Not Your Keys, Not Your Crypto: Centralized Failure Highlights the Importance of DeFi

The FTX meltdown leads crypto holders to move their funds from centralized platforms to the security of decentralized alternatives.

By Billy Endres

The collapse of one of the world's largest cryptocurrency exchanges, FTX and its sibling company, trading firm Alameda Research, has sent shockwaves around the crypto community. The meltdown began when suspicions surfaced regarding the unconsenting use of FTX customers' funds. FTX was reportedly funneling its users' assets to Alameda, which then used the funds to participate in high-risk leveraged trades. Upon hearing that their capital was being blatantly misused, many attempted to withdraw their assets from FTX only to have their requests denied and accounts frozen. 

The rumors were confirmed that the exchange did not have customer assets backed 1:1 when it was unable to return billions of dollars to over 5 million customers. On November 11, FTX CEO Sam Bankman-Fried signed a filing for Chapter 11 bankruptcy for 134 FTX and Alameda subsidiaries. But the drama didn't stop there. The same day, around $400 million was withdrawn from FTX and sent to anonymous wallet addresses. 

This again raised questions, and speculation was rife, with theories surfacing that the exchange had a backdoor embedded to drain any remaining user funds. While these theories and rumors are currently nothing more than that, the legitimacy of centralized trading platforms has understandably been brought into the spotlight.

Proof of reserves

Many traders and investors have requested that all centralized exchanges (CEXs) provide a balance sheet showing 1:1 backing of user funds. Crypto.com was one of the first CEXs to provide cold wallet addresses as proof of reserves while it waits for an audited balance sheet. 

Crypto.com token allocation - proof of reserves

However, soon after the company published the wallet addresses holding user capital, images surfaced showing large withdrawals and deposits of 320,000 ETH between Crypto.com and an unknown wallet address.

Crypto.com transfers 320,000 ETH to Gate.io

While this rang alarm bells for some traders, Crypto.com CEO Kris Marszalek responded to the concerns in a recent live AMA. Marszalek stated that while the company did send the funds to the wrong address, it was a Gate.io corporate, whitelisted account, not an unknown wallet. He also noted that Crypto.com was always in control of its customer's assets and that the exchange will implement measures to ensure the same mistake does not reoccur.

In addition, the images taken from Etherscan were of transactions made over 3 weeks ago, on October 21 - well before and unrelated to the FTX meltdown. 

Decentralize everything

While some investors nervously wait for audited balance sheets to be released by CEXs, others have abandoned centralization altogether. Many traders have withdrawn their capital from centralized platforms and deposited them into Web3 and hardware wallets, including MetaMask, Trust Wallet, Trezor and Ledger. Trust Wallet Token (TWT) price responded positively, rallying over 100% from $1.20 to all-time highs of around $2.70. 

Trust Wallet Token (TWT) breakout following FTX meltdown

MetaMask also saw its previous all-time high exceeded as its daily protocol revenue on November 11 reached $17.1 million - demonstrating that a lot of the industry is flooding to the security of non-custodial wallets.

Metamask daily protocol revenue: $17.1million

A 'not your keys, not your crypto' approach is undoubtedly being taken while industry trust is at an all-time low. It remains to be seen if and when the broader market will recover from the past week's events. However, it is expected that much of the crypto space will be brought back to its roots in a 'decentralize everything, trust no one' type fashion. 

If centralized exchange outflows continue and traders opt to utilize decentralized platforms in higher numbers, there may be a much-needed relief rally for these projects and an eventual DeFi summer.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.