After exchanging heated tweets in a public quarrel with Binance CEO Changpeng Zhao, FTX CEO Sam Bankman-Fried confirmed the crypto industry’s worst fears on November 11, 2022, announcing a Chapter 11 Bankruptcy filing for FTX International, FTX US and Alameda Research.
To make matters worse, the estimated $6 billion liquidity gap that prompted the filing was largely a product of SBF’s less-than-ethical operations leveraging client deposits on his regulated CEX (centralized exchange) to fund high-risk trading on behalf of his cohorts at Alameda.
The multi-billion-dollar meltdown has left much of the crypto space in shambles, with big industry players across the space – mostly recently, Genesis Trading and BlockFi – announcing their exposure to the FTX-Alameda contagion daily.
Retail investors have also had their trust betrayed, as their exchange deposits now hang in the balance.
Harsh indeed, FTX’s foul play and subsequent death spiral have not come to pass without imparting valuable lessons, albeit expensive ones. November’s market woes have served the entire crypto community an emphatic reminder – leaving one’s core principles astray in the pursuit of profits will not yield meaningful progress, especially in the long term.
Here’s the big takeaway – nothing is trustless or decentralized unless it operates on-chain, where transparency reigns paramount, and reserves, AUM (assets under management) and community governance votes can be monitored and confirmed in real-time.
In retrospect, it was inevitable
There is no greater clarity than that provided by hindsight. Nonetheless, in an industry where the long-term viability of PoS (proof-of-stake) consensus has been debated relentlessly in the lead-up to the Ethereum merge, it is almost inconceivable that mass market platforms with opaque governance models, off-chain reserves, and near-zero community involvement accrued unrivaled brand recognition and multi-billion-dollar customer deposits.
Although the largest to date, FTX’s unconscionable insolvency is only the most recent in a year-long chain of CeFi (centralized finance) bankruptcies that have included centralized industry giants 3 Arrows Capital, Voyager Digital and Celsius Network.
That we even find ourselves in a circumstance where longstanding CEXs like Binance are releasing on-chain proof-of-reserves to the public for the first time is a sign that as a collective, we in the crypto community have truly lost the plot.
If ever there is a time (and an opportunity) for a radical recalibration of sorts, it’s now.
Don’t trust – verify
Fortunately, SBF’s billion-dollar mass market betrayal offers much wisdom to be gleaned. In full, objective verification must remain a prerequisite – or even better, a replacement – for trust.
In other words, when verification cannot be performed, trust cannot be granted. In three words, don’t trust –verify.
This is the crucial axiom crypto should have internalized long ago, and it will continue to resurface with interest every time it’s neglected.
Such is the quintessential value proposition of public key cryptography and the related cryptographic proofs that power decentralized ecosystems and empower their users. More importantly still, we must internalize that there is no substitute for on-chain verification because it encompasses every use case cryptocurrency stands to offer.
Crypto’s value proposition – revisited
Money, finance, unique artwork and even privacy tools already exist – yes, audio files and video clips too. Crypto’s decentralized ecosystems do not bring anything into the world that does not already exist.
They merely present infrastructure and a universal ruleset that level the playing field and remove the need to entrust superpowers to opaque, centralized entities. The long-term benefits of decentralized systems are certainly profound, but the pathway to realizing them is gradual, systemic and unsexy.
This is the great gift and curse of decentralized systems – that their powers are only as potent as the discernment of their users.
Taking your cryptocurrency to CeFi for yields is like taking your spouse to McDonald’s for prime cuts – at best you are buying a promise in-name-only, and one with red flags galore. Worse yet, if you hang around too long, it’s only a matter of time before you endure untenable consequences.
Decentralization in black and white
Unless decentralized systems liberate users from forced dependence on centralized entities and third parties, they serve no purpose whatsoever.
Bitcoin provides decentralized money. Ethereum provides decentralized financial tools. Monero enables decentralized private transactions. Sans decentralization, there is no value added to society at large.
CeFi and CEXs are merely legacy financial institutions that have adapted their business models to support digital native assets and instructed their marketing departments to assimilate the Web 3.0 lexicon.
Their reserve management and risk appetite are not beholden to on-chain code or community governance. And rather critically, they are not eligible for the rescue intervention and backstopping traditionally provided by central banks.
Imagine Citibank over-leveraging client funds in the 2007 subprime debt market without access to the printing press at the Federal Reserve. There would be only one inevitable outcome – insolvency and dissolution.
A call to action – getting our priorities straight
As blockchain-based ecosystems stand today, performance remains a primary hurdle to adoption, and that’s okay. That’s simply the cost of decentralization in 2022.
Compromising on the components – technical, financial or otherwise – that are responsible for decentralization renders our ecosystems no different from the imbalanced and exploitative legacy financial system we designed them to replace.
For those of us who see the bigger picture, it is our responsibility to temper our desire for mainstream media penetration and adoption with a steadfast commitment to decentralization – to replace trust with verification.
Should we be successful in this prerogative, there are no limits to the creative ingenuity and innovation this space is capable of producing.
Perhaps optimistic, I submit that it is not far-fetched that a renewed commitment to crypto’s founding principles may lead us to a renaissance of sorts in the years ahead. The exposure of FTX might just be the wake-up call the crypto community needed to realign with its original mission.
