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In brief. FTX collapse is a major event that will have numerous repercussions for the whole crypto industry. Good news: it presents more opportunities than threats.
Here’s how we see the most likely scenario unfolding:
Most immediate effect is a wide-spread panic on the markets and growing mistrust of centralized crypto finance, or CeFi.
In short to mid- term, many CeFi users will withdraw their funds to self-hosted wallets, and traders will consider switching to decentralized finance, or DeFi. Judging by the price of some DeFi tokens, this process is already underway.
Over time, as more details of FTX flaws come to light, it will push regulators to adopt a consistent approach to crypto – an approach that will make it more secure for users, all while removing artificial barriers to its development.
In this Newsletter we try to determine the best strategy for the first two stages: choose the most secure CeFi platforms, all while familiarizing with non-custodial and DeFi options.
If somehow you missed the FTX scandal, here’s a (very short) recap of what happened:
November 2. A leaked balance sheet of Alameda Research, (trading company of FTX founder Sam Bankman-Fried, also known as SBF), showed that a third of its equity was composed by $FTT, the token of FTX exchange basically created out of thin air.
November 6. Binance CEO CZ announces the sale of his company’s $FTT, starting market panic.
November 8. A massive bank run on FTX forces the company to admit it’s facing a liquidity crunch and moves to sell it to Binance.
November 9. After the news accusing FTX of gambling with user funds and a due diligence, Binance backs out of the deal. FTX halts withdrawals and crypto markets tank: $BTC losing as much as 25%.
November 11. Alameda employees resign collectively, FTX’ former exec confirms that it currently has $8.8 billion of liabilities for only $900 of liquid assets. FTX US and 130 affiliate companies file for bankruptcy under Chapter 11. SBF resigns.
November 12. FTX confirms that the platform was hacked the day before, on-chain analytics firm Elliptic estimates the stolen amount at $477 million. SBF and several top execs are reportedly “under supervision” by the authorities of Bahamas, where FTX HQ is located.
FTX was an eminent representative of the CeFi, and its collapse has triggered a massive paranoia: every centralized crypto company that acts as a custodian of client funds has found itself under an intense scrutiny.
The most concerned ones were centralized exchanges, or CEX, which have taken it to Twitter and maligning to reassure their clients. However, words alone do not suffice, and while some of the CEX are ready to prove that clients’ funds are safe, others cannot.
? Here’s what some of the most popular exchanges could show as proof:
Kraken. American exchange launched in 2011, Kraken has set up a Proof of Reserves – an independent audit that uses a cryptographic function called Merkle Tree to gather all user balances and then compares them to the balances on the blockchain addresses that provably belong to Kraken. This tool allows any user to verify that their balance is backed by real assets by comparing select pieces of data to the Merkle root.
Bitstamp. Launched in 2011 in Slovenia, Bitstamp has confided its reserves to the licensed crypto custody firm BitGo. It is audited every year by a Big Four accounting firm.
Coinbase. Launched in the US in 2012, Coinbase went public in 2021 and its stocks are traded on Nasdaq. As a listed company, it naturally undergoes regular audits and reveals the state of its reserves at every quarterly earnings call.
These three exchanges are, in our opinion, some of the most secure in the industry, and not only by their seniority or the transparency tools they use. Their noteworthy quality is the absence of an exchange token, which takes away the possibility of any shady use it might inspire.
? Not everyone could produce enough proof though.
Binance. CZ, CEO of world’s biggest crypto exchange launched in 2017, recently tweeted that it “will start to do proof-of-reserves soon”. It’s better late than never, but we cannot help but ask ourselves why he didn’t do it earlier.
In the meantime, CZ shared cold wallet addresses for some of the top assets holding 475K BTC, 4.8M ETH, 17.6B USDT, 21.7B BUSD, 601M USDC, and 58M BNB. Binance also has an emergency insurance fund called SAFU (Secure Asset Fund for Users), which it recently topped up to $1 billion.
Binance does have a coin called BNB, but its difference from most exchange tokens is that it has a real utility: it fuels the BNB Chain and its ecosystem (read more here).
$BNB lost 19% since November 8, but this is rather normal considering the current turbulence.
Crypto.com. Launched in 2016, this American exchange with a taste for flashy advertising campaigns (not unlike FTX) probably raises the most concerns now. Reacting to the escalating panic, its CEO revealed “partial reserves” amounting to $2 billion outlining 5 biggest coins belonging to its users: BTC, SHIB, ETH, USDT, USDC. While the surprisingly big amount (almost 20%) of SHIB, a memecoin depending solely on its community, raised many eyebrows, this is totally fine if these are users’ funds.
Until the proof of reserves is produced, however, Crypto.com should be considered less trustworthy, especially taking into account that it has a token called Cronos ($CRO) without any other utility than to help monetize the platform, just like the FTT. $CRO lost 45% since November 8.
Other big exchanges like OKX and KuCoin have also pledged to produce a Proof-of-Reserves soon (OKX also released its addresses containing 69K of BTC and $2 billion of other crypto). However, both these exchanges also have their tokens and should be used with caution.
It is saddening that the initial message of Bitcoin was somewhat lost on the way. Cryptocurrencies were created to avoid intermediaries and centralized authority, but the CeFi model, which combined old-world management with new-world assets, appeared to be a profitable (albeit dangerous) endeavor.
FTX crash has given a new momentum to the “Bitcoin maxi” movement, which preaches the “Bitcoin, not crypto” approach. What’s more, on-chain data by Glassnode shows a massive accumulation of Bitcoin in the last week across all types of investors, as well as a historically high rate of BTC withdrawals from exchanges: -106k BTC per month.
Bitcoin dominance is likely to increase after FTX, and its price action – become more optimistic vs altcoins.
Cryptocurrencies flowing from exchanges are going to non-custodial (self-hosted) wallets.
Using a hot (online) non-custodial wallet like Blockstream Green, Exodus, Metamask or Trust Wallet allows users to bypass intermediaries and be their own banker.
For more security, a cold (offline) non-custodial wallet like Ledger, Trezor or KeepKey allows to store your crypto away from hackers. For more info, here’s a short explanation of crypto wallets’ nature.
CEX are still necessary, notably to exchange crypto vs fiat. However, for operations within the crypto space, DeFi provides a great alternative, allowing exchanges, trading, all kinds of derivatives, lending-borrowing and many other functions, all while enabling users stay their own custodians (more on DeFi here).
The FTX demise can mark the beginning of a new era of DeFi adoption ?
The first to convert will be traders and institutions, which are more likely to take some extra time to understand how the DeFi works. The spectacular rise of a DeFi derivatives trading platform dYdX could indicate that this process has already started: while Bitcoin (which often represents the larger crypto market) has lost 19% since November 8, $dYdX has gained 50%.
It is more difficult for a regular user to start using DeFi, but DEX (decentralized exchange) platforms like Uniswap, Sushiswap or Curve are constantly evolving, making it easier to exchange crypto without any intermediary.
All in all, we believe that the FTX example will be used to set new standards in the CeFi sector, notably regarding Proof-of-Reserves, which will become ubiquitous (some ready-to-use PoR tools, like the one developed by Chainlink, are already available).
It will also push the regulators (especially in the US) to reconsider their approach. The SEC denying companies the right to issue physically backed crypto ETFs, all while authorizing futures-backed ones is already a bizarre situation. It becomes even more so when taking into account some very fishy ties of FTX with the SEC head Gary Gensler or else the Democratic Party… but this would be the story for our next article.
Stay safe and always Do Your Own Research ?