Althoughย while the collapse of FTXย Tradingย Ltd shook confidence in centralized cryptocurrency services, regulated exchanges are arguably moreย safe and offer users โpeace of mind,โ DBS Digital Exchange CEO Lionel Lim writes.
Theseย 30ย days marks one year since the Terra-Luna fallout and 6 months since the implosion of FTXย Tradingย Ltd. These spectacular events, which marked the beginning and culmination of plentyย of other collapses respectively, severely shook confidence in digitalย currencies and arguably triggered the industryโs most daunting existential crisis in its 15-year history. Althoughย while the investment class has recovered inย theย year, with Bitcoinย (BTC) up almost 65 percent year-to-date, these milestones are nevertheless an opportune moment to reflect on the setbacks of aย yearย ago and how the industry can build back better.
First, we should acknowledge that these events are not failures of blockchainย 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 persistsย to recognize the integrity and innovative potential of blockchainsย teck, as evidenced by the wholeย lotย of financialย resources inflows into decentralized exchanges following FTXโs collapse, likewise as positive reactions towards Ethereumโs proof-of-stake (PoS) transition and Shapella upgrade.
Lionel Lim is the CEO of DBS Digital Exchange.
Still, regardlessย 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 inย theย caseย of digital investment transactions. Reportsย by DefiLlama, the total volumeย ofย trading on CEXes accounted for almost 90 percent of all transactions across centralized and decentralized exchanges, as of mid-May 2023. Regardlessย of the setback in investor confidence aย yearย ago, the case for CEXes remains clear.
What the industry does must address, onย theย otherย hand, are the numerous points of weakness borne out of interdependencies and an early-held ethos of โmoving fast and breaking things.โ Toย stayย 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 cryptoย tokens native to different blockchainsย teck. This value proposition is clear when seeingย as the alternative: where investors manage plentyย of wallets and directly take part in numerous liquidity pools across different blockchainsย teck. Althoughย while some investors will have the capabilities to do so, the steep learning curve impliesย 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 industryโs โnot your keys, not your coinsโ mantra. Still, reportsย by Chainalysis, 18% of all digitalย currencies stolen by attackers in 2022 came from CEXes, with decentralized applications accounting for the remaining 82%. Althoughย 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.
Inย theย end, an often underappreciated benefit of some CEXes, particularly those that serve high net worth and institutional clients, is the peace of mind that โ thereย is someone to callโ 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
Althoughย while CEXes are likely here to stay, one area where such platforms must makeย better on is the segregation of customer and corporate assets. Now, greaterย than ever, scrutiny around this is mounting. Largely in response to the co-mingling of funds by FTXย Tradingย Ltd, a practice which led to numerous retail investors incurring wholeย lotย of losses when the exchange unraveled, policymakers like Unitedย 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 FTXย Tradingย Ltd, the Centralย Bank of Singapore (MAS) proposed new regulations in a consultation paper published in October of 2022 requiring digitalย currency platforms to segregate their assets from their customersโ. The MAS has likewise sought industry feedback on whether digitalย currency platforms should appoint independent custodians to safeguard customer funds.
Asย aย result, CEXes should rethink the โone-stop-shopโ narrative. Althoughย while it makes sense to have a seamless front end user interface across custody and trading, in the back end, investorsโ 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
Andย once Satoshi Nakamoto published the seminal Bitcoinย (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 โ exchanges โ isย 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 canย potentially just return to its roots โ one born out of a vision for a fairer, more transparent and more efficient financial ecosystem.
