Idea: Distributed Bitcoin Exchange

[dr.bitcoin]

At this point, one of the main weaknesses of the Bitcoin ecosystem is the exchange of BTC to other currencies. Since Bitcoin may need a few more years to take over the global economy, exchanges will remain necessary.

There's only one major player on the market, MtGox. Unfortunately, it is not suitable for anything but very small businesses or small volume traders because of the daily/monthly withdrawal limits – which are currently VERY low ($1000/day, $10,000/month). MtGox (and others) are likely to maintain these limits unless they want to become regulated financial/banking institutions (very expensive) and destroy all privacy for their customers (which MtGox already does by requesting government ID's for all medium / large accounts).

Some believe that the solution would be to have more MtGox/TradeHill/BitcoinExchange – like exchanges around, so if one fails, gets closed down, etc. the others will remain active etc. While that may be true, it does not solve three fundamental problems: withdrawal limits, privacy and trust.

Withdrawal limits of $1000/day and $10,000/month are laughable. No serious business or trader can live with that. IMHO, this is one of the biggest drawbacks for the Bitcoin economy at this time.

Privacy is another major issue. One of the ideas at the heart of Bitcoin was to provide a cash-like anonymous currency. How can it be cash-like when MtGox wants to check ID's and Passports before it releases funds?

Trust will become a more and more important issue as the Bitcoin economy grows. Most Bitcoin users have no problem entrusting 10 BTC to BitcoinExchange for a couple of days. Would they do the same with $1,000,000?

I think there is a simple solution which is in the spirit of Bitcoin: a Distributed Bitcoin Exchange. The software can be anonymous, peer-to-peer, use strong cryptography, and use a network of supernodes to maintain and distribute the database of buy/sell orders. The users/businesses  maintaining the supernodes would be sharing the transaction fees using a fair model, and the whole system could interface with LibertyReserve, Dwolla, banks etc.

In order to take care of the “administrative” side of things, there could be a board-of-trustees-like governing body – initially some prominent characters of the community, later elected members etc. This board could hire, manage and pay programers, developers, CPA's etc.

Financing this project could be done by selling stock in this “corporation” and / or accepting donations of BTC, USD, time, skills, talent etc.

If this project succeeds, maybe later the functionality can be incorporated in the main Bitcoin client, which would make using Bitcoin even simpler.

All comments and opinions are highly appreciated!

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[wizzard0]

The software can be anonymous, peer-to-peer, use strong cryptography, and use a network of supernodes

Unfortunately, cryptography is not a magic pixie dust you can spread over your software and make it "secure".

Same with peer-to-peer.

This idea has been floating in the air for months. What is needed is the concrete design.

[Sukrim]

2 simple questions

If I buy Bitcoins using this exchange, where do I send my money to, and using which kind of payment (paypal, bank wire, cash, check...)?

If I sell Bitcoins, how am I save of being scammed using this distributed exchange and where will my money come from (especially if it's >10000 USD/day!)?

Bonus question:

How is your exchange idea different from OTC trades?

[dr.bitcoin]

Thank you both for your great comments and questions!

While cryptography is no magic pixie dust, it's not black magic either. Java has some libraries that can be used fairly easy to make secure pipes for encrypted communications between peers and supernodes. It also has JXTA, which allows peer-to-peer applications to be developed much easier than in other languages (IMHO). And then there's the Google bitcoin project, written in Java as well. It seems most of the pieces are available, we just need some glue and some extra coding for transactions execution, interfaces, GUI etc.

The users would NOT be trading in an "unregulated/chaotic" OTC manner. The distributed exchange would have its own wallet.dat and Liberty Reserve account (for example). It would also act as an escrow for both BTC and LR, allowing for safe transactions - pretty much like MtGox functions now.

One of the functions of the Board would be to take care of the wallet.dat and the other currencies accounts (directly, or via hired personnel).

To answer Sukrom's questions:

1. when you buy bitcoins, you send the money to the exchange's account (be it LR, cash, check etc.)

2. when you sell bitcoins, you send them to the exchange's wallet.dat (via one-time address) and receive the funds from one of the exchange's accounts mentioned above.

Bonus question answer: this is different from OTC because it involves a trusted third party, the distributed exchange, which makes transactions safer; and since the software of the exchange is distributed / peer-to-peer it cannot be shut down.

Hope this helps. If I didn't make myself clear enough I apologize and I am ready for more questions...

[justusranvier]

I really don't see how you interface with the traditional banking system in an anonymous and distributed way without resorting to the methods that drug dealers use to launder money (with the resulting cost and risk).

I can envision something like btcnearme  hosted on Freenet and maybe automated to some degree though.

[wizzard0]

(...)
It seems most of the pieces are available, we just need some glue and some extra coding for transactions execution, interfaces, GUI etc.

The users would NOT be trading in an "unregulated/chaotic" OTC manner. The distributed exchange would have its own wallet.dat and Liberty Reserve account (for example). It would also act as an escrow for both BTC and LR, allowing for safe transactions - pretty much like MtGox functions now.

One of the functions of the Board would be to take care of the wallet.dat and the other currencies accounts (directly, or via hired personnel).

(...)
this is different from OTC because it involves a trusted third party, the distributed exchange, which makes transactions safer; and since the software of the exchange is distributed / peer-to-peer it cannot be shut down.

Hope this helps. If I didn't make myself clear enough I apologize and I am ready for more questions...

Well, I'm not against your project. I just accidentally trying to implement something remotely similar - http://tvori.info/truelink (a distributed IM is supposed to be simpler than a distributed trading platform, right?)
Turns out it's not so simple, too... Even with most of the pieces available.

(Some) of the problems that we stumbled upon: trust (between participants), search results spam, deniability, key management, account restore/revoke issues, etc. Don't forget that traditional centralized systems are there for a reason.

[frutza]

Great idea it is, simple it is not, young Skywalker... Good luck and keep us posted!

[caveden]

I really don't see how you interface with the traditional banking system in an anonymous and distributed way without resorting to the methods that drug dealers use to launder money (with the resulting cost and risk).

Me neither. If there are known interfaces with the banking system, it can be shut down. Actually, if exchanges like MtGox are ever shut down, it will be through their bank account.

The only way I can see a fully distribute exchange software operating is in a OTC fashion. But that also make it painful for those needing to deal with large amounts. Unless, maybe, there is some (semi-)automated way to verify the credentials of those you're trading with, and also automate multiple bank transfers.
But well, those operating with large amounts must either do it legally - what imply they cannot use bitcoins in a bitcoin prohibition scenario - or must be professional money launders, who I don't think really need help. Maybe we should focus precisely on those poorer ones who live in places where bitcoin happens one day to be forbidden.

[dr.bitcoin]

Interfacing with the banking system is, indeed, a weak link. However, there are (at least) two solutions:

1. using Liberty Reserve; while adding some complexity, it solves the problem without increasing the cost much.
2. using distributed_bitcoin_exchange_dollars (like MtGox dollars) which would be 1:1 with the USD and can be converted via local exchanges.

I am sure there are other (more creative) solutions that I didn't think of. Please feel free to post them here!

Thanks for the comments guys! 

[Aquent]

Ahhh, that ancient dream.

[Nrcewker]

Ahhh, that ancient dream.

not always a dream, may be in the future