Centralized exchange (CEX) continues to have a presence | CoinDesk JAPAN | Coin Desk Japan

About a year has passed since the collapse of Terra/Luna, and about half a year has passed since the collapse of FTX. These dramatic events, each leading to the bankruptcy of multiple crypto companies, have severely undermined confidence in crypto and triggered the most difficult existential crisis in the crypto industry’s 15-year history. .

look back at milestones

Crypto as an asset class has been recovering this year, with Bitcoin (BTC) up about 60% year-to-date, but it’s a great time to reflect on last year’s setbacks and see how the industry can rebuild and do better. It’s a milestone.

First, we need to understand that these two incidents are not the fault of blockchain technology, but the result of poor risk management and corporate governance, as well as misconduct at some failed companies.

The market recognizes the integrity and innovative potential of blockchain, with the massive influx of capital into decentralized exchanges (DEXs) after the FTX collapse, Ethereum’s move to Proof of Stake (PoS), and even This can be seen in the positive reaction to the upgrade “Shapella”.

However, despite these developments, centralized cryptocurrency exchanges (CEX) have not lost their relevance, becoming an important gateway to this asset class as they become more sophisticated and popular among institutional investors. It will continue to have a great influence as a mouth.

After all, CEX remains the dominant platform for digital asset trading. According to DefiLlama, as of mid-May 2023, CEX’s total trading volume will account for nearly 90% of total trading volume across all centralized and decentralized exchanges combined. Despite losing investor confidence last year, CEX’s strength remains evident.

But as an industry, we need to work out a number of weaknesses that stemmed from interdependencies within the industry and an early ethos of “moving fast and breaking.” To survive this crisis of confidence, CEX will need to address the need for better investor protection, risk control and a prudent governance structure.

Strengths of CEX

Managing a digital asset portfolio is complex, requiring investors to have custody, trading, investment products, consulting and efficient fiat currency on-ramp/off-ramp.

In this regard, many CEXs incorporate these solutions into one platform, greatly reducing the technical complexity associated with holding and managing native tokens of different blockchains.

Considering alternative options will make its value clear. In other words, an investor owns multiple wallets and participates directly in multiple liquidity pools on different blockchains. While some investors may be able to accommodate, CEX is likely to remain the platform of choice for many, given the sheer amount of learning to do.

Investors who actively manage their portfolios themselves may want to frequently change their investment allocation between traditional and digital assets. The CEX’s fiat on/off ramp provides essential infrastructure to do this quickly, especially during periods of high market volatility.

safety and security

Safety and security are also strengths of CEX. It might come as a surprise, given that the mantra in the industry is that “the owner of the key is the owner of the coin”. However, according to Chainalysis, 18% of crypto assets stolen by hackers in 2022 will be stored on CEX, while the remaining 82% will be in decentralized applications.

CEX could do better when it comes to protecting its customers from cybercrime, but it appears to be relatively secure compared to decentralized alternatives. As the industry works hard to restore trust and strengthen cybersecurity systems, the security gap between CEX and decentralized applications will continue to widen.

Finally, an often-overlooked benefit of some CEXs, especially those with wealthy and institutional clients, is the comfort of having “someone you can call” if something goes wrong. Investors who manage assets on behalf of their clients, such as family offices and hedge funds, are especially grateful.

With horror stories of people losing access to wallets containing millions of dollars worth of Bitcoin, investors are finding value in using CEX, which offers a dedicated hotline and account manager. deaf.

Rebuild trust with segregated management

CEX is likely to take root as it is, but improvements are required in terms of separating customer and company assets. The scrutiny in this regard is tighter than ever. After many retail investors suffered huge losses when FTX went bankrupt because it mixed customer assets with company assets, policy makers such as U.S. Treasury Secretary Yellen said: It cites “asset segregation” as a key area to be addressed in the future regulatory framework.

Even before FTX’s collapse, Singapore’s central bank, the Monetary Authority of Singapore (MAS), announced in a report released in October 2022 a new policy requiring cryptocurrency platforms to separate their own assets from those of their customers. proposed regulations. MAS is also open to industry feedback on whether crypto platforms should appoint independent custodians to protect their customers’ assets.

In light of this, CEOs should rethink the “one-stop-shop” narrative. While it makes sense to have a seamless front-end user interface from custody to trading, on the back-end investors’ assets are segregated by qualified external custodians such as banks and registered broker-dealers. should be placed under custody.

CEX should issue an independent assurance report from its auditors to demonstrate that assets are segregated and that it has strict risk governance requirements in place.

trustless system

When Satoshi Nakamoto published the Bitcoin Whitepaper in 2008, he envisioned a monetary system that didn’t need to rely on total trust. Yet today, exchanges, the first entry point for many investors into digital assets, still often operate in a lack of transparency.

2022 Events Highlight Investor Protection, Transparency, Strong Governance Structures and Delivering Value to Customers Must Be Top Priority in Exchange Operations for Industry to Move Forward became. As investors increasingly use trusted centralized platforms to manage their digital asset portfolios, CEX, embracing these values, will have a competitive edge.

As it continues to rebuild for the better, the industry must return to its roots: born from a vision of a fairer, more transparent and efficient financial ecosystem.

Mr. Lionel Lim: CEO of DBS Digital Exchange.

｜Translation and editing: Akiko Yamaguchi, Takayuki Masuda
| Image: Brock Wegner/Unsplash (edited by CoinDesk)
｜Original: Centralized Exchanges Are Here to Stay