A team of bitcoin enthusiasts is approaching completion of the first stage of launching Bitsquare, a decentralized bitcoin exchange. Bitsquare has been designed to ensure privacy but not be controlled by a central authority like other bitcoin exchanges.

Bitsquare is currently seeking 120 BTC for the development of its first milestone through Lighthouse, a crowdsource funding platform. The first phase of the funding campaign ends today (Feb. 9.) and the campaign has only raised 42% of its goal. Whether the campaign will be able to raise the rest depends on the incoming donations today.

Need for a Decentralized Exchange

“We were motivated to develop Bitsquare because no truly decentralized exchanges currently exist despite the core bitcoin principle being to enable decentralized financial transactions between individuals,”

said Richard Myers to CCN.com, a Bitsquare team member who oversees communications.

“The problems with centralized bitcoin exchanges have been obvious for a long time. Centralized exchanges are not only a single point of failure, but also a target of theft by both hackers and insiders. The Mt.Gox loss is an obvious example, as is the more recent Bitstamp hack.”

“Privacy is another concern,” Myers continued. “Coinbase reportedly traces how their customers use their bitcoin and blocks accounts that make purchases they object to.” Centralized exchanges also lack transparency, Myers added. “The lack of transparency of centralized exchanges also leads to problems such as occurred at Mt. Gox where accounting fictions enabled trades not backed by real funds. It is also suspected that some Chinese exchanges artificially increased trade volume in a way that could have contributed to a run-up in the bitcoin price.” Response to the concept of a decentralized exchange has been positive, judging from the comments posted on the Internet. But being a new idea, some concerns have been raised by bitcoin users.

Concerns Raised

“We often hear the valid concern that speculative day trading cannot be performed with a decentralized exchange. This is true, but it can be minimized in countries with fast payment methods. We sometimes hear the concern that new users, who have no bitcoin, will not be able to use the system because it requires bitcoin for the trade fees and security deposit.”

However, Bitsquare anticipates gaining a lot of support due to its advantages. These include: instant accessibility (no need for approval from a central authority), privacy (no one except trading partners exchange personally identifying data), transparency (every aspect of the project from code to crowdfunding is transparent), and ease of use.

Bitsquare’s white paper, posted on its website, says several trust mechanisms ensure both parties in a trade will fulfill their obligations for the trade. Myers expanded on these mechanisms for CCN.com.

“A two-of-three multisig bitcoin address is the core technology that ensures parties faithfully follow the trade protocol. An independent arbitrator acts as the third signature to refund or release funds when a disagreement about settlement occurs between traders. Both traders must also contribute a refundable security deposit to the multisig account to fund active arbitration and to encourage good behavior. Initially, we also anticipate that trades will be limited to small amounts to reduce the incentive for bad actors to use the system to, for example, launder funds from a hacked bank account.”

Bitsquare has outlined a registration process that does not leak privacy, except between trade partners or to an arbitrator in the case of an active arbitration, Myers told CCN.com.

“Registration helps ensure bad actors cannot create unlimited fake accounts. Registration may optionally also include verification of identity and payment account details. Arbitrators may also issue fraud reports for users they find have acted in bad faith so that other traders will avoid trading with them. As a final level of protection, a conventional contract will be generated that can be presented in court if legal action is taken against a fraudulent trader.”

Also read: Is 2015 the year of the decentralized bitcoin exchange?

Arbitrators to be Key

Third party arbitrators will play an important role in Bitsquare. Asked by CCN.com how Bitsquare can ensure a trader that an arbitrator will be available in a timely manner if needed, Myers responded:

“Arbitrators will publish information about their availability. For example, whether they will settle cases within 24 hours or 72 hours. Arbitrators who do not fulfill their promised availability will lose customers.”

Myers said anyone can become an arbitrator and traders are free to choose which arbitrators they trust. In the event an arbitrator is needed, one will be randomly selected for each trade from the overlapping set of arbitrators both buyer and seller trust. The fee for active arbitration will be paid for from the security deposit and refunded if no active arbitration occurs, Myers said. The exact fee will be set by each arbitrator, but it is anticipated to be the equivalent of between $20 and $50 to settle a case.

“Because arbitrators decide their fee, a market price should develop based on the experience, reliability and reputation of each arbitrator”

Asked about trade fees, Myers said the trade fee will be set as low as possible to protect against spam orders and market manipulation. “The fee must also provide enough passive income to arbitrators that they remain available despite infrequent income from active arbitration.”

The Bitsquare white paper says there is a limit on trade volume to reduce overall risk exposure.

“Initially, we expect trades will be for between one and five bitcoin and increase to perhaps ten bitcoin as traders gain experience with fraud using different fiat payment methods. Arbitrators will likely also advertise limits to the trade size they will support. Best practices are expected to evolve over time.”

For information, visit https://bitsquare.io/