Written one year after the Luna storm: trust rebuilds, centralized exchanges will survive

As we continue to rebuild, the industry may return to its roots: an industry born of a vision of a fairer, more transparent and efficient financial ecosystem.

Source: Coindesk

Compiler: Mary Liu, Bitui BitpushNews

This month marks the one-year anniversary of the Terra-Luna incident and six months since the FTX crash. These incidents respectively represent the beginning and climax of a series of explosions in other encryption projects, which have seriously shaken people's confidence in cryptocurrencies and can be said to have triggered the most terrifying existential crisis in the 15-year history of the encryption industry.

Despite the pick-up this year, with Bitcoin up nearly 65% so far this year, these historical events are still worth ruminating about how the crypto industry can be better rebuilt.

First of all, we should admit that these incidents are not failures of blockchain technology, but the result of poor risk management and corporate governance, and some failed companies have fraudulent practices. The market continues to recognize the integrity and innovative potential of blockchain, as evidenced by the massive inflows into decentralized exchanges following the FTX crash, as well as the positive reaction to Ethereum’s proof-of-stake (PoS) transition and Shapella upgrade.

However, despite these developments, centralized digital asset exchanges (CEXs) will continue to remain relevant and wield outsize influence as a key entry point into the asset class, especially as it grows in maturity and institutional adoption. After all, they are still the dominant platforms when it comes to trading digital assets.

According to DefiLlama, as of mid-May 2023, CEX's total transaction volume accounted for almost 90% of all transactions on centralized and decentralized exchanges. Despite investor confidence slumping last year, the outlook for CEX remains bright.

What the industry does need to address, however, are the many vulnerabilities that come with interdependence and the “move fast and break things” ethos of the early days. To survive this crisis of confidence, CEXs need to address the need for better investor protection, risk control, and prudent governance structures.

CEX will continue to exist

Managing digital asset portfolios is operationally complex, and investors need a comprehensive set of capabilities, such as custody, trading, investment products, consulting, and efficient fiat currency deposit and withdrawal channels. In this regard, many CEXs have integrated these solutions into one platform, greatly reducing the technical complexity of owning and managing native tokens of different blockchains. When considering alternatives, this value proposition is clear: investors manage multiple wallets and participate directly in multiple liquidity pools across different blockchains. While some investors have the ability to do so, the high learning curve suggests that CEX will remain the platform of choice for many.

Investors who actively manage their portfolios may also wish to frequently rebalance asset allocations between traditional and digital assets. Therefore, the fiat currency deposit and withdrawal infrastructure layer in CEX is very critical, which is especially important during market fluctuations.

Safety and security are other advantages that a CEX can provide. Although the slogan "not your private key, not your token" has been circulating in the industry, according to Chainalysis data, 18% of all cryptocurrencies stolen by hackers in 2022 will come from CEX, and the remaining 82% will be decentralized. application. While CEXs still have a lot of room for improvement in better protecting customers from cyber breaches, they are relatively more secure. The security gap between CEXs and decentralized applications should continue to widen as the industry works to restore trust and strengthen its cybersecurity systems.

Finally, an often underappreciated benefit of CEXs (especially those serving high-net-worth clients and institutional clients) is the peace of mind of having a customer service call if something goes wrong. This is especially true for investors who manage assets on behalf of clients, such as family offices and hedge funds. Horror stories of millions of bitcoins locked away in wallets are common, and investors will find value in working with centralized exchanges (CEXes) that offer dedicated hotlines or account managers.

Rebuild trust by segregated assets

While CEXs are likely here to stay, one area where such platforms must improve is the separation of customer and company assets. Now, there is more scrutiny surrounding this than ever before. Policymakers such as U.S. Treasury Secretary Janet Yellen see asset segregation as a key area to be addressed in future regulatory frameworks, in large part to prevent a repeat of FTX's commingling of client funds, a practice that led many retail investors to Suffering significant losses when the exchange goes bankrupt.

Before the collapse of FTX, the Monetary Authority of Singapore (MAS) proposed new regulations in a consultation paper issued in October 2022, requiring cryptocurrency platforms to separate their assets from those of customers. An independent custodian should be appointed to safeguard client funds seeking industry feedback.

Therefore, CEX should reconsider the term "one-stop service". While it makes sense to have a seamless front-end user interface between custody and trading, on the back end, investors' assets should be held in separate custody with an external and qualified custodian, such as a bank or registered broker-dealer. CEXs should seek and issue independent attestations from auditors verifying that assets are indeed segregated and that robust risk and governance requirements are in place.

Instill trust in a trustless system

When Satoshi Nakamoto published the groundbreaking Bitcoin white paper in 2008, they envisioned a monetary system that no longer needed to rely on blind trust. Yet the entry point for most investors today to digital assets — exchanges — still operate in a mostly opaque manner.

The events of 2022 demonstrate that for the industry to move forward, investor protection, transparency, robust governance structures and delivering value to customers must come back to the forefront of how exchanges are built and operated. CEXs that embrace these values will find themselves with a competitive advantage as investors increasingly rely on trusted, centralized platforms to manage their digital asset portfolios.

As we continue to rebuild, the industry may return to its roots: an industry born of a vision of a fairer, more transparent and efficient financial ecosystem.