The rapid collapse of FTX, once the world’s second largest crypto exchange, followed by the collapse of Celsius has eroded trust in centralized crypto services. The short history of the industry has shown that hacking attacks and misappropriation of funds are the top two causes of centralized cryptocurrency exchanges (CEXs) crashing or losing customers.
If FTX is the worst example of funds misappropriation, the worst example of how a Hacking attack can lead to failure.
While CEXs have played a key role in crypto adoption, the ongoing crisis of confidence does not bode well for the crypto industry. Fear of becoming the next victim of a CEX failure has prompted many investors to consider decentralized exchanges (DEXs). The DEX to CEX inflow ratio hit an all-time high of over 60% shortly after FTX’s bankruptcy in November 2022, according to Chainalysis.
Source: chain analysis
CEXs have an urgent job of rebuilding trust and the focus should be on misappropriating funds. While the crypto industry is still plagued by hacker attacks, their impact is usually limited and contained. Although 2022 was the worst year in terms of crypto hacking, the value of cryptos stolen from CEXs has dropped significantly compared to 2016-2020. Over 80% of cryptocurrencies stolen by hackers in 2022 were actually connected to decentralized finance (DeFi) protocols, with cross-chain bridges being the most vulnerable point.
How Can Crypto Users Trust Centralized Exchanges Again?
Trust was one of the most important pillars of the blockchain concept. The decentralized character should be inherent in all processes transparency. Some CEXs can sometimes ignore their larger mission of maintaining user trust no matter what, and FTX is a painful example.
If centralized crypto services fail to erect barriers to filter out bad actors, governments will take matters into their own hands, which could negatively impact the industry through over-regulation.
The FTX collapse was a catalyst for crypto regulation in most developed countries. While the United States faces a battle between the Securities and Exchange Commission and the Commodity Futures Trading Commission over who should take a leading role in regulating cryptocurrencies, the United Kingdom is already laying out concrete plans.
But even if governments slow down to enact stricter regulations, it will take years for all the rules to be properly enforced. Before that happens, trusted third parties can make a greater contribution to restoring trust in CEXs. For example, private rating agencies can work faster and more efficiently than regulators.
CEXs need to become more transparent before regulation comes
Governments will slowly but surely impose more control over crypto operations, but CEXs can avoid over-regulation by becoming more accountable themselves.
Some crypto exchanges are already pushing to make this happen. CoinEx recently introduced the “Merkle Tree” verification method for proving reserves. It became one of the first centralized exchanges to disclose proof of reserves, which is a way to verify assets and verify that a platform has sufficient on-chain funds to secure its customers’ assets. With all user funds backed by reserve assets, there is no risk of misusing CEX funds for lending or risk-taking through leverage – practices that led to the collapse of FTX and its sister company Alameda Research.
CoinEx uses the Merkle Tree method to prove that it has a 100% reserve ratio, which means that in the event of a spike in customer withdrawals, the exchange will have sufficient funds to fulfill all requests. The exchange has maintained a reserve ratio of 100% since its inception in 2017.
CoinEx has also taken a number of measures to protect user assets, including standard two-factor authentication, a high-speed trade-matching engine, login reminders, monitoring for anomalous IP address changes, multi-layer payout verification, API permissions, and real-name authentication .
The platform has maintained a zero accident record to date thanks to its responsible approach to embezzlement of funds and hacking.
To improve risk control and asset security, CoinEX has also released the Security Vulnerability and Threat Intelligence Bounty Program, which encourages users to investigate and record potential security vulnerabilities on the platform. The program divides potential vulnerabilities into three tiers based on their threat and offers participants up to 10,000 USDT.
A joint effort could help rebuild trust
While exchanges work on their own to improve risk controls, they can also work together and share information to better spot bad players.
The US crypto exchange Gemini has been calling for a self-regulatory organization for the US crypto market since 2018. The collapse of the FTX exchange is likely to accelerate the adoption of such collaborative efforts.
The latest reports suggest that Binance is forming a consortium to be joined by other CEXs and organizations to restore confidence in the crypto industry. The consortium is expected to be managed decentrally by all participants.
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