Table of Contents
main conclusions
Trust in exchanges is gone, with customers withdrawing thousands of bitcoins in the last month Proof of reserve does nothing in its current format to broker trust Regulators need to step in as the industry has lost control of itself November was not good for the crypto markets. But when we turn the page to December, what does the future look like?
Trust in exchanges is at an all-time low
First of all: The FTX collapse showed the world how opaque these centralized companies are. The reality is that it’s nearly impossible for the average customer to know what’s going on behind the scenes. Sam Bankman-Fried (SBF) has graced the covers of Forbes magazine, spoken before the US Congress, and was President Joe Biden’s second-largest donor during his 2020 campaign. If SBF can fall, who is safe? Customers responded by withdrawing their bitcoins from exchanges. I mapped net bitcoin flows to and from exchanges since the FTX imploded. The pattern is quite evident. I had already analyzed this reaction in detail in the week following the implosion.
Will proof of booking save the day?
The response, led mainly by Binance CEO Changpeng Zhao – from another acronym nickname, CZ – has been to instill proof of reserve in the chain. Because, ironically, blockchain should be perfectly positioned to solve all of this. I tweeted this to CZ when the disaster was starting. For me, in addition to being painfully ironic, it’s frustrating and sad.
Would all the insolvency chat not be solved if FTX had some sort of on-chain proof of reserves? Seems ironic in the crypto industry that we are all talking about whether or not FTX are good for it. Is it not meant to be transparent in crypto ? — Dan Ashmore (@DanniiAshmore) November 7, 2022
But the proof of reserves that have already been implemented by several exchanges are redundant. They involve posting a wallet address with funds. OK. But what good is proving reserves without proving liabilities? There are also many more questions that are definitely not answered when going to an arbitrary address online. How do we know the exchange has access to these funds? As Jesse Powell, CEO of Kraken in the process of stepping down, said, “Audit proof of reserves requires cryptographic proof of customer balances and wallet control.” Cryptocurrency needs to grow. This twisted version of an “audit” is not doing that. CZ said it is working with a number of people, including Ethereum founder Vitalik Buterin, to address some of these concerns through a more robust Merkle reserve system. Let’s hope it arrives sooner rather than later.
Crypto needs regulation
It used to be a blasphemous sight. So it was polarizing. Now, it’s hard to argue with that. Cryptocurrency needs regulation. I’m tired of seeing people get hurt so badly. Hearing the letter from the investor who lost $2 million as part of the FTX debacle being read during the New York Times freak show in an interview with Bankman-Fried, who said this was all just an incident. There are thousands of other stories like this of people being crushed, and it’s heartbreaking. Regulators are far from the only reason all of this has happened, but like it or not, it’s up to them to help bring a semblance of reality to what has become an all-out Western of fraud, scams and violent risk management. Because the encryption has clearly shown that it is not working in its current state. Let’s start by defining what security is and filtering encryption into that framework instead of leaving everyone in the dark. Lending products that struggled so mightily – I wrote about their plight recently here – like BlockFi (now bankrupt), Celsius, Voyager Digital and so many others, were the most prominent parts of this nebulous legal picture. Next, we can move on to policing crypto once we’ve defined what it really is. Because she’s no longer an Internet nerd’s game. An exchange disappeared with $8 billion in customer funds. Which, you know, followed a series of other bankruptcies that also happened to billions of client funds earlier this year. I’ve seen this movie many times. Proof of reservations is a step in the right direction, but the way it’s been implemented so far is totally useless. Regulators – time to do what you know how to do.
