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By Bernd Stöckl is the CPO and co-founder of Palmswap
The crypto industry was just getting over the TerraUSD collapse that resulted in the wipeout of 3AC, Celsius and Voyager, when another storm, much bigger than the last one, hit it in the form of FTX. And once again, the cryptocurrency sector is dealing with the aftereffects of the FTX collapse.
Last month, the cryptocurrency exchange FTX filed for Chapter 11 bankruptcy protection in the U.S. The centralized exchange (CEX) was founded in 2019 by Sam Bankman-Fried, a former derivatives trader at Jane Street Capital, and went on to raise billions of dollars from the likes of Andreessen Horowitz, Polychain Capital, Three Arrows Capital, SoftBank, Singapore’s Temasek, Tiger Global and BlackRock. Then in just over three years, it all came crashing down.
However, it wasn’t just a mistake or a leveraged trading position, as its CEO Sam Bankman Fried (SBF), has been parroting. In fact, the platform was misusing customer funds. On top of that, there has been a conflict of interest with Alameda Research, the sister company of FTX, borrowing billions in customer funds from the exchange.
Meanwhile, the balance sheet of the exchange and Alameda Research was made up mostly of the FTT token, the native coin of the crypto exchange issued by FTX itself, along with other illiquid tokens.
It’s been a rollercoaster ride this year, with about $1.5 trillion wiped out from the total crypto market cap. While crypto asset prices have recorded a massive drawdown, firms have also started to default. The contagion effect of the collapse has been exacerbated by the fact that many firms had been using FTX as a collateral provider.
The collapse of the CEX has already impacted the likes of BlockFi, Circle, Genesis, Multicoin Capital, Amber Group, Wintermute, Ontario Teachers’ Pension Plan and Sequoia Capital, among others.
Now, even over a month later, its effects on the sector can still be seen, with the crypto trading firm Orthogonal Trading and its own lending unit, Orthogonal Credit, being the latest ones to be “severely impacted by the collapse of FTX.”
It has been revealed that FTX had more than one million creditors, which means crypto traders and investors, both small and big ones, have also been hit hard by the meltdown of the CEX.
In light of this, other exchanges are now trying to reassure investors about their businesses’ financial health.
Who’s Next?
FTX’s bankruptcy filing came as a surprise to many in the cryptocurrency industry, as the company was one of the most well-funded exchanges in the space. It is now being followed by more consolidation in the industry as weaker exchanges are forced to shut down or be acquired by stronger ones.
Last month, some sinister rumors were circulating around Crypto.com and Gate.io. Some people have been saying that the two companies were in cahoots with each other and were up to something sinister.
As users went on to protect themselves from another disaster, Crypto.com saw an increase in withdrawals at the time while its CEO Kris Marszalek assured that his firm had a “tremendously strong balance sheet.” According to him, the exchange wasn’t engaged in any nefarious activities. Instead, it was “business as usual” and they “always had 1-to-1 reserves.”
Now, Crypto.com, among other exchanges, is promising to publish “proof of reserves” to reassure users that they are, in fact, in possession of user funds and haven’t gambled them away.
While “proof of reserves” in itself is not enough, it is a step in the right direction, and “proof of liabilities” will further help assuage customers’ concerns.
However, amidst the “proof of reserves” movement, it was found that Crypto.com and Gate.io may be faking their reserves. Crypto.com apparently mistakenly sent $400 million worth of Ether to another crypto exchange Gate.io back in October.
This, however, wasn’t the first time such a thing occurred at Crypto.com. In May 2021, the exchange, again mistakenly, transferred some $7.2 million to a woman instead of about a $68 refund that she was due. But the most interesting thing has been that Crypto.com did not realize this error until several months later during an audit. That’s when the exchange sought to place a freeze order on her accounts to recoup the full amount.
Crypto.com, which reportedly has 70 million users globally, was also hit by the FTX debacle as the exchange had transferred $1 billion to FTX over a year, which was aimed at “hedging” customers’ orders, according to Marszalek. But “only had exposure of under $10 million when FTX shut down,” he added.
The company made headlines in 2021 for its marketing deals, including rebranding the Staples Center sports stadium to Crypto.com Arena and a “Fortune favors the brave” commercial featuring celebrity actor Matt Damon.
Meanwhile, some questionable transactions raised red flags as crypto sleuths dig into the Hong Kong-based Gate.io’s on-chain history. Even Binance is getting the heat as it released a report from global financial audit, tax and advisory firm Mazars showing that the largest CEX’s customer bitcoin reserves are overcollateralized, which has been called “misleading.”
Succinctly put, in the aftermath of the FTX collapse, centralized exchange users are understandably jittery and high on alert.
Decentralized is the Key
Crypto exchanges that have come a long way since their humble beginnings in the early 2010s. At the time of this writing, hundreds of exchanges are in operation, with more popping up all the time. As a result, the industry has grown tremendously, and the exchanges have adapted to meet the ever-changing market demands.
While new exchanges enter the market, many have made an exit. In some cases, it has been due to exchanges being hacked, which leads to a loss of confidence. We saw this happen with the Mt. Gox exchange in 2014, where 850,000 BTC were stolen, leading to a massive crash in the price of Bitcoin.
Besides the pressure of bear markets, many exchanges also steal user funds and pull the rug out from under investors.
With crypto gaining mainstream adoption, it is imperative that, as an industry, we do better. Educating the users and promoting personal custody of assets among the users are extremely essential here.
Decentralized exchanges (DEXs) can also play an important role here. After all, they are not subject to the same centralized risks as CEXs. With CEXs, a single point of failure can lead to the loss of user funds.
DEXs offer several advantages over CEXs, including greater security, privacy and control over one’s own funds. They are not subject to the same regulations and restrictions as traditional exchanges either. Moreover, DEXs can be used by anyone in the world, regardless of their location, which makes them ideal for users in countries with restrictive laws around financial trading.
Simply put, DEXs offer a much more democratic and transparent way of trading. In addition, since there is no central authority, all users are equal, which creates a level playing field and allows for a more efficient market.
For instance, at Palmswap, we are building a decentralized perpetual trading exchange that offers the best of both the DEX and CEX worlds. Users get the ease of trading, the option to use leverage, access to different tools and low fees, in addition to smart contracts to facilitate trades and complete control over assets.
What’s Ahead?
The collapse of FTX is having a ripple effect throughout the industry, with several firms defaulting on their obligations. It is impossible to say for sure which exchanges will be the next to crumble, but it is clear that the pressure is mounting. With so much money at stake, and so many exchanges facing serious problems, it is only a matter of time before another one goes under.
As a result, this has put further strain on the industry, which is already grappling with many challenges, including a lack of regulatory clarity, a bear market and a general slowdown in the global economy. The collapse of FTX is likely to weigh further on the industry in the near term.
But this is actually the time to encourage and promote self-custody. Also, transparency and decentralization can help overcome the problems plaguing the crypto exchanges.
While DeFi and DEXs are nowhere near ready to be adopted by the masses, we can use this time to build a stronger foundation because one thing is clear — DeFi is a step in the right direction.
About the author:
Bernd Stöckl is the CPO and co-founder of Palmswap, a decentralized perpetual contract trading protocol that aims to become the next-generation perpetual DEX for cryptocurrency markets.
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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