By Arthur de la Brunière, Web3 analyst, EY Fabernovel.
While October was already reported as the month with the most protocol hacks, with an estimated $760 million stolen, the famed “cryptosphere” once again finds itself weakened. As a reminder, the cumulative total of cryptocurrency attacks in 2022 amounts to $2.98 billion, a record.
This new cataclysm leaves speechless an ecosystem that has built itself around one of the main exchange platforms on the market, as well as its founder Sam Bankman-Fried, the “effective altruist” very involved in American regulation and privileged interlocutor of the authorities federal. It comes just after the setbacks of Terra (LUNA) and Celsius that plunged the sector into a crisis of confidence and usage more than a liquidity crunch in a bear market.
Centralized Exchanges (CEX): “not your keys, not your cryptocurrency”
Centralized exchanges (CEX) are a good first entry point into the cryptocurrency market. Indeed, they are easy to use and regularly offer offers for their investors, as well as a large choice of cryptocurrencies.
However, like traditional banks, they pose a risk to users in the event of a crisis: if everyone is simultaneously trying to withdraw their money from an exchange and that exchange has deposited its users’ funds elsewhere – or worse, lent them out at la its subsidiary Alameda Research for quantitative trading, going against its legal commitments: the exchange can no longer cover all withdrawals and is forced to block them.
Double trouble, however, in the case of FTX: in the new economy, that of tokens, users who hold FTT, the FTX token, are part of the platform’s investors. At Web3, scaring its users means scaring its investors, thus seeing the value of its token and, in the case of FTX, its capital melt away.
To avoid exposing yourself to this type of illiquidity risk, experts regularly advise taking your cryptocurrencies off platforms where the client – individual or company – does not have control over their assets. Not your keys, not your encryption.
FTX, a platform “too small to save”?
While these centralized platforms strongly resemble traditional banking players, one important difference remains: these CEX platforms are not “too big to fail,” or even not big enough to be bailed out, by both private and public investors. Indeed, if Greek banks had been forced to limit or freeze withdrawals in June 2015, as FTX had to do a few days ago following the revelations of its ties to Almeda Research, some might have been helped, some might not.
But the comparison stops there, because while a liquidity crisis appears to have been the first domino in FTX’s failure, the investigations that followed point to a much more serious global and massive fraud by Sam Bankman-Fried.
Towards the need to build a sustainable ecosystem
This event will certainly accelerate market regulation, which is needed to reassure those who are still trying to build a sustainable ecosystem (#BUIDL) despite the context.
But this crisis of trust, whether it be of users, companies or investors, can only really be overcome by trying to move in a more reasonable direction. Jeremy Allaire, founder of open source platform The Circle, explained in a Nov. 8 tweet that “it is imperative that we move decisively from the cryptocurrency speculation phase to the ‘utility value’ phase, and this must be radically rooted in more open and transparent. The good news is that the foundations that have been built with cryptographic infrastructure and public blockchains give us the building blocks to develop financial services with radically greater transparency than we have experienced so far. »
The search for the democratization of more virtuous and transparent uses (subject of a study by EY Fabernovel and Arbevel “Web3: the 5 uses with virtuous potential”) must give way to speculative uses.
To cite just two examples of the technological maturity of the sector: Ethereum has managed, without causing a media sensation, its great merger towards a protocol that consumes much less energy, and the usefulness and efficiency of blockchain technology when used in a public way is no longer to prove, in terms of data sharing, transparency and security. On the contrary, this news highlights, once again, the unreasonable uses of a technology, for which speculation and fraud are the nerve center.
Furthermore, we also have to step back as the comparisons that headlines make represent different scales. When Lehman held $639 billion in assets shortly before becoming the world’s largest bankruptcy, FTX reported between $10 billion and $50 billion in assets, more than 12 times smaller than Lehman’s highest estimate. Ditto doing the exercise with FTX’s high valuation at $32 billion comparing it to the merger of the market capitalization of nearly 20% of the four GAFAs combined in a quarter between August 20 and November 17, 2022, representing 1,215 billions of dollars .
Position yourself as a company
To undertake projects related to NFTs or cryptocurrencies, companies must first of all start from the basics: sufficient knowledge of the subject and risk control – financial, legal, tax, reputational… Comprehensive due diligence should enable the selection of strong partners; an operating model adapted to Web3 must be put in place to build its projects while maintaining control of its resources and to move from centralized exchanges to internal management.
Another recent press analysis note found on Finyear: Tech is not dead
About the author: Arthur de la Brunière, Web3 analyst, EY Fabernovel
Arthur is a Senior Web3 Analyst at Fabernovel EY, supports companies in their innovation transformation, participates in acculturating companies on these new Web3 topics and analyzes the cryptocurrency market. He is also responsible for research and development related to the Web3 ecosystem within EY Fabernovel experimenting and testing blockchain, smart contract and NFT technologies and real-time use cases.
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