The mantra of Andreas Antonopoulos — not your keys, not your bitcoin — is now being echoed by Arwen CEO Sharon Goldberg, whose team has developed a protocol that allows traders to retain custody of their crypto assets while trading on centralized exchanges.
Like the Lightning Network, Arwen is a Layer 2 protocol, but instead of enabling fast transactions, Arwen enables trading without any counterparty risk.
This new security solution, which in essence is bolted on to an exchange's existing infrastructure, promises to be "the most secure method for trading cryptocurrencies on centralized exchanges available on the market today", and relies on a method of trading known as cross-chain atomic swaps.
Making atomic swaps mainstream
The Arwen team, who are a group of VC-funded academics at Boston University, are using atomic swaps to overcome two key challenges facing the crypto ecosystem: security and liquidity.
This is broken down in the white paper, which describes how the exchange mechanism builds on principles originally developed by the TierNolan atomic trade protocol (2013), Spilman channels (2013), and the Lightning Network (2015), to create a protocol that allows traders to transact directly against a centralized exchange's orderbook without surrendering full custody of the coins.
The process is described as an "on-blockchain escrow service", and it is these escrow fees that provide the network with an income. From the whitepaper: "The Arwen Trading Protocol is a blockchain-backed two-party cryptographic protocol between a user Alice and a centralized cryptocurrency exchange. Alice first locks her coins in an on-blockchain user escrow. Next, Alice asks the exchange to lock its coins in an on-blockchain exchange escrow. To compensates the exchange for locking up its coins, Alice pays an escrow fee to the exchange using the coins Alice locked in her user escrow. Alice can now trade across a pair of escrows. [...] Finally, the escrows are closed and the coins are released to the wallets of the user and the exchange."
To make trades in this way, the trader must download an open source program which stores the secret trading keys used to secure the Arwen escrows. This allows the trader to maintain full custody of the coins at all times, and eventually — as the team have planned — will make it possible to trade directly from hardware wallets like Ledger and Trezor.
If the exchange is hacked during the transaction, then the assets fall back to the base layer blockchain, preventing hackers from accessing the crypto assets. Then, in a similar way to the Lightning Network, a mediation process begins where the entire blockchain acts as a dispute resolution system to agree on off-chain balances before the funds are dispersed.
"The problem is that trading on centralized exchanges without an advanced security system is inherently risky for traders," says Arwen CEO Sharon Goldberg. "If an exchange is compromised during a trade, customer funds are at risk. With Arwen, customer funds are secure even if an exchange is hacked."
Security and liquidity
As discussed in a medium post explaining the launch, Arwen aims to combine the best of both decentralized and centralized exchanges, addressing the lack of liquidity provided by decentralized exchanges, and the custodial issues of centralized exchanges.
By tapping into the central pools of liquidity provided by exchanges, Arwen claims to avoid the problems of peer-to-peer platforms like EtherDelta, which often suffer from a lack of liquidity because there are simply too few users.
By taking transactions off-chain, Arwen also claim be able to avoid congestion, making trades much faster than on decentralized exchanges: "Liquidity isn't the only challenge for a typical DEX" explains Goldberg. "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"
For this protocol to be able to work with exchanges, however, they must be compatible: Arwen requires exchanges to integrate a system known as the Request for Quote model (RFQ).
Despite this, several well-known exchanges are reported to be in conversation with the team, and one has already jumped onboard. After completing a security audit on the protocol, Singapore-based Kucoin is now working with Arwen to integrate the testnet, and expects to launch full support at the beginning of the second quarter of 2019.