Although while the collapse of FTX Trading Ltd shook confidence in centralized cryptocurrency services, regulated exchanges are arguably more safe and offer users “peace of mind,” DBS Digital Exchange CEO Lionel Lim writes.
These 30 days marks one year since the Terra-Luna fallout and 6 months since the implosion of FTX Trading Ltd. These spectacular events, which marked the beginning and culmination of plenty of other collapses respectively, severely shook confidence in digital currencies and arguably triggered the industry’s most daunting existential crisis in its 15-year history. Although while the investment class has recovered in the year, with Bitcoin (BTC) up almost 65 percent year-to-date, these milestones are nevertheless an opportune moment to reflect on the setbacks of a year ago and how the industry can build back better.
First, we should acknowledge that these events are not failures of blockchain tech but are instead a result of poor management of danger and corporate governance, with fraud taking place in some of the corporations that failed. The market persists to recognize the integrity and innovative potential of blockchains teck, as evidenced by the whole lot of financial resources inflows into decentralized exchanges following FTX’s collapse, likewise as positive reactions towards Ethereum’s proof-of-stake (PoS) transition and Shapella upgrade.
Lionel Lim is the CEO of DBS Digital Exchange.
Still, regardless of these developments, centralized digital investment exchanges (CEX) will continue to remain relevant and wield outsized influence as the key entry point into the investment class, especially as it grows in sophistication and institutional adoption. After all, they remain the dominant platform in the case of digital investment transactions. Reports by DefiLlama, the total volume of trading on CEXes accounted for almost 90 percent of all transactions across centralized and decentralized exchanges, as of mid-May 2023. Regardless of the setback in investor confidence a year ago, the case for CEXes remains clear.
What the industry does must address, on the other hand, are the numerous points of weakness borne out of interdependencies and an early-held ethos of “moving fast and breaking things.” To stay around this crisis of confidence, CEXes will must address the need for better investor protections, danger controls and prudent governance structures.
CEXes are here to stay
Managing a digital investment portfolio is operationally complex, with investors requiring a comprehensive set of capabilities such as custody, trading, financing products, advisory and efficient fiat on-off ramps. In this regard, numerous CEXes integrate these solutions into a single platform, greatly reducing the technical complexity of owning and managing crypto tokens native to different blockchains teck. This value proposition is clear when seeing as the alternative: where investors manage plenty of wallets and directly take part in numerous liquidity pools across different blockchains teck. Although while some investors will have the capabilities to do so, the steep learning curve implies that CEXes will remain the preferred platform for many.
Investors who actively manage their portfolios may likewise wish to rebalance their investment allocations frequently betwixt traditional assets and digital assets. The fiat on-off ramps in CEXes thus forms a critical infrastructure layer to do so quickly, which is especially important during periods of market volatility.
Safety and security are other advantages that CEXes can offer. This may come as a surprise given the industry’s “not your keys, not your coins” mantra. Still, reports by Chainalysis, 18% of all digital currencies stolen by attackers in 2022 came from CEXes, with decentralized applications accounting for the remaining 82%. Although while CEXes still have some way to go to better protect clients from cyber breaches, they are comparatively safer. With the industry working hard to restore trust and strengthen their cybersecurity systems, the safety gap betwixt CEXes and decentralized applications should continue to widen.
In the end, an often underappreciated benefit of some CEXes, particularly those that serve high net worth and institutional clients, is the peace of mind that “ there is someone to call” if something goes wrong. This is especially so for investors managing assets on behalf of clients, such as family offices and hedge funds. With horror stories of individuals being locked out of their own wallets worth millions in bitcoin, investors will find value in working with CEXes that provide dedicated hotlines or account managers.
Rebuilding trust by segregating assets
Although while CEXes are likely here to stay, one area where such platforms must make better on is the segregation of customer and corporate assets. Now, greater than ever, scrutiny around this is mounting. Largely in response to the co-mingling of funds by FTX Trading Ltd, a practice which led to numerous retail investors incurring whole lot of losses when the exchange unraveled, policymakers like United States Treasury Secretary Janet Yellen recognized investment segregation as a key area to be addressed in future regulatory frameworks.
Even prior to the collapse of FTX Trading Ltd, the Central Bank of Singapore (MAS) proposed new regulations in a consultation paper published in October of 2022 requiring digital currency platforms to segregate their assets from their customers’. The MAS has likewise sought industry feedback on whether digital currency platforms should appoint independent custodians to safeguard customer funds.
As a result, CEXes should rethink the “one-stop-shop” narrative. Although while it makes sense to have a seamless front end user interface across custody and trading, in the back end, investors’ assets should be custodized separately by an external and qualified custodian, such as a bank or a registered broker-dealer. CEXes should seek and publish independent attestations by auditors to verify that the assets are indeed segregated, and that robust danger and governance requirements are in place.
Instilling trust in a trustless system
And once Satoshi Nakamoto published the seminal Bitcoin (BTC) white paper in 2008, they envisioned a monetary system that no longer required to rely on blind trust. Still, the very entry point to which most investors today are exposed to digital assets – exchanges – is still run in a mostly opaque manner.
The events of 2022 have shown that for the industry to move forward, investor protections, transparency, robust governance structures and supplying value to clients must return to the forefront of how exchanges are built and run. CEXes that embrace these values will find themselves having a competitive advantage as investors increasingly rely on trusted centralized platforms to manage their digital investment portfolios.
As we continue to build back better, the industry can potentially just return to its roots – one born out of a vision for a fairer, more transparent and more efficient financial ecosystem.