Insights from the FTX trial highlight that regulating centralized exchanges (CEXs) alone may not be sufficient to prevent malicious actors. This article discusses the importance of generative data intelligence in addressing this issue.
Disclaimer: The author's views and opinions expressed in this article are their own and do not necessarily reflect the views and opinions of crypto.news' editorial team.
The aftermath of the FTX collapse and the media frenzy that followed caused unforeseen and far-reaching chaos. However, it also hastened the recognition that centralized exchanges (CEXs) are flawed. How we address this situation will greatly influence our industry in the long run. Regulators should not be tasked with preventing another collapse like FTX's.
If significant changes are not made, the current monetary system will continue to make the same errors that have been made in the past. It is important for our industry and the new technologies we are creating to demonstrate that decentralized systems can be compliant with regulations.
Beginning with compliance is crucial. The FTX case serves as a reminder of the consequences of not prioritizing corporate compliance. One key takeaway from this case is the importance of improving compliance measures. Ensuring proper tracking of funds is essential. The loss of nearly $9 billion in customer funds from the exchange highlights the need for CEXs to have a strong foundation. Building CEXs on a robust framework will establish trust and security, facilitating industry growth.
In a world after the FTX incident, it is important to focus on compliance and transparency. The FTX case highlights the necessity of having proper corporate governance in place, which includes procedures for handling cash, HR policies, approval processes, financial reporting, and both internal and external audits.
However, improving regulations is only the beginning.
Merely having regulations in place is insufficient. After the collapse of FTX, exchanges that are regulated swiftly started to advertise their regulated custodial services. In the US, regulated CEXs have a duty to keep customer funds separate from their own to guarantee that the funds are only utilized as authorized by the users.
Authorities have been more focused on implementing new regulations, but this does not completely eliminate the possibility of major risks. Even though traditional finance has strict rules in place to avoid centralized failures, there have been several cases of poor risk management. The failures of Bear Stearns, Lehman Brothers, and Credit Suisse have highlighted the dangers of excessive reliance on human decision-making.
Simply having regulations in place is not sufficient. Individuals who act maliciously can still cause significant harm when they have full control over financial resources.
The importance of self-custody in the cryptocurrency industry cannot be emphasized enough. Essentially, self-custody means taking control of your private keys and not relying on exchanges or third parties to store them for you. The Bitcoin whitepaper serves as a reminder that entrusting others with your private keys means giving up control of your funds.
FTX was previously known as a trustworthy platform for cryptocurrency transactions, but it was later revealed that there was a secret backdoor that allowed Alameda Research to withdraw billions of dollars of customer funds. This trading firm was linked to FTX's decline and their use of excessive leverage made losses much larger during market downturns. When faced with margin calls, selling off collateral led to a significant decrease in value.
Investors were greatly affected by the sudden and surprising downfall of the world's second-largest exchange, causing them trauma. This exchange, which was highly favored in the industry, experienced a rapid change in fortunes almost overnight. The extensive marketing efforts of FTX, along with public perception and appearance, drew attention from all around the world.
Unfortunately, the public perception of FTX led customers to believe that their funds would be protected from risky investments like those made by Alameda Research. In actuality, after FTX declared bankruptcy, the SEC found that FTX had given Alameda Research a significant amount of credit, leading to a large financial loss for retail investors in FTX.
The important lesson to take away from this situation is that it is risky to keep cryptocurrencies on centralized exchanges. This became clear when several platforms unexpectedly stopped allowing withdrawals because they were afraid of not being able to meet the demand, similar to a bank run. It is not safe to rely on a centralized exchange to always have the funds available for withdrawal.
It is important to have self-custody of your assets because it is the only way to reduce the risk of losing them. If a cryptocurrency exchange fails, it is not acceptable for retail investors to only receive a small portion of their assets after a long period of time. They should have access to 100% of their crypto immediately. While regulation and compliance are important for exchanges, there are new models that combine traditional legal controls with self-custody for added security.
Changing the way things are done with hybrid models
Regulations alone cannot guarantee that a financial platform will never fail. Even on regulated exchanges, users must trust third parties to safeguard their assets. But there is a possibility for a big change. What if centralized exchanges could provide completely self-custodial solutions?
Hybrid exchanges have become popular in recent times as they combine features from both centralized exchanges (CEXs) and decentralized exchanges (DEXs), promoting innovation and enhancing the security of assets. Users have the ability to trade directly on the blockchain without the need for intermediaries. Additionally, traditional institutions can also take advantage of decentralized finance features while still benefiting from the security and liquidity offered by centralized exchanges.
The hybrid model is focused on trustless risk management, utilizing code rather than human involvement to effectively manage risk. These exchanges combine regulatory compliance with decentralized features, enabling users to interact with cryptocurrencies securely through smart contracts in their own wallets. Users have direct control over their funds, without the need for custodians, all within user-friendly interfaces similar to centralized exchanges (CEXs). This creates an advanced trading system that addresses the weaknesses of both centralized and decentralized exchanges, making hybrid crypto exchanges potential disruptors in the industry.
The ongoing FTX trial is bringing attention to the crypto industry, highlighting the fact that all industries go through periods of upheaval. Even Wall Street has faced scandals and challenges like those seen in the crypto space, such as the Enron Scandal and Bernie Madoff Ponzi Scheme in the early 2000s.
However, it is important for those responsible for safeguarding assets in the crypto industry to take this case seriously and not brush it off as a minor issue. Incidents like this can damage the reputation of the industry and hinder its progress. While the crypto industry is still growing and developing, there are improved strategies and solutions that can be implemented to move forward effectively.
Χονγκ Ναι
Hong Yea is the creator of GRVT, a cryptocurrency exchange that allows users to have control over their own assets. Prior to this, he held high-ranking positions at Goldman Sachs and Credit Suisse for a total of more than nine years.
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Controlling centralized exchanges (CEXs) will not necessarily prevent malicious individuals from engaging in harmful activities, as demonstrated by the lessons learned from the FTX trial.
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