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By Sadie Williamson
For an industry whose raison d’etre is to usher in an era of trustless financial transactions, the cryptocurrency sector is coming to the end of a truly torrid year – one that has dramatically rocked the faith of its assorted disciples.
Bitcoin bloomed into being to solve the middle-man problem and restore sovereignty and privacy to the individual, yet the 800-pound gorillas of the industry have been the digital asset exchanges that facilitate the majority of daily transactions. This year, one of those gorillas (FTX) went to the wall after a calamitous chain of events that exposed the cult of personality at the heart of the platform. And it wasn’t the only multi-billion-dollar crypto company that bit the dust in 2022.
Boom and Bust
Like other markets, crypto operates on a cycle of boom-and-crash, and as such, it has endured several troubled years already. In 2014, Bitcoin lost 63% as the Mt. Gox exchange went bust: it was the FTX of its day, with lurid tales of misappropriated funds, falsified data, and a long line of burned creditors. Four years later, when the ICO bubble popped, the market capitalization of all digital assets fell by over $700 billion. And when Covid hit in 2020, Bitcoin lost half of its value in just two days, plummeting to under $4,000 before closing out the year at $29k. Volatility is nothing new.
You might think that such a track record would nurture thick skins in those who participate in crypto’s largely unregulated sandbox: everyday users, investors, gamers, lenders, NFT traders. But the collapse of FTX caught virtually everyone by surprise, fomenting disgust and distrust in equal measure and spreading contagion throughout the markets.
Because a number of heavy hitters had exposure to FTX – with two creditors owed $226m and $203m – the second-order effects were significant. Thick skin? Those affected by the fallout needed a carapace of stone.
FTX may have been the biggest story of the year; with a million creditors left out of pocket, how could it not be? There’s already a documentary in the works (SBF and the End of Silicon Valley) and rumors of a future Netflix series. But even before its implosion in November, 2022 had been an exceptionally tough year, with reputational damage coming from multiple quarters.
Back in May, FTX was sitting pretty while the Terra (LUNA) cryptocurrency went up in flames. As with FTX, there was a hubristic figurehead at the wheel, Terraform Labs’ founder Do Kwon, who has – unlike Sam Bankman-Fried – since managed to evade the long arms of the law. Terra’s downfall was linked to its algorithmic stablecoin TerraUSD (UST), which was backed by sister token Luna. Users deployed both assets in Terra’s decentralized money market Anchor Protocol to earn a suspiciously high APY on collateralized loans. Long story short, both Luna and UST crashed and burned once the so-called stablecoin lost its dollar peg after users unstaked en masse.
This particular crash caused an industrywide sell-off, provoking cascading withdrawals over at crypto lender and exchange Celsius Network, which was perceived to have close connections to Terra. Within a matter of months, Celsius went from managing billions of dollars in assets to filing for Chapter 11, with KeyFi CEO John Stone later accusing the lender of operating like a Ponzi scheme by investing customer funds in risky trading strategies.
Earlier this month, a U.S. bankruptcy judge ruled that customers whose deposits were never commingled with other Celsius funds should receive their deposits back. Unfortunately, such individuals represent a small percentage of the New Jersey-based company’s user base, with the amount due for return estimated at $44 million. When Celsius closed its doors in July, it had a $1.3 billion hole in its balance sheet, the bulk of that owed to customers.
The market had not yet fulfilled its butcher’s bill of pain and suffering: the Singapore-based crypto hedge fund Three Arrows Capital (3AC) was the next to file for bankruptcy, having defaulted on a $670 million loan to digital asset brokerage Voyager (which also went bust as a result). As with Celsius, 3AC’s path to insolvency could be traced back to Terra, with wider macro factors also playing a role. As if to shine a spotlight on the general disarray, subsequent court documents revealed that founders Su Zhu and Kyle Davies had purchased a yacht with consumer funds.
Erosion of trust? You could say that. The collapse of Celsius – and another crypto lender, BlockFi, in November – has shattered the confidence of those who believed they could reliably earn passive revenue from borrowing/lending protocols. The downfall of 3AC has caused huge reputational damage to crypto hedge funds. And the demise of FTX (not to mention swirling FUD now enveloping top trading exchange Binance) has respawned talk of “Not your keys, not your coins.”
Users Are Taking Back Control
Forget BTC, the credo currently in vogue is DTA: Don’t trust anyone. Not centralized exchanges, nor over-leveraged hedge funds who rehypothecate money from retail and CeFi companies while making crazy speculative bets in DeFi, nor messianic “effective altruists” like Sam Bankman-Fried.
Many believe that we have tracked too far from the principles eloquently laid out in Satoshi Nakamoto’s Bitcoin whitepaper, and that greed and hubris have spread like cancer through the industry as centralized platforms wield more and more power. Recent corrections have provoked a mass exodus from exchanges, with millions of users withdrawing their assets from hot wallets and storing them offline instead. One notable beneficiary has been Trust Wallet, whose native token TWT soared by nearly 150% in six days following the implosion of FTX.
A non-custodial cryptocurrency wallet, Trust Wallet lets users retain full ownership and control of their own coins and private keys. Interestingly, the decentralized wallet is integrated with Binance, meaning users can effectively plug into the exchange’s vast ecosystem without entrusting it with their digital assets.
Taking back control through self-custody offers users a means of avoiding the collateral damage that has blighted the industry this year. Indeed, the events of 2022 can be viewed as one lurid advert for self-custody, which is why Binance boss Changpeng Zhao now regularly preaches about the topic, encouraging users to control their keys if they can tolerate the risk.
In a recent Twitter Space discussion, Zhao clarified earlier comments by saying he believed most people were “not able to back up their security keys,” claiming they would lose their keys, fail to properly encrypt their backup, or share their seed phrase with someone who later rips them off. Those capable of safely managing their funds, he said, should do so.
While hardware/cold wallets are not risk-free, Zhao’s claim that 99% of people are incapable of managing their portfolios offline might be a bit of a stretch – unless of course he includes people that aren’t already in crypto.
If there is a silver lining to be extracted from this tumultuous year, it might be an elevated appreciation for security among crypto users. The aforementioned flight from exchanges is a sure sign of this dawning awareness, and THORChain has followed Binance’s lead in integrating Trust Wallet into its platform for those who want the best of both worlds. Elsewhere, we have seen the MPC movement gain momentum.
MPC – Multi-party computation – is a type of non-custodial wallet that dispenses with the need for users to write down and safely store their seed phrase, the process Zhao believes is still abstract for everyday users. While a private key is still generated, with MPC it is abstracted behind a layer of complex cryptographic tech, meaning wallet recovery is possible through a mixture of email access, facial recognition and a mobile application. No private key, no problem, in other words.
The industry’s first user-focused, MPC-powered wallet ZenGo describes itself as “the only self-custody wallet with no private key vulnerability,” and it has seen a massive 375% increase in asset deposits since the collapse of FTX. Regulated exchange Coinbase has since launched its own MPC wallet, claiming it “provides the virtually impenetrable nature of cold, offline storage, with the frictionless convenience of hot, online wallets.”
It’s easy to see the MPC wallet trend continuing into 2023, even barring further collapses. In reality, users need no more warnings about the risks of storing funds in vulnerable hot wallets or interacting with too-good-to-be-true DeFi protocols offering eye-watering APYs. Those who fail to take the right precautions are simply asking for trouble. Particularly since hacks (typically exploits of cross-chain bridges and DeFi apps due to smart contract bugs) have accounted for $3 billion worth of losses this year alone.
The FTX saga will play out in high-definition over the coming months, particularly with SBF now in custody and facing a laundry list of criminal charges. Despite all the negative press though, 2023 could end up being a fruitful year for those crypto users who properly manage risk and establish sounder security processes. Of course, many victims of this year’s bloodletting are likely gone for good, with a bitter impression of the industry that’ll last a lifetime.
Author bio
Sadie Williamson is the founder of Williamson Fintech Consulting, building blockchain solutions since before it was cool. Sadie has more than a decade of experience helping fintech firms with blockchain custom technology, software and mobile development, and multi-vertical applications. She’s a crypto contributing writer to various publications as VentureBeat, Bitcoin Magazine, Hackernoon and more.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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