Whom Do You Trust?
One important area of your life where trust plays a crucial role is your personal finances. Most people in the U.S. feel comfortable trusting a third party to store their savings. Likewise, while some worry about the fluctuations in their stock portfolio, they usually aren’t worried about their assets disappearing from their account. This is because there’s a widespread baseline of trust in the banking and financial technology (FinTech) sector.
However, the advent of blockchain tech and cryptocurrencies has brought about a new understanding of trust. Blockchain-enabled decentralized applications (dApps) allow you to trust in a process or transaction without having to trust the entity with which you are transacting. This simple, yet revolutionary concept has major implications on our relationship with our personal finances, and far beyond into our everyday lives.
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Trust vs. Trustless in Crypto
The concept of trustlessness is a core element of blockchain, crypto payments, and smart contracts. “Trustless” means that you don’t have to trust a third party: a bank, a person, or any intermediary that could operate between you and your cryptocurrency transactions or holdings. Depending on how you choose to store, move, and trade your assets, you may have a trustless set-up or a set-up that requires the trust of a third party.
“Don’t trust; verify!” and “In Bitcoin we trust” are trustlessness-related phrases you may come across as you explore the cryptocurrency space. If you are new to crypto, you may ask yourself: “How can I trust code?” If you’re familiar with Bitcoin, you likely already know the answer. Essentially, these networks are censorship-resistant and decentralized, featuring enhanced security protocols. When you send a transaction, it’s permanent, and the sender can’t reverse the payment. If you’ve ever been on the receiving end of a bounced check, reverted credit card payment, or reversed Paypal transaction, you can likely see how revolutionary this is.
The implications for global commerce are significant. Furthermore, the trustless component of blockchains goes far beyond payments and includes implications for crypto self-custody, smart contracts, and asset trading solutions.
Trustless Crypto Wallets
A trustless crypto wallet is a non-custodial crypto wallet. This means your crypto wallet contains the private keys that control the crypto funds associated with them. Since only you control these funds, it’s generally considered trustless.
On the other hand, a custodial wallet isn’t generally considered trustless. You are trusting the “custodian” to hold your assets on your behalf. When you buy crypto on a centralized exchange (CEX) like Gemini, Huobi, or Kraken, your purchases are automatically stored and secured in your exchange wallet.
While such an exchange transaction is not trustless in the crypto sense, you may feel more comfortable using a crypto custodian in the same way that you feel more comfortable using a bank to store large sums of money. Holding your own wallet and keys comes with its own set of challenges and requirements to ensure security and access. However, after purchasing on a custodied exchange, you could also choose to withdraw your funds to a trustless non-custodial wallet where you have sole control of your cryptocurrency.
Do Decentralized Exchanges Make Trading Trustless?
One trustless option that has been evolving in the crypto trading sphere is the decentralized exchange (DEX). When a centralized exchange uses an order book, market maker, or liquidity provider to facilitate your trades, they must be trusted as an intermediary to oversee and transact the trade. Considering they already control your funds via your centralized exchange wallet, most traders aren’t too concerned about this.
For those who have withdrawn their funds to a non-custodial wallet, how do they trade while maintaining trustlessness? This is possible via trading on a DEX where the trades are executed via smart contracts. One popular example of this is Uniswap, where you can swap ERC-20 tokens while maintaining control of your private keys.
These trustless trades can be executed through the use of atomic swaps, smart contracts that rely almost exclusively on decentralized code for enforcement rather than on a third party. In short, both sets of crypto assets must be submitted into a smart contract for it to execute the transaction. This structure facilitates trustless trades between strangers. If one party inputs funds and the other does not, generally the funds are just returned to the sender automatically.
For some users, there are potential downsides to relying on such types of trustless systems as well. For example, in a DEX all trades must generally be executed on-chain. This means trades may in some cases be subject to higher transaction fees than would be the case with a CEX. Even failed orders must be validated on-chain, triggering further fees.
“In Code We Trust” — Are There Truly “Trustless” Systems?
While many expound upon how blockchains have eliminated the need for trust, others argue that this trust has simply been transferred — from one set of people and systems to another set of code and consensus mechanisms that run these networks and everything built on them. For example, you have to trust the code to be bug-free. At various points in the development of the burgeoning decentralized finance (DeFi) space, users of trustless systems have experienced malfunctions in trustless platforms, and have even lost their funds due to malicious hackers exploiting vulnerabilities in the code of trustless systems.
Proponents of trustless systems would counter that these blockchains have become increasingly safer and more robust as the DeFi space has evolved. Since blockchain networks generally do not have a central point of failure, trustless systems are practically impossible to shut down. Smart contract audit procedures, bug bounty programs, and better coding procedures in the industry are making these networks increasingly resilient to hacking and malicious actors. Indeed, with billions of U.S. dollars locked in DeFi protocols, it seems that an increasing number of people feel comfortable putting trust in these trustless systems. You can also purchase smart contract insurance to help protect yourself against potential losses.
In crypto, you don’t necessarily have to trust any other person (or institution), but there is someone you must trust: yourself. While the self-custody of crypto is referred to as trustless, you must decide if you can trust yourself with this responsibility. This entails safely storing any passwords, having a recovery phrase, and following other best practices. If your passwords are lost or stolen, you might not be able to recover your funds.
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