In a video interview with The Daily Decrypt, founder and lead developer Manfred Karrer announced that the bitcoin exchange Bitsquare is preparing for launch next week on April 27. The exciting thing about Bitsquare is that it will be the first real attempt at a fully decentralized bitcoin exchange.
As you may know already, there are many exchanges in the bitcoin ecosystem. Typically a bitcoin exchange operates as a gateway for users to enter in-and-out of bitcoin, normally in fiat currency. Most exchanges that service bitcoin users are centralized in nature, meaning they are a central point of failure between the user and bitcoin/fiat. A classic example of this is Mt.Gox, which when they imploded they took many users funds along with it.
One of the holy grails in bitcoin has always been to have a fully decentralized exchange. Part of “decentralization” would be a distributed system not controlled or governed by any one group, just like bitcoin is. Another part of the equation though is trust; having a trust-less system is part of a truly decentralized network.
How Bitsquare works
Bitsquare is an open-source system worked on by a handful of developers around the world. The exchange system allows users to buy and sell bitcoins with each other using their matching engine; the exchange is not controlled by any company and is software downloaded so you can run a peer-to-peer platform to connect with others on the network. Users can purchase bitcoin with a bank transfer as long as it’s supported by SEPA or OKPay.
Manfred Karrer broke down how the system operates in another interview, saying Bitsquare works as follows:
To start, a user must download and install the Bitsquare software on his computer.
Once installed and opened, the software connects to other Bitsquare users through a peer-to-peer network over Tor. All these nodes will immediately send and forward their trading offers to the newly connected user. These offers are locally accumulated into a single order book, where they are categorized and sorted by price, payment method and more.
If the user sees an offer he likes, he can choose to accept it. If the user doesn’t see an offer he likes, he can create a new offer, which is also sent and forwarded to all nodes on the network, and appears in their order books. As long as the user is online and connected to other nodes, his offer remains visible in all order books.
Once a match is made, a series of steps is set in motion, most of which are automated by the Bitsquare software.
First, both parties in the deal appoint a mutually agreed on third party arbitrator ‒ or they simply accept the arbitrator that is appointed by default.
Second, both trading partners deposit bitcoins into a newly generated 2-of-3 multi-signature (“multisig”) address. Specifically, the seller deposits the bitcoins he’s selling, while both trading partners include an additional security deposit. One of the keys of the multisig address is held by the buyer, one of the keys is held by the seller, and the third key is given to the arbitrator. As such, both trading partners need to agree before bitcoins can be spent from the address ‒ or one of the trading partners requires help from the arbitrator to do so.
Both trading partners also pay a small trading fee to Bitsquare’s stakeholders.
Third, the buyer sends his payment to the seller, outside of Bitsquare. This can be done in a number of ways, including bank wire transfers, several payment systems and various altcoins. When done, he confirms the payment on Bitsquare. This also signs his half of a transaction from the multisig address, which pays both trading partners their share of the locked up bitcoins.
Fourth and last, the seller receives the payment, and he confirms this through Bitsquare as well. This signs his part of the transaction, meaning two of the three signatures are included. The transaction is broadcast, and both parties are paid their share from the multisig address.
If all goes well, the arbitrator never comes into play.
In theory, it appears that Bitsquare is the coveted decentralized exchange that many in bitcoin seek. However, there are central points of failure which unfortunately doesn’t make it truly and completely decentralized. Bitsquare does remove a centralized middleman such as a bitcoin exchange service provider, which is a huge net positive. But since users are still dealing with fiat currencies such as the dollar, they still need to go through banks in order to do a wire transfer to the other party.
Due to strict banking regulations, this introduces the central point of failure. Users must go in-and-out of government controlled money, where anything from compliance issues, to suspicious activity reports, can set off a red flag where a bank can control your money and disrupt the transaction. Because of the way fiat money works, any bitcoin exchange that deals as a fiat gateway will not be trust-less or decentralized.
Karrer went on to say,
“It’s true that Bitsquare is not really designed for day-traders using wire transfers. Bitsquare more closely resembles something like LocalBitcoins in that regard. But note that some payment methods are instant, or at least much faster than wire transfers, in which case trades take as little time as a blockchain confirmation. And yes, there are some barriers of entry. But on the other hand, users don’t need to submit any ID-documents, there is no waiting period to be approved, or anything like that. It also removes barriers.”
The end-game is clear
The trade-offs with Bitsquare make it a unique exchange with properties that give it an edge over any other exchange on the market. It may not be truly decentralized, but it’s many steps ahead of traditional bitcoin exchanges.
The fact remains that it removes the middleman of an actual exchange service provider, reducing overall counter party risk. And there are other beneficial characteristics that it possesses including enhanced privacy for bitcoin buyers and sellers. Overall, Bitsquare introduces a new way to exchange bitcoin and opens the doors to many possibilities.