There’s no hiding it, the crypto industry has been having a rough year. Huge names like Celsius, Voyager Digital, BlockFi and now FTX have all gone belly up, leading many to conclude that crypto and blockchains have failed in their mission to introduce a more transparent and trustless financial system.
The key thing to note is that all of these examples refer to the collapse of centralised platforms, which all run on a fundamentally centralised model of operations, which is broadly known as ‘CeFi’ (centralised finance).
The thing about centralised exchanges and platforms like Celsius, Voyager and FTX, is that while they may operate in the digital asset space, their underlying business models are more or less the same as the institutions in the world of traditional finance.
At their core, centralised exchanges offer investors the ability to invest in cryptocurrencies, but because the exchanges hold the ‘keys’ to these assets, investors don’t really ‘own’ them in a real sense. They merely offer exposure to crypto assets in the same way that traditional financial institutions offer their clients exposure to stocks and other assets.
At its core, the incentives for centralised exchanges are very much the same as the Wall St firms that caused the Global Financial Crisis in 2008. They are economically motivated to take risks with client funds, all the while getting as close to regulators as possible in a bid to appear trustworthy and safe.
In the weeks leading up to the collapse of FTX, its former CEO Sam Bankman-Fried was in talks with regulators at Washington DC, even going as far to say that the “trustless” world of Decentralised Finance (DeFi) needed more regulation in order to protect consumers.
When Satoshi Nakamoto first created Bitcoin in 2008, it was exactly this type of financial misdealing that the pseudonymous founder was trying to alleviate, even going as far as citing what’s known as the ‘Bob Rubin Trade’ (a situation where the house always wins) in the first block of Bitcoin ever mined.
For the first time in human history, the foundation of financial decision making shifted from banking executives and politicians to mathematics, cryptography and a string of code, allowing people to participate in an alternative financial system where the rules of the game are public and unbreakable.
In 2015, this new financial system received its first major upgrade when Ethereum introduced smart contracts, delivering the utility of trustless financial interactions and opening up the world of DeFi to hundreds of thousands of new users.
DeFi is the antidote
Despite the crypto market being rocked by the sudden implosion of FTX, decentralised exchanges like UniSwap, Balancer and Curve have all been running smoothly. While users of decentralised exchanges have still seen the overall value of their crypto portfolios drop, they have never lost access to their assets.
For context, decentralised exchanges are peer-to-peer marketplaces where crypto investors make transactions directly without handing over management of their funds to an intermediary. On these platforms transactions are facilitated through the use of self-executing agreements written in code called smart contracts.
Platforms like these are designed to preserve the benefits introduced by Bitcoin: trustlessness, transparency, and the self-custody of assets.
The collapse of FTX revealed that no matter how ‘altruistic’ leaders may seem, it’s an unpleasant truth that it remains impossible to trust figureheads to do the right thing. So, instead of enforcing trust through regulation, DeFi eliminates the need for trust altogether. As a result, the adoption of DeFi around the world has grown significantly over time.
Australian DeFi co-founder Mark Monfort weighs in
In conversation with The Chainsaw, Mark Monfort, the co-founder of the Australian DeFi Association and Web3 venture studio Not Centralised, said that he finds it frustrating how quickly people have labelled the collapse of FTX as a “failure of crypto”.
“It’s ironic how people are pointing to this FTX drama as a failure of crypto when bigger scams have happened in traditional finance like Bernie Madoff and Tom Petters. At the end of the day centralised finance has issues with people, processes and procedures. Additionally, it’s not regulation that will save this from happening again in the future. Traditional finance is much more regulated but the scams still happen,” he said.
“If only there was a way of having transparency over what people say and instead of just trusting them — which is one of the classic weaknesses of human nature — we could verify.
Well, blockchain tech offers all of that with its core tenets of automation, transparency, easier value transfer, security and composability,” Monfort added.
Speaking to the utility of blockchain technology in preventing future FTX-like collapses, Monfort looks to the permissionless nature of decentralised protocols:
“DeFi protocols like Aave and UniSwap continued to work unabated by the FTX noise. In events where liquidations occurred on DeFi, those things were automated and didn’t need to go through courts and arbitration like we’re seeing now with FTX. DeFi worked, and continues to work as needed,” he added.
While DeFi’s core premise is trustlessness, Monfort said that DeFi builders will still need to step in time with efforts from regulators if they want to see DeFi taken up in the mainstream.
“In terms of DeFi progression, we need to embrace the fact that many folks can’t get into this yet as they don’t see the protections in this space and regulators are trying to offer that. The balance will be with having a best of both worlds approach where best of web2 and best of web3 come together to solve real world problems”.
At the end of the day, the collapse of FTX was a failure of CeFi, not DeFi. The ‘middle men’ at FTX misused customer funders without their clients ever knowing that billions of dollars of their money was being moved around to prop up failing parts of the exchange.
With the continued investment and development, DeFi will help limit the human errors and guide users away from scams and exploits. However, a key point here is that because DeFi is truly trustless, the irreversible nature of blockchain transactions means that if something does go wrong, there’s no customer help line to call to retrieve your funds …
If investors can look past the decline in crypto asset prices, they will see that ultimately, the fundamental building blocks of the technology that powers the cryptocurrency industry are growing and maturing.