Learning the Hard Way: The FTX Debacle Once Again Demonstrates DeFis Strengths
The collapse of the second-largest centralized cryptocurrency exchange FTX has asserted how centralized finance (CeFi) is different, and in many regards, riskier than decentralized finance (DeFi).
The first domino went down on November 2, 2022, when Coindeskpublished a reportrevealing the balance sheet of FTX founder Sam Bankman-Frieds trading firm Alameda Research. Barely a week later, after misleading customers continuously about the solvency of FTX and its subsidiaries, SBF tweeted a lengthy, viralapology. He thenresignedas FTX CEO, with FTX filing shortly afterward for Chapter 11 bankruptcy, and has since been arrested and indicted on charges of fraud and money laundering among others.
As gut-wrenching as the FTX collapse was, it doesnt paint the complete picture of what the blockchain-crypto industry stands for it demonstrates the dangers of centralization and the importance of decentralizing the financial ecosystem.
The Pitfalls of CeFi
FTX is not the only CeFi platform to have fallen in 2022. Other centralized crypto platforms like Celsius, BlockFi, and Voyager Digital also faced the same fate in Q2 of this year.
With multiple instances of such failures, it is only logical to argue that CeFi crypto platforms continue to fail because of legacy finance-like models. Despite the importance of centralized platforms in onboarding new users to crypto, it is hard to ignore the threat they can carry toward the space.
The FTX crash has similarities with the 2008 financial crisis, with many calling it the crypto industrys Lehman Brothers moment. Just like banks, CeFi crypto protocols can be liable to take high risks with user funds, sometimes without adequately backed collateral assets.
Too many CeFi platforms follow the infamous Wall Street-inspired black box accounting model, which we have seen this year inevitably lead to crisis. These entities typically lack transparency, with companies engaging in back-room deals without investors knowledge. Moreover, unilateral decision-making and questionable management practices can make these protocols unsafe for handling user assets.
Investors also dont have sovereign control over their crypto, as the platforms hold users private keys. Following thenot your keys, not your cryptodictum, most platforms can suspend asset withdrawals at any time. Without self-custody, users are powerless to manage their own assets.
FTX is a classic example of how CeFi can let down investors. Apart from Bankman-Fried and his core team, FTX users had no clue that the company was mishandling their assets and accruing massive, irreparable debt. They engaged in shady deals, invested carelessly, and then suddenly suspended asset withdrawals.
Additionally, evidence is emerging that the implosion of the Terra Luna crypto ecosystem in May was rooted in CeFi profiteering as well. Do Kwon, Terras polarizing founder, stated in a recentseries of tweetshis belief that a Bankman-Fried-led coalition of FTX, Alameda Research, and Genesis Trading were responsible for the manipulation that caused thede-peg of TerraUSD(UST) and ensuing crash of crypto markets
And Do Kwon is not alone in his speculation. U.S. federal prosecutors havelaunched an investigationinto Bankman-Frieds actions to examine whether he illicitly influenced the trading of the UST and LUNA crypto tokens. While it is clear that Terra and their decentralized money token model had structural flaws, the prospects of yet another crypto black swan event being orchestrated by centralized actors speaks volumes to the importance of open, transparent finance.
Luckily, investors are beginning to realize CeFis systemic issues and moving their crypto holdings to DeFi protocols with renewed vigor. The events of the past six months illustrate clearly: when used properly, DeFi offers better security and transparency while managing user assets.
Why DeFi is Better
Blockchain analytics platform Nansen hasreporteda double-digit percentage increase in DeFi users in the aftermath of the FTX collapse. For example, MakerDAOs number of user addresses has increased by 33%, Aaves by 70%, Curves by 63%, and Compounds by 30%.
On November 14th, the decentralized exchange Uniswaprecorded$1.1 billion in trading volume, passing Coinbase to become the second-largest crypto exchange after Binance. Moreover, hardware wallets like Ledger offering self-custody of user assets havereportedrecord sales on 15th November.
The FTX collapse has inaugurated a paradigm shift in the crypto industry as more users flock to DeFi ecosystems. There are multiple reasons why people are now choosing DeFi over CeFi platforms.
DeFi protocols run on smart contract-based trustless code that doesnt depend on any individual or central management team. Because algorithms perform asset valuations automatically, theres no option for strong-arming or negotiating. If the code detects any danger, it executes liquidation at a safe stage.
Second, DeFi protocols empower users to take control of their crypto holdings with self-custodial software and hardware wallets. As users own their private keys, they always have access to their funds. No one can unfairly suspend asset withdrawals, enabling users to enter or exit a position at any time.
DeFi platforms often depend on decentralized autonomous organizations (DAOs) to govern these protocols. This community governance model lets users directly vote and participate in decision-making for protocol upgrades and improvements. Some DAOs even offer a tiered voting system for implementing quick, strategic decisions.
In the post-FTX market, the aforementioned benefits make DeFi a better alternative for crypto users.
Crypto Hasnt Failed, CeFi Has
J.P. Morgan, one of the largest American investment banks, expressed concerns about centralization in its weekly crypto report. Theywrote,…while the news of the collapse of FTX is empowering crypto skeptics, we would point out that all of the recent collapses in the crypto ecosystem have been from centralized players and not from decentralized protocols.
J.P. Morgans comment is a timely reminder that the crypto ecosystem is not a monolith: it is marked by a clear, fundamental division between CeFi and DeFi. As a result, the FTX fiasco shouldnt make us question the utility and credibility of blockchain-cryptocurrency technology in general. On the contrary, its a timely reminder to leave CeFi and shift towards DeFi to build a robust crypto ecosystem for the future.
About the author:
Lang Meiis the CEO of AirDAO, previously known as Ambrosus Ecosystem, a DAO focused on building a decentralized system to enable social and financial interactions. By the age of 20, Lang had founded three profitable startups. Originally born in China, he got his Bachelor of Science-Business, Information Management & Entrepreneurship from the University of Colorado Boulder and then made his way to Silicon Valley, the hotspot for tech startups. He was introduced to Crypto in 2017 and followed the space until jumping in a few years later.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
