After FTX: how the crypto industry will change

The FTX scandal will have many consequences for the crypto industry and its users. Centralized crypto finance (CeFi), of which FTX was an eminent representative, will have to find other means of proving their trustworthiness than just words. Regulators will have to set clear legal framework dedicated to protecting CeFi users.

Many users who didn’t want to bother with self-custody of crypto before, will start using non-custodial wallets.

Many users and traders who preferred CeFi solutions before, will switch to DeFi (or decentralized finance) alternatives.

All these processes are already underway. In the meantime, companies able to efficiently navigate them could come out as winners in the long term.

CeFi to become more secure

It is important to understand that CeFi firms are traditional financial companies that manage crypto. Unlike blockchain-based services, they rely on their users’ trust.

FTX looks like yet another case in the long history of financial fraud, and its demise has hurt all CeFi companies by undermining users’ trust in them. To prove their credibility, most CeFi companies have issued reassuring statements, but only few could produce real proof.

Kraken exchange showed itself as one of the most advanced firms: it already has an established Proof-of-Reserves tool, which uses a cryptographic function called Merkle Tree to gather all user balances and compare them to the balances on the blockchain addresses that provably belong to Kraken. This tool allows any user to verify that their balance is backed by real assets by comparing select pieces of data to the Merkle root.

Companies like Coinbase (exchange) and Nexo (lending-borrowing) have a third-party audit, which is regularly made public.

Other firms, however, were not able to prove their reserves, showing how immature the sector really was. This will change though: Binance, Crypto.com, OKX, KuCoin and many others have pledged to produce a proof “soon”, while Binance CEO CZ predicted that Merkle-Tree-based Proof-of-Reserve will become ubiquitous.

CZ has been quite active in the whole FTX story, initiating markets panic in the beginning and leading the CeFi improvement thought afterwards. In his yesterday’s Twitter spaces he spoke about creating an industry recovery fund financed by Binance and other centralized exchanges, which would help smaller players in difficult situations. He also mentioned the creation of an association that will promote useful regulations for the sector.

CeFi regulation

The FTX case will undoubtedly push the regulators to look into the CeFi sector more attentively. In the EU, the MiCA law will act as such framework starting from 2023, but the US will have to work on it. The much-discussed DCCPA 2022 (Digital Commodities Consumer Protection Act) can serve as a vehicle for the CeFi regulation, but taking into account that Sam Bankman-Fried of FTX was deeply involved with its current draft, the regulators might need to get a better consult.

Users to turn to self-custody

While centralized exchanges are necessary for converting crypto to/from fiat, storing funds on them is a bad idea, and contrary to the very reason crypto was created.

FTX has pushed users who were otherwise reluctant to use unhosted wallets to change their minds: on-chain analytics firm Glassnode noted a substantial rise in Bitcoin outflows from exchanges, which have reached a historic rate of 106k BTC/month.

Providers of hardware wallets allowing to store crypto not only without intermediaries, but also offline, have already noticed a spiked interest. Ledger announced that the company registered its biggest sales week ever following the FTX collapse, and Trezor reported a 300% week-on-week sales surge.

DeFi adoption to grow

The FTX demise showed once again the inherent vulnerabilities of the CeFi, and it will motivate more users to turn to its alternative – the DeFi, which operates without any central authority.

Daily trading volume in all DEX (decentralized exchanges) has surged from the average of $1.5 billion to over $8 billion in the few days following the crash (source: DefiLlama).

What’s more, some DeFi tokens have defied the current market slump and started rising. For example, $dYdX (a token used by the eponymous derivatives trading platform) has gained 48% since November 8^th.

In the end, the FTX debacle might give all actors of the crypto industry motivation to reconsider their current practices and offer better protection to  users. Always remember the adage “not your keys, not your money”.

Written by D.Center