Nov 16, 2022
FTX Fallout: Of Crypto Oxymorons and Regulatory Paradoxes
2022 has undoubtedly been a year to forget for crypto enthusiasts.
About half a year ago, in May 2022, the crypto market was rocked by the USD60 billion crash of TerraUSD. The resultant rippling wave of contagion effects led to the collapse of 3AC, Voyager Digital and Celsius Network.
Fast forward to November 2022, the crypto market was overpowered by a rather unsettling feeling of déjà vu when another calamity struck. This time through the meteoric collapse of FTX, which threatens to cast the crypto market into a state of perpetual crypto winter, i.e., into a crypto ice age.
Similar Horrors Faced in Trad Finance
The conditions of the global financial system in the early twentieth century were not too unlike the current crypto market, with banks being excessively prone to contagion effects arising from any crisis at other banks.
The tipping point came in the guise of the Panic of 1907, aka the Knickerbocker Crisis, which was caused primarily by a highly leveraged short squeeze that went wrong.
The collapse of the Knickerbocker Trust Company, the third-largest trust company in New York, triggered a wave of bank runs. The harrowing experience of the Panic of 1907, which threatened to annihilate the global economy, led to the establishment of the U.S Federal Reserve in December 1913.
Taking a leaf out of the book of the traditional financial system (TradFi), the panacea for the extreme volatility-induced instability of the crypto market may lie in regulatory intervention, especially for centralized exchanges (CEX).
Conceptually, CEXs are very much oxymorons as these exchanges are antithetical to cryptocurrency’s notion of decentralization as embodied in the emphasis on the peer-to-peer (P2P) element in Bitcoin’s whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”
Notwithstanding their conceptual aberrance, CEXs are far more popular than their decentralized counterparts, i.e., decentralized exchanges (DEXs), with CEXs accounting for about 95% of crypto exchanges as of February 2022. So, crypto regulation would primarily be CEX regulation.
Two Sides of the Crypto Regulation Coin
As always, there are two sides to the crypto coin, and it is no different when it comes to crypto regulation. While calls for crypto regulation have been growing louder by the day, the meltdown of FTX aptly illustrates that regulatory intervention is certainly not a silver bullet.
After all, the fact that FTX and its subsidiaries are regulated in a host of countries, including the UAE, Japan, Australia, and most parts of Europe, did not prevent its business mismanagement which resulted in USD1 billion worth of missing user funds.
From a practical perspective, cryptocurrencies’ cross-border nature renders them to be geographically borderless. Hence, the effects of regulations are more in form rather than substance. Undoubtedly, regulations do have much to offer to the crypto market, particularly by controlling excessive leverage and speculation, both of which are primary ingredients for financial disaster.
But still, the million-dollar question remains about how crypto regulations can be accurately implemented.
Trust in Thyself
A much-touted approach to crypto regulation is that of self-regulation. The central idea of CEXs and DEXs as self-regulatory organizations (SROs) is that operating guidelines and codes of conduct govern these exchanges. These guidelines and codes would be put in place by industry bodies constituted by the crypto market players themselves and the regulators.
The underlying premise of SROs is those market players, and the regulators would work hand-in-hand under a private-public-partnership (PPP) arrangement. Under such an arrangement, they would engage in a symbiotic partnership of close coordination and information sharing.
In the crypto world, an adage goes, “not your keys, not your coins.”
Self-Custody of Your Assets!
In line with the idea of self-regulation is the idea of self-custody of crypto assets by their owners.
ONLY the crypto owners themselves know their private keys by storing their assets in:-
- Hot Wallets (MetaMask and Trust Wallet)
- Cold Wallets (Ledger and Trezor)
Self-custodians would not need to address the risk of loss in the contingent event of any crisis befalling their crypto service providers (such as FTX).
In the case of FTX, users who have yet to withdraw their crypto assets before the bankruptcy filing of the fallen exchange may lose all their investments. In general, crypto owners have learned their lessons as the volume of Bitcoins deposited in individual crypto wallet addresses has increased following the FTX crisis.
How to Protect your Assets
- NOT leaving your crypto assets on any CEX, more so if the investment constitutes more than 5% of your overall portfolio;
- Using a hot or cold wallet to store your crypto assets;
- Invest some time to empower yourself by learning about ways to protect better the seed phrases of your wallet;
- Conducting your crypto tradings through a DEX, notable examples include Uniswap, Pancakeswap, Curve, or SushiSwap;
- Resorting to the splash-and-dash strategy if you decide to use a CEX for your crypto tradings by moving your crypto assets back to your hardware wallet or online hot wallet as soon as the transaction has been completed;
- If you still want to store on CEX, make sure they are fully encrypted, have a strong Merkle Trees Proof-of-reserves, and on-chain Proof-of-liabilities.
Conclusion
The pride and joy of the crypto market are decentralized finance (DeFi) which has weathered the onslaught of meltdowns relatively much better than its CeFi sibling. In an ideal world, there would be no need for regulation as cryptocurrencies would be as decentralized as they are trustless but alas, crypto utopia is but an idealistic dream.
As much as crypto regulation is antithetical to the ideals of decentralization and trustlessness, bringing CeFi even closer to being a blockchain-based version of TradFi, recent events over the past few months have shown that crypto regulation is very much a paradoxical necessity.
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