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The fallout from the FTX collapse and the ensuing media storm resulted in unexpected and widespread disruption. Yet, the truth is that it has fostered the perception that centralized exchanges (CEX) are broken. How we pick up the pieces will have a long-term impact on our industry. It is not the role of regulators to prevent FTX from further collapsing.
Without meaningful change, this new monetary system will continue to repeat the mistakes of the past. Our industry and emerging technologies must show the world that decentralizing complaints is possible.
Compliance is the starting point
The FTX incident highlights the risks of ignoring corporate compliance. One of the big lessons from the FTX incident is that compliance needs to be strengthened. We have to do a better job of tracking our funds. With approximately $9 billion in customer funds lost due to exchange disruptions, it is clear that CEX must be built on a robust framework. This serves as a foundation of trust and security for industry growth.
In the post-FTX world, compliance and transparency must be prioritized. The FTX case highlights why corporate governance is necessary, covering cash management, human resources protocols, approval mechanisms, financial reporting, and internal and external audits.
But tighter regulation is just a good start.
Regulation alone is not enough
After the collapse of FTX, regulated exchanges immediately began promoting regulated custody services. In the US, regulated CEXs are required to segregate customer funds from their own funds to ensure that funds are used only in accordance with users' permissions.
Regulators are also becoming increasingly diligent in enforcing new rules, but this does not eliminate significant risks. Risk mismanagement has repeatedly occurred in traditional finance, despite strict regulations aimed at preventing widespread failures. The collapses of Bear Stearns, Lehman Brothers, and more recently Credit Suisse also revealed the dangers of relying too much on human intervention.
Regulation alone is not enough. Even when bad actors literally control your wallet, they can wreak havoc.
Self-control is key
Another big lesson is self-control. It's a popular topic in the industry, but what this actually means is often debated. The Bitcoin whitepaper remains a fundamental reminder that when you entrust your private keys to an exchange or other third party, you relinquish control of your money.
Once promoted as a reputable exchange, FTX was considered a well-run and safe place to trade cryptocurrencies. More than that, FTX was something of an industry darling. However, the reality was completely different. A secret backdoor had been established that allowed Alameda Research, the trading company involved in FTX's bankruptcy, to withdraw billions in customer funds. Alameda's overleverage, while advantageous in bull markets, greatly magnified losses during downturns. When faced with margin calls during the crisis, selling collateral risked a significant drop in value.
Part of the trauma for investors was the swift and unexpected collapse of the world's second-largest exchange. The fortunes of an industry darling rapidly reversed almost overnight. As a matter of fact, the optics and public perception and his FTX's ridiculous marketing spend made the whole world take notice.
Sadly, this public perception led customers to mistakenly believe that their funds would be protected from speculative activities such as those undertaken by Alameda Research. In fact, after FTX's bankruptcy, the U.S. Securities and Exchange Commission (SEC) found that FTX provided Alameda Research with a “virtually unlimited line of credit,” creating billions of dollars in losses for FTX's retail investors. explained.
The lessons learned were both shocking and harmful. Storing cryptocurrencies on any centralized exchange is risky. This is evidenced by the increasing number of platforms suddenly stopping withdrawals without warning due to the fear of bank runs. In a rundown, everyone rushes to the bank to withdraw their funds at once, leaving the bank, in this case the centralized exchange, unable to meet the repayment deadline. Request for withdrawal.
That's why self-care is so important. Keeping your assets under your control is the only way to reduce your risk of loss. However, if a cryptocurrency exchange fails, retail investors should not be comfortable receiving only a small portion of their assets years later. They have the right to instant access to his 100% of their cryptocurrencies at any time. However, while regulation and compliance remain valuable safeguards for exchanges, new models are emerging that combine traditional legal money management controls with self-custody.
Paradigm shift with hybrid model
No amount of regulation can prevent financial platforms from completely failing. Even within a regulated exchange, users transfer control of their assets to a third party for safekeeping. But the tools for a paradigm shift already exist. What if there was a way for CEX to offer a 100% self-custodial solution?
In recent years, hybrid exchanges have emerged as the answer. Combining the strengths of CEX and decentralized exchanges (DEX) enables innovation and enhances asset security. Users can transact directly on-chain without intermediaries. At the same time, traditional financial institutions can access decentralized finance capabilities while benefiting from the security and liquidity of CEX.
More importantly, hybrid models with trustless risk management and self-management address concerns by relying on code rather than human intervention to effectively manage risk. The hybrid exchange blends regulatory compliance with decentralized features, allowing users to engage with cryptocurrencies directly in their secure wallets via smart contracts. Users can also bypass the custodian and manage their funds directly. All of this is done within an accessible and user-friendly interface similar to CEX. The result is an advanced trading system that alleviates the traditional weaknesses of both CEX and DEX, positioning hybrid crypto exchanges as potential game changers.
A wake-up call for cryptocurrencies
While the FTX trial continues to garner attention, it's worth noting that such upheavals are common in the industry. Wall Street itself has been through scandals and challenges similar to the crypto industry. Remember the Enron scandal and the Bernie Madoff pyramid scheme of the early 2000s?
Still, as stewards of the cryptocurrency industry, we must not dismiss this incident as just a glitch. Scandals like this tarnish the industry's reputation and set us back each time. While the cryptocurrency industry is still evolving and maturing over time, there are more and more better ways to move forward.
