The collapse of the FTX crypto exchange and other centralized platforms in 2022 has now pushed investors toward noncustodial DeFi platforms.
The implosion of the now-bankrupt FTX exchange has raised many worries over unregulated centralized platforms. Investors have now come in questioning how safe it is to keep their funds on these platforms and have voiced their candid fears about centralized decision-making without any checks.
FTX held one billion in a client’s fund and was found to be using customer-deposited crypto assets to minimize its business losses. Moreover, a recent report indicates that the downfall of many crypto exchanges over the past ten years has permanently taken 1.2 million Bitcoin (BTC) – around 6% of all Bitcoin – out of circulation.
The revelation of unethical practices by FTX in its bankruptcy filing has set a wave of panic among investors who are already losing trust in centralized trading companies. Exchange outflows reached historic highs of 106,000 BTC per month in the wake of the FTX saga and the loss of trust in centralized exchanges which has pushed investors toward self-custody and decentralized finance (DeFi) platforms.
Users are pulling money from crypto exchanges and appear to be turning to noncustodial options to trade funds. Uniswap, one of the biggest decentralized exchanges (DEX) in the ecosystem registered a considerable surge in trading volume on November 11, the day the FTX exchange filed for bankruptcy.
With FTX’s implosion working as a catalyst, DEX trading has seen a considerable increase in volume. In the past week, Uniswap registered more than a billion dollars in 24-hour trading volume, a lot higher than most of the centralized exchanges within the same time frame.
DeFi chief of staff at Polygon, Aishwary Gupta, said that the failure of centralized entities like the FTX exchange has reminded users about the importance of decentralized finance.
“DeFi-centric platforms simply cannot fall victim to shady business practices because ‘code is law’ for them. Users realize it as well. In the wake of the FTX implosion, Uniswap flipped Coinbase to become the second-largest platform for trading Ethereum after Binance. As decentralized platforms are run by auditable and transparent smart contracts instead of people, there is simply no way for corruption or mismanagement to enter the equation.”
Based on data acquired from Token Terminal, the daily trading volume of the perpetual exchanges reached $5 billion, which is the highest daily trading volume since the Terra meltdown seen in May 2022.
Reporters reached out to PalmSwap, a decentralized perpetual exchange, to review investor behavior in the wake of the FTX crisis and how it affected their platform in general. The chief product officer and co-founder of Palmswap, Bernd Stöckl, said that the exchange has seen a considerable bump in trading volumes.
“The usage of DeFi will surely rise thanks to the FTX downfall. It is said that Crypto.com, Gate.io, Gemini, and some other centralized exchanges are in hot waters. With so many CEXs falling, trust in custodial wallets is very low and the advantages of DeFi will surely be adopted by more users.”
The co-founder and DeFi infrastructure provider VALK, Elie Azzi, thinks that the increase in DEX volumes might be the start of a long-term trend, given that there is a general reluctance from the traders to trust CEXs with their assets. He stated:
“DEXs are innovating at a much faster rate than their counterparts, with execution and settlement times becoming almost instantaneous on certain chains. The trend is that DEXs are developing the usability and UI of CEXs, whilst improving on the logic in the back end. Combined with the unique features that DEXs bring, including self-custody, the ability to trade from one’s wallet and retain control of private keys.”
He also mentioned that centralized exchanges might see more strict controls and transparency initiatives. However:
“This transparency would exist prima facie in full DeFi. Rather, no one would need to trust CEXs with assets, and any activity, be it trading, liquidity provision, or else would be recorded in real-time on-chain.”
DeFi’s Struggle With Targeted Hacks
While DeFi protocols have seen a considerable spike in the wake of centralized exchange failures, the budding ecosystem itself has been a major target for hackers in 2022.
Based on data from the crypto analytics group Chainalysis, almost 97% of all the crypto stolen in the first three months of 2022 has been taken from decentralized finance protocols, up from 72% in 2021 and only 30% in 2020.
Some of the largest DeFi exploits of 2022 include the Ronin network exploit executed in March that resulted in a loss of around $620 million worth of funds. The Nomad Bridge was compromised for nearly $190 million and the Wormhole Bridge hack lost $320 million. In October alone, $718 million worth of crypto assets were stolen from 11 DeFi protocols.
Most of the hacks executed in the DeFi ecosystem have happened on cross-chain bridges, which, CEO and co-founder at DeFi staking protocol Vesper Finance, Jordan Kruger, thinks should not be considered as decentralized finance exploits.
“A substantial proportion of those exploits (approx. $3 billion this year) have been bridge attacks. Bridges aren’t ‘DeFi’ so much as infrastructure. CEX losses dwarf this number by an order of magnitude. That said, DeFi will improve and become more secure faster than its centralized counterparts because of its ability to iterate faster. This is similar to the way Linux greatly benefitted from an open-source approach and has achieved a strong reputation for security and phenomenal adoption.”
Decentralized finance is built on the ethos of real decentralization and the decision-making process is mostly automated using smart contracts. While DeFi strives to eliminate all forms of human interventions, vulnerabilities still arise in different ways including breaches of sensitive data and poor coding of smart contracts.
CEO of AirDAO, Lang Mei, said that the budding DeFi technology is prone to some bugs and problems but one needs to remember that most of the hacks:
“Having been related to either lending or cross-chain bridging, it can be immensely challenging to prevent vulnerabilities in technology which is both radically new and often has a highly-accelerated development schedule due to competition.”
He said that extra measures can be taken by the developers to mitigate possibilities of exploitable code in their decentralized apps including:
“White hat hacking, bug bounty programs, and testnet incentivization are all valuable tools to help identify and correct mistakes. They can also be used to attract and engage users, so it’s essentially a win-win from a team perspective. Decentralization of governance power is also important through the distribution of token supply and safeguards such as multi-signature wallets.”
The co-founder of community-owned DApp ecosystem Peaq, Till Wendler, said that it is quite hard to get rid of human-related flaws in smart contracts, code, and design. He said:
“Most thorough smart contract security audit only gets you so far — some exploits result from the way smart contracts interact between themselves in the wider ecosystem, not just from their intrinsic design flaws. That said, the DeFi space is definitely now in a better shape than it used to be, and it’s working out its own best security practices on the go, growing more and more reliable by the hour.”
The CEO at bug bounty protocol Immunefi, Mitchell Amador, said that DeFi can take help from progression in the security department:
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“There’s a huge explosion of security tech being quietly built in the background to tackle the security problem from all angles. Over time, given innovations in UX and security as well as DeFi’s inherent features of transparency, DeFi could permanently overtake centralized platforms, but this dynamic also depends on the wild card of regulations.”
The collapse of centralized platforms in 2022 together with the subsequent rise of noncustodial and DeFi services in its wake is a sign of changing times. Nonetheless, based on many in the crypto sector, the most critical factor in the FTX saga was the lack of understanding and due diligence from the crypto investors.
Myriad crypto pundits have now been advocating for self-custody and the use of the decentralized platform for some time. The co-founder of the Umbria Network, Barney Chambers, said:
“The cryptocurrency space continues to be the wild, Wild West of finance. Here are a few pointers to ensure funds are safe: Never connect your wallet to a website you don’t trust, hold your keys in a trusted place such as a hardware wallet, never trust strangers on the internet when asking for help, and always [do your research]!”
Currently, the only way that investors can guarantee their funds are protected is to demand the parties they are investing in to offer transparent and clear information on all accounting and rely heavily on noncustodial solutions in terms of both wallets and trading venues.
The ecosystem head at decentralized operating protocol dappOS, Darren Mayberry, said that noncustodial services need to be the way forward for the investors. He explained:
“Accountability and audits should be standard procedures for all investors, due diligence is a natural part of business, as is fact-checking and investigation. As for non-custodial wallets — they are the most reliable form of storage that transfers liability solely onto their owner and thus negates the possibility of counterparty risks.”
Decentralized finance platforms may have their set of risks and vulnerabilities, but industry observers think that proper due diligence and reduction of human error could make the budding ecosystem of DEX platforms a go-to option over CEX platforms.