DeFi Fumbled Its Post-FTX Advantage in 2023, but There’s Still Hope for 2024

Essentially, this boils down to the issue of DeFi’s poor capital and liquidity efficiency. Without getting too deep into the technical aspects, centralized order book models are infinitely more efficient than DeFi’s approach, but lack transparency. With such models, it’s very easy for the house to be betting against its users, and even misappropriating user funds.

Why FTX deserves a second chance

When FTX fell apart last year, the repercussions were devastating. The contagion not only caused crypto assets to tumble and damaged the portfolios of professional traders, but it also eliminated a prominent investment pool for blockchain startups. Countless individual investors witnessed their life savings evaporate, and I sympathize with all the victims. 

While acknowledging past mistakes and repercussions, there is a silver lining that cannot be ignored. Although unpopular in some quarters, the news of a potential FTX relaunch under a new name has sparked a wave of optimism in the crypto community, and with good reason. A relaunch could bring about a range of positive outcomes for the industry, investors and customers alike.

Relaunching FTX has its merits

One of the most significant advantages of a successful FTX relaunch would be the potential to attract more investors back into the crypto space. Should the exchange re-emerge with a new management team and a realized commitment to rectify past issues, it may garner renewed interest from the wider investing community. And the positive effects would compound. Increased investor participation would infuse the exchange with additional funds, which could then be used to repay users who have experienced losses in the past, again instilling trust in centralized crypto exchanges.

While the crypto community is rightly skeptical of the motives behind launching FTX 2.0, there is precedent showing that it is in fact possible to make creditors whole through restructuring. The Bitfinex incident is a great example. In 2016, crypto exchange Bitfinex was hacked, and 120,000 Bitcoins were subsequently stolen. In response to the hack, Bitfinex released the “recovery rights tokens” (RRT), designed to serve as an IOU to affected customers. These tokens promised a share of future profits to compensate for the losses. Within a year, all the tokens were redeemed and customers were repaid. 

True, Bitfinex’s troubles stemmed from external parties, not internal criminal activity as was the case with FTX. On that point, another popular comparison for the FTX scandal is Bernie Madoff’s record-breaking fraud. But the comparison to Madoff is weak because Madoff ran a simple Ponzi scheme, whereas FTX did have a viable business model, despite the additional criminal activities running alongside. Thus, despite the differences in the origin of their downfall, Bitfinex sets a precedent for a large-scale crypto comeback despite a major dent in credibility and trust. A similar comeback on FTX’s part could compensate affected users with its potential future profit, for instance, offering them a stake in the exchange’s success and a path to recouping their funds over time.

That being said, revitalizing the tarnished name of FTX requires careful recalibration of governance and internal structures. The exchange must undergo strategic and tangible changes to set itself apart from the now-infamous name of Sam Bankman-Fried, who is in jail. For instance, the new management team could voluntarily provide evidence to the prosecution to maximize their distance from the former management. Furthermore, FTX 2.0 may also consider setting up a compensation fund, with profits from new business to top it up, providing restitution to customers in case of unforeseen issues or losses. 

In order to prevent illegal activities, the new FTX must implement stricter compliance measures and enhance its efforts to improve transparency, including clear guidelines for the separation of powers between the board of directors, executive management and operational teams. This would rectify the mistakes made possible by the inexperienced original team behind FTX and the illegal transfer of funds to Alameda Research.

Of course, restructuring isn’t the only way to recover customers’ funds. There is also the option of going through traditional proceedings, such as the rehabilitation plan proposed for Mt. Gox. The Japanese exchange filed for bankruptcy shortly after it was hacked in 2014. However, not until late 2021 were the creditors and the government able to reach an agreement on a rehabilitation plan. The lesson drawn here is that a restructuring plan akin to Bitfinex’s could potentially compensate creditors much faster. 

No one’s a fan of bailouts. That’s especially true knowing the failures of the management can oftentimes go unpunished while using taxpayer money to return misused funds. But restructuring is different. New management teams are appointed to revitalize existing businesses, while the bad actors suffer the consequences of their crimes. In this format, a business recovery can return value to the market. 

Even though there are already plenty of centralized and decentralized alternatives available, FTX does have an established presence in the market. Instead of abandoning their solid platforms and systems that have built up a large customer base, a relaunch utilizing these strengths could bring tremendous market value, especially if there is a chance of recovering lost funds for users. 

Taking a page from DeFi’s playbook

Centralized exchanges undeniably have their purposes, as they are often a trusted gateway for people to enter the crypto space, which is crucial to driving greater Web3 adoption. 

Yet, that trust was undermined when FTX’s clear lack of risk management and transparency emerged. Clearly, revamped risk management features will play a pivotal role in its relaunch. And for this, there are valuable lessons to be learned from decentralized finance platforms. 

While DeFi is not flawless in its current form, it does offer higher transparency compared to centralized control. DeFi allows transactions to be executed via a public blockchain network without reliance on central service providers. A truly decentralized protocol would have prevented the FTX disaster thanks to its immutable, decentralized, transparent and permissionless nature. There’s no way to siphon off funds into an alternative company without anyone noticing, as we saw with FTX.

As it becomes increasingly clear that DeFi has advantages, there are cases where centralized exchanges are increasingly incorporating DeFi elements such as the implementation of cold wallets or verifiable proof-of-solvency. It would be interesting to see whether the FTX reboot plans to integrate any such approaches.

To wrap up, supporting the FTX relaunch provides an opportunity for the crypto industry to learn from past mistakes, rebuild trust and foster greater adoption. While relaunching FTX holds tremendous potential, it is essential to couple it with significant improvements and continued innovation. Emulating DeFi’s transparency, security and risk management will be crucial for the long-term success of the relaunched exchange. By combining the strengths of centralized exchanges with the transparency and innovation of DeFi, we can pave the way for a more resilient and trustworthy future in the crypto financial landscape.

The TradFi vs. DeFi rivalry is hitting a new peak — and that’s bad for everyone

For the last year or so, we have watched the crypto sector endure a series of implosions. Now the traditional banking industry is facing a seismic shakeout of its own. The swift collapses of Silvergate Bank, Silicon Valley Bank, Signature Bank and then Credit Suisse each individually rank among the largest bank failures in the world since the global financial crisis of 2008. 

For me, one of the more shocking aspects of the unfolding drama is just how deeply the battlelines have been drawn between traditional finance and decentralized finance (DeFi). And that’s not helpful for either side. 

A wide majority of DeFi thought leaders are unapologetically celebrating the downfall of these banks. Regardless of the potential job losses and financial fallout — including among crypto firms — many DeFi commenters are taking a “holier than thou” stance and reveling in TradFi’s calamity. 

Meanwhile, the collapses of crypto’s friendliest banks have seen TradFi players guffawing, as crypto startup founders scramble to find alternative banking partners, just to stay in business. 

And even more distasteful, the focus for many is using this chaos to gain “clout” for their personal brand. Note former Coinbase CTO Balaji Srinivasan’s egotistical bet on the turmoil driving BTC to US$1 million, insensitive to the real financial hardships facing hardworking people.

Whichever side we individually prefer, this bloodlust won’t result in a stable, sustainable financial system. Deepening the divisions between DeFi and TradFi helps neither side. We should be taking collective, holistic efforts to upgrade the world’s financial system and expand financial access. 

What went wrong: the blame game

The collapse of Silvergate Bank seems to be a case of poor risk management across the board. The U.S. government’s whiplash monetary and fiscal policies, the bank’s poor management and even worse communication, and startups’ poor financial management all played a role. Meanwhile, SVB seems to have been single-handedly taken down by venture capitalist FUD and groupthink.

It remains to be seen if there is any truth to the claims that Signature Bank was purposely taken out by the authorities. The theory goes that the U.S. government wanted to ensure crypto gets its share of the blame instead of U.S. policy. This accusation itself of course is telling, indicating an atmosphere of heightened suspicion and lack of trust. As for Credit Suisse, the writing seems to have been on the wall for some time, yet conspiracy theories abound. 

This blame game itself is a sign of the growing factionalism across the finance industry.

How we can de-escalate from here

We need to avoid escalating what could become a death spiral, with each side trying to undermine and obstruct the stable development of the other. The future of finance requires a truce between traditional financial institutions and the crypto industry. Deepening allegiance to the battlelines only feeds the public’s distrust of finance in general, and degrades the image of the finance industry to a self-interested power struggle.

On the DeFi side, we need to work collaboratively with the adults in the room. By engaging positively with regulators and major TradFi players, we can educate all parties on the benefits and advantages of DeFi. In fact, the strengths of decentralization, such as on-chain transparency as well as non-custodial and trustless solutions, are more relevant than ever in the current context. 

Besides, DeFi doesn’t exactly hold the moral high ground. Before anything else, we cannot claim victory until we learn the basics from TradFi and rid the wider DeFi ecosystem of ponzinomics. From my own experience in TradFi derivatives, I know that for the most part, there are excellent risk management practices in place, which DeFi can still learn from.

As for professionals in traditional finance, my advice is to find the TradFi-experienced DeFi players and learn from them. Crypto is not the enemy. It’s the next evolution of finance. And now is the time to engage with crypto finance. If TradFi institutions don’t use this opportunity to embrace innovation and gain the lead in the blockchain revolution, they will forfeit their advantage and soon fall behind. 

The same goes for regulators. Aggressively targeting crypto firms now will backfire in the long run. It’s much better, and more logical, to engage, embrace and evolve in step with innovation, or risk having that innovation flee to other, more welcoming regions instead.

Let’s work together, constructively

The finance industry’s behavior weighs on the public’s opinion of and trust in the overall ecosystem. Ultimately, pitting DeFi and TradFi against each other is detrimental to building a stable and sustainable financial system for all. After all, this is ultimately everyone’s shared goal. 

We need to combine the best of both worlds, drawing from the TradFi systems we know and building on the DeFi systems we’re only just beginning to explore. Collaboration is key to building robust financial systems that offer transparency and inclusion for all.

Why global coordination on crypto regulation is paramount

Following the collapse of crypto-exchange giant FTX, national governments are expediting the process of putting crypto regulations firmly in place. Many “crypto hubs” are reassessing how to capitalize on the benefits of the technology while proactively mitigating its risks. Noteworthy examples of jurisdictions where regulators are making headway — and grabbing headlines — include those in the United States, the European Union, the United Kingdom, Hong Kong and Singapore.

But the race to regulate crypto could actually be a problem, according to regulators at the supranational level. The Financial Stability Board (FSB) and the International Monetary Fund (IMF) are advocating the creation of globally coordinated crypto regulation standards before national authorities get locked into differing, even incompatible frameworks. 

According to the FSB, the potential for across-the-board consistency and comprehensiveness of crypto-asset regulation is expected to “strengthen international cooperation, coordination and information sharing.” To achieve that, the FSB advocates equivalent regulations for digital assets and intermediaries that perform the same function as their traditional finance (TradFi) counterparts. 

Meanwhile, on the user side of the equation, investors are now prioritizing self-custody crypto wallets and shifting toward decentralized exchanges, seeking greater transparency and control. This ongoing shift toward decentralized finance (DeFi) is causing national and supranational regulators to take another look at the benefits of decentralization, just as they set out to coordinate a global regulatory approach to crypto.

Shortcomings of centralized finance

As the FTX debacle revealed, the shortcomings and drawbacks of centralized exchanges (CEXs) reflect certain opaque qualities of TradFi, where much behind-closed-doors activity is accepted as a matter of course. In addition to the lack of transparency relating to balance sheets and client assets, centralized finance organizations keep their systems and records off-chain.

Meanwhile, DeFi offers permissionless financial products that offer high transparency regarding client funds and non-custodial wallets. In short, the undetected misuse of user funds we saw at FTX could never happen in DeFi. Built on public blockchains, the composability of smart contracts also enables considerable space for fintech innovation. For example, right now, we’re seeing a major uptick in efforts to improve DeFi’s user experience and user interface (UX/UI) design, especially as simple, user-friendly interfaces are the primary advantages for most centralized exchanges.

Prompted by the FTX scandal and the resulting upsurge in interest in DeFi platforms, regulatory bodies and TradFi institutions are taking a closer look at DeFi. Our team at SynFutures recently discussed the relative advantages of DeFi with the IMF, highlighting the benefits of decentralization, such as on-chain transparency as well as non-custodial and trustless solutions as a viable alternative to TradFi. 

As we pointed out to the IMF, DeFi is about more than the single asset class of cryptocurrency. DeFi’s goal is to democratize access to all kinds of investment products and services. Where market trust has been forfeited to intermediaries and distracted by strong marketing fronts, DeFi reinstates the real operational backbone: solid code and permissionless systems.

DeFi’s potential to improve on TradFi

Given its open-source nature, DeFi has been able to iterate and innovate quickly, improving on existing TradFi infrastructure at a remarkable rate. However, the uncertainty that remains around DeFi hinders its mass adoption. 

First, permissionlessness can be exploited by bad actors, enabling money laundering and illicit financing. Second, the absence of clear regulatory guidelines also means customers are more susceptible to becoming targets of Ponzi schemes or otherwise deceptive activities. Third, smart contracts can be subject to exploitation and hacks, especially when unaudited.

While DeFi prefers to differentiate itself from TradFi, it is imperative for DeFi to build upon and implement the existing security measures prevalent within TradFi, such as risk control, treasury management and regulatory frameworks. DeFi’s mass adoption hinges on accountability and consumer protections in the same way that TradFi globally has relied on regulatory and self-regulatory practices for functional stability. Moving forward, public trust in the industry will depend on government regulation and trusted blockchain applications.

My expectation is that efforts to institute a global crypto framework would likely start with replicating TradFi’s measures. This next step in establishing a pattern of proactive cryptocurrency regulation illustrates the global community’s continued effort to provide a clear framework for crypto services. Borrowing modes of governance from an already familiar TradFi network could also have a wider impact on how governments go about implementing regulatory measures. This would require all parties within the crypto industry, as well as within national and supranational regulatory bodies working together, to ensure the rules don’t limit innovation, and to support and protect both consumers and firms across borders.