Repent, There's Still Time: The FTX-Binance Fiasco Teaches Important Lessons

The cryptocurrency industry is currently going through one of the most shocking incidents in its decade-long history. Amidst the crypto winter, the FTX-Binance slugfest has exposed the industry's fault lines, providing important lessons for us. Before elaborating on the lessons, it's important to understand what exactly has been happening with FTX-Binance since last week.

On 2nd November, Alameda Research's leaked balance sheet showed that the company held a large amount of FTX crypto exchange's native FTT token. This raised concerns that Sam Bankman-Fried's trading firm, Alameda Research, has some relationship with FTX, one of the largest centralized crypto exchanges.

On 5th November, Whale Alert tweeted that an unknown wallet transferred 23 million FTT tokens worth $584.5 million into Binance, the world's largest centralized crypto exchange. This accounted for 17% of FTX's total token supply. An apprehensive Twitterati immediately responded to this sudden crypto movement with panic.

The next day, Caroline Ellison, Alameda's CEO, tweeted for damage control, stating that the leaked balance sheet misrepresented their holdings. It only showed "a subset of our corporate entities" while other assets worth over $10 billion "aren't reflected there". Although, this didn't stop Twitter users from talking about the possible fallouts.

Binance CEO, Changpeng Zhao (CZ), noticed the conversations and tweeted on 6th November that Binance would liquidate its entire FTT holdings. He assured that Binance would do it "in a way that minimizes market impact." Alameda CEO responded to CZ saying they would "happily" buy Binance's FTT holdings at $22 per share.

Nevertheless, FTX users started withdrawing their funds from the crypto exchange, anticipating its eventual collapse. On 7th November, Sam Bankman-Fried tweeted, "A competitor is trying to go after us with false rumors. FTX is fine. Assets are fine." With this now-deleted tweet, Bankman-Fried openly took a jibe at CZ and Binance, assuring investors that FTX had $1 billion in excess cash.

FTX and Binance share a long-drawn history of rivalry with CZ and Bankman-Fried often competing for becoming the largest crypto exchange. Thus, it isn't surprising that CZ expressed disinterest in Alameda CEO's offer of buying FTT at $22. However, on 8th November, Bankman-Fried announced FTX has "come to an agreement on a strategic transaction with Binance...this will clear out liquidity crunches".

Keeping aside their past differences, CZ tweeted "FTX asked for our help. There is a significant liquidity crunch. To protect users, we signed a non-binding LOI...". But, in less than 48 hours, Binance backed out of the deal citing "mishandled customer funds and alleged US agency investigations." Consequently, the crypto market received a massive shock as investors became more sceptical and fearful.

According to media reports, Bankman-Fried sought $8 billion in emergency funding to manage the liquidity crunch due to massive withdrawals. On 9th November, the FTX website experienced downtime, later warning users against depositing and its inability to process withdrawals. Finally, on 10th November, Bankman-Fried tweeted an apology, saying "I'm sorry...and should have done better..."

The FTX-Binance issue raises important problems in the crypto industry, provoking us to ask some serious questions. Right now, the industry needs to identify these core problems and address them immediately to restore investor confidence.

Lessons From the FTX-Binance Saga

In 2008, Satoshi Nakamoto's Bitcoin whitepaper championed the need for permissionless, decentralized financial ecosystems. However, centralized exchanges like FTX often do the exact opposite by accumulating all capital flows in a central entity.

Ahmed Ismail, FLUID's Founder, President & CEO, explained, "...this is yet another example of the big problem in the cryptocurrency world, where custodianship and liquidity are concentrated and fragmented...". Echoing the sentiment, Rishabh Gupta, Director of Operations at TDeFi, stated, "I believe that the core problem is still the same- a 'single point of failure'."

The crypto industry has the necessary technology and infrastructure to avoid FTX-like incidents. For example, liquidity aggregators play a crucial role in maintaining stable liquidity reserves even during high market volatility. These aggregators help exchanges from succumbing to liquidity crunches, like the one FTX is now facing. But liquidity aggregators for centralized exchanges are still prone to censorship from the management authorities.

Thus, decentralized exchanges offer a better alternative. Bernd Stockl, the CPO and co-founder of Palmswap, said, "Traditional centralized asset exchanges are handled by a few people with permissioned access."

This automatically translates to liquidity concentration with the managerial teams taking unilateral decisions to allow or restrict trading during volatile markets. A decentralized financial ecosystem always adopts a community-first approach, which can directly participate in decision-making.

Rishabh Gupta explains that the FTX debacle is a "reminder that decentralized platforms with well-structured governance structures are the future of crypto. The premise of DeFi has been strengthened by this collapse of entities lacking counterparty risk measures."

But developing decentralized applications (dApps) is a challenging task. Startup founders often need the help of incubators and launchpads to guide and mentor them in developing robust platforms. So, incubators have a role in ensuring that dApps are devoid of bugs and other vulnerabilities that might later harm investors.

Emphasising the need for thorough risk assessment, Hatu Sheikh, CMO at DAO Maker, said, "Incubator teams need to meticulously scrutinize a project's tokenomics, read their whitepapers, and run thorough background checks."

However, adequate safety measures can only come from an ongoing and thorough security assessment. Andrew Beal, Spokesperson at Forta, explained, "In CeFi, we must trust operators of an exchange or custodian to act honestly, and accurately report. DeFi on the other hand is public and transparent by design. No trust required. Layer real-time monitoring on DeFi, and accountability is taken to the next level via external watchdogs."

Thus, it ultimately boils down to decentralizing the ecosystem and managing risk in the crypto industry. While the FTX-Binance incident has wreaked havoc across the market, there's no need to lose hope. An industry with over 300 million unique wallet holders isn't going to disappear or lose trust in the trustless system in a fortnight.

So, the crypto industry and individual companies must become more responsible and continue to develop innovative technological solutions. All hands must be on deck to mitigate risks and restore investor confidence.

During the 2008 financial crisis, no one blamed or questioned the integrity of the U.S. dollar. So, during this 'Lehman Brothers' moment in the crypto industry, there is no need to question the inherent value or lack thereof of crypto. Rather, the goal is to continue to grow by avoiding the risky pitfalls.