By Karan Ambwani
In 2022, the cryptocurrency industry experienced one of its busiest years on record. An important event was the collapse of one of the largest centralized stock exchanges. The effects of this collapse continue to be felt as the industry assesses the extent of the damage inflicted. In addition, fears, uncertainties and doubts (FUD) regarding central custodian banks have increased among retail investors.
One notable trend is that since Nov. 4, centralized exchanges (CEXs) have seen over $10 billion in net outflows of assets, leading to a double-digit percentage drop in stablecoin holdings. A study by Chainanalysis found that after the collapse of FTX, over 68 percent of assets flowed from centralized exchanges into personal wallets of institutions worth at least $100,000. This was comparable to the Celsius Network and TerraUSD implosions in mid-2022 when outflows were 69 percent and 77 percent, respectively.
These types of major industry change events or macroeconomic factors usually lead to the creation of an additional industry segment that serves the same user base and market but faces the challenges in a unique way. For example, the COVID pandemic has prompted a shift toward remote work and online education, which has fueled the growth of companies offering these types of services, such as B. Zoom, Slack and Coursera. The 2008 recession that followed the financial crisis led companies to look for ways to reduce costs and increase efficiencies, leading to the growth of companies offering cloud computing services such as Amazon Web Services and Microsoft Azure.
Similarly, this movement of assets from CEXs has reminded users to directly control and access their assets by transferring them to a personal wallet – following the original principles. The paradigm shift enabling trading and investing activities would move from personal wallets to decentralized finance (DeFi) protocols, where users can facilitate ongoing trading or participate in other activities such as lending without a central intermediary or custodian.
Transparency is key
Another interesting trend to watch is that the centralized incumbents are adopting self-regulatory mechanisms to ensure transparency and regain trust in their solutions.
Exchanges publish so-called Proof-of-Reserve to show publicly that they have enough assets to cover all customer deposits. This is to build trust with their customers and show that they are solvent. A common method of providing evidence is for the exchange to conduct an independent audit, where a third party verifies the exchange’s accounts and confirms that it has the appropriate amount of funds. Another method is for the exchange to share its transaction history or a Merkle proof that allows users to see that it received and spent the appropriate amount of money.
It is important for users to be aware of an exchange’s policy on demonstrating reserves as this can help ensure their funds are safe and secure. Some exchanges may be more transparent about their proof of reserve than others, so it’s always a good idea to do your due diligence before using any centralized product or service.
Besides PORs, another key piece of information used to measure an exchange’s financial health is its reserve-liability ratio. That is, the ratio of the company’s reserves to its liabilities, since showing assets alone doesn’t tell much until we have insight into the company’s liabilities. We don’t yet see any standardization on this critical information – although this could be one of the focus areas for regulators in the coming years.
More on the use of decentralized technologies
Most major DEXs like dYdX and others have seen a spike in user growth and transactions following the FTX debacle. Decentralized exchanges have inherent transparency with on-chain visibility of reserves, treasury and liquidity pools. The wallet interactions and transactions are stored on distributed networks, governed by smart contracts, and the data can be easily queried on the blockchain.
The DeFi space is poised to grow rapidly, evolve and become the de facto infrastructure for trading digital assets in the future. The shift to self-custody and decentralized products is the need of the hour for every user and technologist in the Web3 world. Users should invest more time in learning and understanding how asset self-custody works, how to keep their funds and keys safe, and how to more securely interact with decentralized services like decentralized exchanges (DEXs).
The author is the leading dYdX Foundation in India
Follow us on Twitter, Facebook, LinkedIn
Learn Crypto Trading, Yield Farms, Income strategies and more at CrytoAnswers
https://nov.link/cryptoanswers
Comments are closed.