Topic: Idea for a decentralized security exchange (Read 3156 times)

Yes, I'm aware a lot of the software already exists. The more that I think about it, the more I feel like colored bitcoins is the way to go. But a real exchange is a lot more than that. You need everything else that goes along with it. Namely, a p2p way of distributing information regarding the available securities and finding people to trade with.

The thing is, no one runs a decentralized exchange. That's the point. Who runs Bitcoin? The only thing you need is a website or someplace for users to download the client software and there you go.

Now, the better question is why isn't there incentive for people (both traders and issuers) to use a decentralized exchange. Up until now there hasn't been. But BTCT is gone. Bitfunder can't be used by US residents so it might as well be gone. And Havelock Invesments is too small and will likely suffer the same fate as Bitfunder and BTCT if it gets bigger. There is now a HUGE incentive to a decentralized exchange that can't get shut down because we are almost out of options.

Here is what we need:

- Colored coins as the backend to deal with marking transactions as belonging to a specific security, etc. We need an API based on top of colored coins that let's a trader or issuer perform everything they'd need to do with a security and have it happen using colored coins. For example, create a security, trade shares from on address to another for a given price, get the last trade price of a security, etc. I'm working on specifying this API right now.

- A client that runs as a p2p system for distributing security data and facilitating trading. This can work like any other p2p system (gnutella, bit torrent, bitcoin, etc). It will be used to distribute information and updates about each security by the issuers and allow the traders to post orders for buying and selling which can be automatically filled by the network. This is the part that doesn't exist yet, but it is nothing novel, technology-wise. It is also the part that doesn't require the bitcoin network or the same level of security. All the security and anonymity are provided by the bitcoin network. Because this will be a p2p network with no central server, it can not get shut down.

The government has a legitimate concern. Terrorist finance is real.
But I'm not in a position to know how much of a problem it is for Bitcoin.

I'm skeptical about it being a problem for Bitcoin but there aren't enough statistics to really know yet.

Anyway, instead of thinking of terrorist finance as something involving the Taliban think of it as more state sponsored violence, using Bitcoin. If you're concerned about states abusing Bitcoin and you understand many terrorist groups are state sponsored then you can understand it will be a legitimate threat at some point.

I thought terrorist finance was something made up by the government to scare us into more and more regulations...

Do you really think we can stop terrorists receiving funds?
The real terrorists are already funded by our tax money IMO.

The SEC is a minor player.

I agree with you. And you were right about Labcoin being a total scam. I do want regulation of issuers and I do think issuers should be checked and held accountable by the SEC if necessary. But what does regulating corporations have to do with preventing investors from investing?

I'm all for making corporations become transparent and regulated so that people aren't scammed and don't lose their money. The current set of SEC rules don't make any sense at all and don't apply very well for the particular situations you see in the Bitcoin community. Bitcoin investors do not want the SEC interfering with their ability to invest, region blocking, or invading their privacy. I also don't think Bitcoin investors want to mistakenly fund terrorism, or be involved in money laundering.

The problem is fraud, scams, money laundering and terrorist finance. The regulations of the SEC don't really apply to Bitcoin with it's decentralized concepts and P2P digital money. For example with Bitcoin everyone is pseudo-anonymous, does knowing an investor prevent money laundering? No not necessarily. But it does make sense if someone were trying to move large amounts of Bitcoins or to have suspicious activity which looks like money laundering to have an ability to look more closely at that. The fork in the road is between those developers who push for anonymity and those who don't. Anonymity means every individual will have to report directly to the government similar to how you have to report your earnings to the IRS while transparency on the blockchain would allow the blockchain to report it all. Either way we will have to interface with the government at some point.

The benefit of digital is that you can be selective. Small investors should not be scrutinized or forced to give up their privacy. That means if someone is not investing large amounts of Bitcoins at the time there shouldn't be a need for verification anyway. Money laundering is usually something which takes place with large amounts of Bitcoins. If all the Bitcoins are anonymous this presents a problem though, because if a terrorist or money laundering situation does happen it puts a bad light on the entire Bitcoin economy if every transaction is hidden from authorities and this forces authorities to detain, question, and eventually make everyone report their activities.

At this time while it is true that there are a lot of illicit Bitcoins floating around out there, and a lot of scams, a lot of fraud and theft, the SEC has no solutions and until the Bitcoin community takes it seriously it's not even the SEC's fault entirely.

What do you propose should be done to prevent scams? fraud and money laundering?  Should we have anonymity? if we do then how do we report a scam, a crime, or prove our innocence?

All of this development discussion is kinda cool. I don't know why it's in Securities though, because these ideas either skip over entirely or flat out ignore the problems and standards of finance, which no amount of technical architecture, however great, can address entirely on its own.


"They" aren't "centralized exchanges", they are/were play exchanges operating on the notion that having a website and putting up the appearances of trading along with a lot of good intentions makes a thing real. They don't make it real.


There'd be one, MPEx. MPOE is a bond through which the options trader finances itself, and the trader together with MPEx form the underlying for S.MPOE (traded here).


Issuers of real securities have no problem using the actually secure exchange, or with being held accountable, and so forth. People who either lack the requisite skill or knowledge, who simply don't have something of value to offer, or who are outright scamming on the other hand have a problem, and rightfully so, in terms of being accepted by MPEx and meeting its standards. A scenario in which this problem is removed and the only block to listing is messing around with some code or paying someone else a pittance to do it for you is doomed to as much spectacular failure as you've seen emanating from the previous "citizen finance" attempts.


This is a rather skewed representation of what's happening. That a series of people not qualified to run a securities exchange have stepped up in an attempt to bring low-boundary, incredibly sketchy non-solutions to "the community" at large and have subsequently found themselves in over their heads does not mean the problem is "the current set of regulation". The problem is that finance is not a mass consumer thing to be packaged up and handed out by anyone at all with a hope and a dream.

There's a big difference between the sort of red tape regulation nonsense governments have no business injecting here and enforcing simple, established, powerful rules that keep scammy and otherwise worthless stuff out.

OpenSource software exists right now running on servers and being available for listing and trading assets denominated in BTC using Open Transactions (via blinded tokens), Colored Bitcoins and Ripple. Also there are centralized (often closed source) exchanges that put a strong focus on crypto (e.g. MPOE where every trade etc. is signed with PGP keys so it is externally verifiable and auditable).

In contrast your idea, even though a nice one and probably relatively easy to implement, is NOT implemented anywhere that I know of, even in a test/beta scenario.

The problem with these decentralized exchanges is that there are few incentives to operate one. Ripple solved it by creating XRP and they get a lot of hate because of that. Colored Coins seems to piggyback as much as possible on Bitcoin, so it wouldn't really need much anyways besides a note on the company website to trade this asset and OpenTransactions... well I have yet to see someone even using them, though the software exist for years now.

We need people starting a security on ANY existing platform and stop about designing ideas on how to come up with yet another decentralized trading platform. The platforms exist for months and years already, it is just that issuers of securities seem to be more happy with using centralized websites than not-so-nice but secure and distributed exchanges. Similar issue like Chaumian blinded money (which was even being tested live) compared to PayPal (or bitcoin-qt vs. inputs.io). Their selling point is simply "trust us, then all you need is username + pwd". People care about simple more than about security and privacy, even(!) in the Bitcoin ecosystem!

I'm starting to repeat myself but colored coins aren't an abstract idea either. There are working implementations and highly talented people developing it further as we speak. A lot of effort was also placed in the design, with solutions to problems you haven't even thought of yet if you're just starting out.

You're welcome to join the development effort. coloredcoins.org is a good place to start, or https://groups.google.com/forum/#!forum/bitcoinx when you want to go into the details.
 
It's still too soon to list any major asset on it, but if you want to do some more active field testing, you should ask Alex if the software is ready for that.

I realize what I am describing is very similar to Colored Coins. Like I said before there are many other projects which are similar.

But what I am proposing isn't just an abstract idea. I'm saying we need to actually start making a security using an idea like I proposed or maybe just following the colored coins proposal.

There are enough great protocol ideas out there, we need to actually implement one and start with a very simple trading API and get some securities on board.

What I proposed was the simplest and quickest way to get to that point as far as I can tell. Sure, it might not be elegant, but it would work and right now that is what we need as we are losing centralized exchanges left and right. If BitFunder ends up getting shut down, havelock won't be too far behind and bitcoin securities will be a thing of the past.

I'm a software engineer working in the finance industry and I'm going to start working on this in my spare time although I worry that I don't have enough spare time to make progress quick enough in this project.

a) Yes, that's true but we can simply use larger transactions of a minimum size. In the future, I predict miners will accept these smaller transactions if they are a security trade because they will be known not to be simply spam on the blockchain. Or maybe they could include higher fees.

b) Read up on how contracts work for bitcoin transactions. Both parties need to sign the transaction in order for the transaction to be valid if it is written that way. The bitcoin protocol actually various kinds of contract through a simple scripting language. The only trust that is necessary is whether the issues actually has a legitimate business and will pay dividends as he claims. That is the same problem we have with the present centralized exchanges. The way around that is by people to do their due diligence through internet forums like this.

c) The bloat on the blockchain will be negligible. Which occurs more often these days: a security is traded on NYSE, or one of the other US exchanges, or a dollar is exchanged between two people. People spend and receive money far more often than than they buy and sell securities (unless they are in the business of day trading). Even in the bitcoin world, the number of people who actually buy bitcoin securities is just a tiny fraction of those who invest in bitcoins. That's why the price of bitcoin didn't move when BTCT announced it was closing or when BitFunder announced it was being closed to US residents. I also think the transaction fee for security trades should be higher than for normal bitcoin trades. Right now people pay 1% to buy and sell on bitfunder and other exchanges. With a real distributed security exchange fees will be much less but could still be more than the current transaction fee.

Possibly. But when you donate to non-profits do you have to give your identity to donate or can you send a bag of cash? if the answer is no, why would there be a different expectation if its a business? Money laundering? We need a lawyer to explain that difference.

Okay so money laundering is the actual problem and not anonymous trading, not Bitcoin, not a decentralized exchange. Money laundering is the problem along with terrorist finance. How do we isolate that problem and work with regulators to come up with regulations and technological solutions which everyone can live with?

The current set of regulation obviously the community cannot live with. That is why Bitfunder and btct are shutting down. If it were just a matter of KYC then Bitfunder would have no reason to shut down. Bitfunder could just verify the current shareholders and let them continue trading. None of this had to happen except for the fact that the current laws in place have a lot of other stuff added to it which go beyond solving the problem of terrorist financing and money laundering.

A lot of the laws exist because traditional banking institutions involve trusting people and so there needs to be a lot more regulation of the industry. Bitcoin doesn't have as many people who have to be trusted so there is just too much regulation which serves no good purpose for Bitcoin users.

And that is why you can use Litecoins which doesn't have the MAX_BLOCK_SIZE limit. People are fine using any blockchain with colored coins on top if Bitcoin isn't acceptable.

Mastercoin can work for Bitcoin and colored coin can be used with Litecoin.


A) We need KYC data to prevent money laundering and terrorist financing (correct?)
B) We need decentralized exchanges because the current regulations are impossible for US investors to comply with (correct?)

If both of are correct then read below for my opinions.

A distributed company isn't run from the USA and may not have to comply with US law. A company registered in the USA would have to comply. If it got big enough it would be pressured to comply because it would be capable of compliance.

But that is not likely to matter in the Bitcoin world. Bitcoin businesses will simply register anywhere but the USA and then there is no "name your investors" rule unless that rule exists in every country on earth.

The whole global economy isn't based in the USA and businesses are global. Bitcoin is a global currency. The Internet is a global communication system. We do not have laws and regulations which can easily regulate the Internet as it is and to have Bitcoin too and say everyone must name themselves is equal to saying everyone must have a drivers license to access the Internet. It's an unrealistic regulation if we were to try and do that because people wont follow it for many social reasons. KYC doesn't take effect usually unless you're dealing with beyond a certain amount of money, and in that case I would agree that money laundering becomes a serious danger. But we don't make people give their ID to send their cash back and forth offline, and we don't make people use their ID to send small amounts of money. Small businesses should not have the same level of regulation as large businesses because compliance is expensive. Little investors shouldn't have to give their ID to invest but I agree if they are accredited investors or trying to move over $10,000 then it should be just like with bank accounts and it should be flagged. So why not flag them when they try to cash out the $10,000 or more or when they try to withdraw more than a certain amount of Bitcoin? If someone is literally trading hundreds of dollars why should they have to give up pseudo-anonymity?

The main thing is to allow US investors to be able to take part in the Bitcoin economy. Issuers who happen to be US business owners will have to come into compliance. KYC is mainly for money laundering right? So it should focus on the large investors who want to deal with large amounts of money and right now none of the Bitcoin businesses are big enough to warrant the level of compliance and regulation that people are talking about.

Verified and Unverified status could be granted to allow large and small investors to invest. Verified investors should be able to invest as many Bitcoins as they want and withdraw as much as they want similar to coinbase. If the exchange is decentralized via the blockchain then corporations could make large investors verify themselves. But right now most of this is impossible because building an exchange which complies with the web of laws is impossible.

Compliance will have to wait until there are sensible laws to comply with. If you're setting regulations and compliance rules which are in a language which make it impossible for anyone to realistically comply whether decentralized or not, then Bitcoin will end up being decentralized and used in underground fashion until the law is something businesses can comply with. Money laundering sucks, and the possibility of terrorists financing also sucks, but the regulations currently on the books are regulations any technologist will tell you is unrealistic and unworkable.

If you want to have to send your drivers license and ssn just to send an email then keep promoting these sorts of anti-technology regulations and that is where it leads. If you want to be realistic about this then we have to figure out a way to do it which actually makes sense for the technology. KYC is fine and if a corporation is big enough and has a large enough amount of money then that makes sense. Corporations shouldn't be able to be hidden, so if you want to make corporations comply with KYC this would be perfectly fine for anyone trying to dump a bunch of shares or buy a bunch of shares of an established corporation.

It would not be fine to try one sized fits all. If someone is buying shares in a lemonade stand they shouldn't have to deal with KYC because the amount of money moving around might be too small to care. If there is a way to do it through some new legal setup then lets consider that but I don't think its possible to do it as if Bitcoin wallets are a bank and each Bitcoin company or Bitcoin users has to be under those regulations.

Conclusion: We need some form of KYC but the current form doesn't fit Bitcoin and must be customized. We need to build tools and mechanisms in the Bitcoin community to promote transparency and help to prevent terrorist financing and money laundering.

But in exchange for doing this the Bitcoin business community and its users need exemptions from the impossible to follow regulations. This means that a new set of customized laws have to be put in place specifically for cryptocurrencies and they should be carefully thought out. Until that happens there is no possibility of compliance so to discuss compliance at this point is silly. Congress needs to pass special laws to encourage compliance and make clear what the rules are. Smart people need to figure out how to do KYC in a way which is convenient for users. Before that happens it's impossible to build a compliant exchange when there are no laws set up to comply with to make it possible to build it.

In a lot of jurisdictions, you need to be able to name your investors. Decentralized does not mean "only unknown/pseudonymous/anonymous share holders" though - companies likely would require people to submit KYC data + a bitcoin address where shares are to be stored. Then they could publish a list of addresses known to them and customers can trade among each other as much as they want. Any share transferred to an unknown address is assumed to be invalid.

I was thinking about the legal aspect of trading anonymously the other day.

Obliviously the government cannot trace your earnings from trading. (if you don't convert it to FIAT)
But what about the companies that receive earnings from selling stock?

Surely they must convert it to FIAT. Would that be illegal?

Because Bitcoin supports at max. ~7 transactions (or less, if they are complex) per second. Anything above that requires a hard fork to increase MAX_BLOCK_SIZE at least. Also storing market offers would lead to immense bloat and a lot of them would be pruned away after some time anyways as markets shift. If you charge (significant) fees for them, they will not really take on as the fees would be much higher than any centralized service.

I already mentioned colored coins and Hops is something I haven't heard about - could you link the current client for it, or is it just a whitepaper (then it falls into the "forum ramblings" category).

Why not store the order book in the blockchain? There is also Hops which is completely trustless, or colored coin which is pretty darn good. Actually Colored coin has some advantages over Mastercoin and some disadvantages, Hops is trustless according to the whitepaper.

They got disabled quite early and enabling them one by one is a soft-fork in many cases. Also to trade one needs a order book - are you really suggesting that the whole order book for several decentralized exchanges should be stored in the memorypool of Bitcoin clients?

I am aware that Bitcoin CAN work with scripts (and in some cases it might make sense to represent IOUs with Bitcoins). The trading + order books of the represented IOUs however should likely happen outside, either with blinded tokens on dedicated servers like OpenTransactions suggests, on a completely new alt-chain (several ideas flying around, never heard about actual implementations - maybe Namecoin could be viewed as one), on Ripple or a fork of it or on a centralized exchange (GLBSE, btct, bitfunder... you see how they end up!).

If you use BTC to issue IOUs (no matter if Mastercoin or colored coins), you anyways have the "trust issue" that a lot of people around here don't seem to like about Ripple. The only thing that's left aside from requiring trust (which any of these solutions will need) is that it is not sure if Ripple consensus really is as safe as advertised. Contrast that with the known problems/limitations of MasterCoin and colored coins and you might get why I suggested it in the first place.

Also it works _right now_ with a working open source client and server, order books, trades etc. as opposed to a lot of other technologies presented here which are in the best case just starting up with some funding and in the worst case some forum ramblings of people who think "a p2p exchange would be a nice idea, someone just has to do it!" (Edit: like the OP who re-invented colored coins).

Here is the Mastercoin code for Python or Ruby.

https://github.com/maraoz/pymastercoin/blob/master/message.py
https://github.com/maran/mastercoin-ruby
https://github.com/maran/mastercoin-ruby/blob/master/lib/mastercoin-ruby.rb

It's being tested and it looks pretty good. I've seen Colored Coin code also and it looks good too but there is no implementation that I can find of Colored Coin which works. Maybe if you can find some implementation to show then I can change my mind but as of right now neither seem to have functional implementations.

Anyway let the best technology win. I'm following both.

The "crowdfunding" method of Mastercoin is questionable, to say the least. Colored coins are supported by both companies such as eToro and volunteers.

I mean that the current design of how Mastercoin is supposed to work is inferior. I can't speculate about what Master coin may or may not evolve into in the future.

Mastercoin currently has almost no code at all. Code may or may not be developed in the future using collected funds. The code that already exists for colored coins is ahead and is still actively developed.

Of course they do, weren't you listening? The old site was bitcoinx.org, now it's superseded by http://coloredcoins.org/ (which, by the way, is now live! Still being worked on though).


Edit: I followed up on recent developments on Mastercoin and it seems it's a bit further along than I thought. My points still stand though.

I posted links to code, even...

Additionally, this code submission for upstream bitcoin is intended to help enable a standard way of encoding metadata -- such as stocks/bonds, rather than current ad hoc methods such as the one employed by mastercoin.

     Relay OP_RETURN data TxOut as standard transaction type.
     https://github.com/bitcoin/bitcoin/pull/2738