even a few seconds of latency can be problematic, given the volatility of cryptocurrency prices.”
The Medium post from Arwen also discusses the possibility of front-running on past DEXs due to the fact that trade details are often published on a public blockchain before the trade has been executed.
What’s the Catch?
While Arwen’s technology is an impressive development in terms of crypto asset exchange security, it’s still not a perfect solution for all traders — at least not yet.
For example, those who wish to trade on margin will need to stick with their current options for now.
“We currently don't support trading instruments that rely on margin trading,” said Heilman. “We have spent some time thinking about how to do this, but those protocols are not ready yet.”
Additionally, there is a requirement for the exchange to lock up an equal amount of the crypto assets that their users wish to trade in blockchain-controlled escrow.
“In Arwen all trades are fully collateralized,” said Heilman. “For this reason the user must pay a prorated fee for the exchange to collateralize a payment channel. Users who are less interested in security may not want to bother with paying this fee.”
At launch, Kucoin, which has a 24-hour trading volume of $6.3 million at the time of this writing, will integrate with the Arwen protocol, and the supported crypto assets will be Bitcoin, Litecoin, Bitcoin Cash, Zcash, Ethereum, and all ERC-20 tokens. For now, the testnet version of the protocol supports Bitcoin, Bitcoin Cash, and Litecoin.