Problems with Existing CEXs

The cryptocurrency exchange industry has experienced explosive growth alongside recurring failures that expose fundamental design flaws. From catastrophic collapses to persistent operational issues, these problems create unnecessary risk, erode trust, and limit institutional adoption.

Problem 1: Opaque Liquidation Mechanics

Most centralized exchanges treat liquidation formulas as proprietary information, preventing traders from accurately modeling their risk exposure.

The Issue: Hidden maintenance margin requirements, unclear mark price construction, and undisclosed auto-deleveraging (ADL) priority rules create a "black box" where traders cannot predict when liquidations will occur.

Quantified Impact:

• Surprise Rate: 15-25% of liquidations occur at unexpected prices

• Financial Cost: $1B+ annually in unexpected losses across the industry

• Example: A trader expects liquidation at $48,500 based on stated MMR, but actual liquidation occurs at $49,200 due to hidden factors—resulting in $7,000 unexpected loss on a 10 BTC position.

Root Cause: Misaligned incentives. Exchanges profit from liquidation fees (0.5-1.5% of position) plus insurance fund surplus, creating conflicts of interest when formulas are opaque.

use.com Solution: Published liquidation formulas with version control:

$Liquidation_{Long} = Entry \times \left(1 - \frac{MMR}{1 + Leverage}\right)$

$Liquidation_{Short} = Entry \times \left(1 + \frac{MMR}{1 + Leverage}\right)$

All parameters (MMR, mark price weights, ADL priority) are disclosed, enabling traders to calculate exact liquidation prices independently.

Problem 2: Volatility Downtime and Performance Degradation

During high volatility—when reliable execution is most critical—many exchanges experience severe performance degradation or complete outages.

The Issue:

• Latency Explosion: Normal 50-100ms API latency increases to 500-5000ms (10-50× worse)

• Matching Delays: Order processing delays from 0.1 seconds to 50+ seconds

• Complete Outages: Hours of downtime during critical market movements

Quantified Impact:

• Annual Cost: $7B+ in missed exits and forced liquidations across major exchanges

• Historical Events: March 2020 crash saw multiple exchanges down 2-6 hours during 50% BTC price drop

• Example: Trader with $500K BTC long cannot exit during 8% drop due to API timeout, losing $32,000 (80% of the move)

Root Cause: Monolithic architecture where single component failure causes system-wide impact, with no graceful degradation.

use.com Solution: Symbol-sharded architecture with published SLOs:

• Matching latency (p99): < 800 µs

• API latency (p99): < 15 ms

• Uptime: > 99.95% monthly

• Public dashboards for independent verification

Problem 3: Inflationary Token Economics

Most exchange tokens suffer from uncapped or poorly controlled supply expansion, creating persistent sell pressure.

The Issue: Staking rewards, liquidity mining, and team unlocks often create 20-40% annual inflation, overwhelming demand growth.

Quantified Impact:

Typical CEX Token Annual Supply Change: $NetInflation = Staking(8\%) + LiquidityMining(12\%) + Unlocks(15\%) - Burns(5\%) = +30\%$

Price Impact: If demand grows 20% but supply grows 30%, price declines 7.7% despite growing platform usage.

Historical Data: Major CEX tokens down 67-93% from peak despite exchange growth, due to supply expansion outpacing demand.

use.com Solution: Revenue-driven deflation:

$Burn_t = \min\left(\frac{0.20 \times NetProfit_t}{VWAP_t}, CirculatingSupply_t\right)$

Example Trajectory:

• Year 1: +15M unlocks, -8M burns = +7M (+3.5%)

• Year 2: +12M unlocks, -15M burns = -3M (-1.5%)

• Year 3: +8M unlocks, -22M burns = -14M (-7%)

Net deflationary as revenue scales, with hard cap at 100M tokens (50% reduction from 200M initial supply).

Problem 4: Custody Uncertainty and Counterparty Risk

Lack of real-time proof-of-reserves and unclear wallet segregation creates significant counterparty risk.

The Issue:

• Fractional Reserves: FTX held only 5.6% of claimed reserves ($900M vs $16B)

• Commingled Funds: User assets mixed with operational funds, enabling misappropriation

• Delayed Attestations: Quarterly or annual proof-of-reserves means reserves could be depleted between attestations

Quantified Impact: $14B+ in user funds lost since 2014 due to custody failures:

• Mt. Gox (2014): $450M

• QuadrigaCX (2019): $190M

• FTX (2022): $8B+

• Celsius (2022): $4.7B

• BlockFi (2022): $1B+

use.com Solution:

• MPC + HSM: Multi-party computation eliminates single points of failure

• Segregation: Hot (2-5%), warm (15-25%), cold (70-80%) with separate operational wallets

• Proof-of-Reserves: Quarterly attestations with cryptographic verification:

$\sum OnChainReserves \geq \sum UserLiabilities + OperationalBuffer$

Users can verify their balance inclusion via Merkle proof without revealing other users' data.

Problem 5: Compliance Inconsistency

Uneven KYC/AML enforcement and unclear jurisdictional gating reduce institutional participation and increase legal exposure.

The Issue:

• Selective Enforcement: VIP users receive relaxed compliance (70-80% consistency) vs regular users (95% consistency)

• Jurisdictional Ambiguity: Products available in jurisdictions without proper licensing

• Inconsistent Verification: Different standards applied based on user value

Quantified Impact: $4.6B+ in regulatory penalties (2020-2024):

• Exchange A (2021): $100M for AML failures

• Exchange B (2022): $50M for unlicensed securities

• Exchange C (2023): $4.3B for AML + sanctions violations

• Exchange D (2024): $150M for KYC failures

use.com Solution: Tiered KYC with consistent enforcement:

• Tier 1 (Lite): $1,000 daily limit

• Tier 2 (Standard): $50,000 daily limit

• Tier 3 (Enhanced): Unlimited with monitoring

• Tier 4 (Institutional): Enhanced due diligence

Products gated by jurisdiction and tier, with 99%+ enforcement consistency (no VIP exceptions) and 100% audit trail.

Conclusion

The problems plaguing existing exchanges—opaque liquidation, volatility downtime, inflationary tokens, custody uncertainty, and compliance inconsistency—are not inevitable. They result from architectural choices, misaligned incentives, and insufficient commitment to transparency.

use.com addresses each systematically through published formulas, deterministic architecture, revenue-driven deflation, MPC custody with proof-of-reserves, and compliance-native design. By solving these fundamental problems, use.com aims to set a new standard for centralized cryptocurrency infrastructure.

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Related Sections:

• Risk Engine & Liquidation System

• Security Architecture

• Tokenomics Summary