Centralized exchanges are permanent

It has been one year since the Terra-Luna fallout and six months since the implosion of FTX. These events severely shook confidence in cryptocurrencies, triggering the industry’s most daunting existential crisis in its 15-year history. While the asset class has recovered this year, it is an opportune moment to reflect on the setbacks of last year and how the industry can build back better.

These events are not failures of blockchain technology but are instead a result of poor risk management and corporate governance, with fraud taking place in some of the companies that failed. The market continues to recognize the integrity and innovative potential of blockchains.

Centralized digital asset exchanges (CEX) will continue to remain relevant and wield outsized influence as the key entry point into the asset class, especially as it grows in sophistication and institutional adoption. They remain the dominant platform when it comes to digital asset transactions. Despite the setback in investor confidence last year, the case for CEXes remains clear.

To survive this crisis of confidence, CEXes will need to address the need for better investor protections, risk controls, and prudent governance structures.

Managing a digital asset portfolio is operationally complex, with investors requiring a comprehensive set of capabilities such as custody, trading, investment products, advisory, and efficient fiat on-off ramps. In this regard, many CEXes integrate these solutions into a single platform, greatly reducing the technical complexity of owning and managing tokens native to different blockchains. This value proposition is clear when considering the alternative: where investors manage several wallets and directly participate in multiple liquidity pools across different blockchains.

Safety and security are other advantages that CEXes can offer. While CEXes still have some way to go to better protect clients from cyber breaches, they are comparatively safer. The safety gap between CEXes and decentralized applications should continue to widen.

An often underappreciated benefit of some CEXes is the peace of mind that “there’s someone to call” if something goes wrong. With horror stories of individuals being locked out of their own wallets worth millions in bitcoin, investors will find value in working with CEXes that provide dedicated hotlines or account managers.

While CEXes are likely here to stay, one area where such platforms must improve on is the segregation of customer and corporate assets. Largely in response to the co-mingling of funds by FTX, policymakers like U.S. Treasury Secretary Janet Yellen recognized asset segregation as a key area to be addressed in future regulatory frameworks.

Prior to the collapse of FTX, the Monetary Authority of Singapore (MAS) proposed new regulations in a consultation paper published in October 2022, requiring cryptocurrency platforms to separate their assets from those of their customers. The MAS has also asked for industry feedback on whether cryptocurrency platforms should appoint independent custodians to safeguard customer funds.

While centralized exchanges (CEXes) still have some ways to go in protecting clients from cyber breaches, they are comparatively safer. Therefore, CEXes should reconsider the “one-stop-shop” narrative. While it makes sense to have a seamless front-end user interface across custody and trading, investors’ assets should be separately held and custodized by an external and qualified custodian, such as a bank or a registered broker-dealer. CEXes should seek and publish independent attestations by auditors to verify that the assets are indeed segregated and that robust risk and governance requirements are in place.

Instilling trust in a trustless system

When Satoshi Nakamoto published the seminal Bitcoin white paper in 2008, they envisioned a monetary system that no longer needed to rely on blind trust. Yet, the very entry point to which most investors today are exposed to digital assets – exchanges – is still run in a mostly opaque manner.

The events of 2022 have shown that for the industry to move forward, investor protections, transparency, robust governance structures, and providing value to clients must return to the forefront of how exchanges are built and run. CEXes that embrace these values will find themselves having a competitive advantage as investors increasingly rely on trusted centralized platforms to manage their digital asset portfolios.

See also: What DeFi Must Sacrifice to Appease Regulators | Opinion

As we continue to build back better, the industry might just return to its roots – one born out of a vision for a fairer, more transparent, and more efficient financial ecosystem.

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