How FTX Exposed the Problems in Centralised Finance and Underlined the Need for DeFi

In a massive setback to the crypto community around the world, the recent meltdown of crypto exchange FTX raised serious questions about the sustainability of the CeFi trading model (centralised finance). The FTX debacle is not the first of its kind. Over the last two years, the industry has come to grips with similar malicious maneuvers from industry-leading centralised exchanges like Celsius Network, BlockFi, and Voyager Digital.

FTX’s crash and subsequent filing for bankruptcy is a strong reminder of the basic rule of holding minimum funds on CEXs, only for immediate trading.

What Transpired at FTX?

Officially headquartered in the Bahamas, with offices in Chicago and Miami, FTX, until recently, was a high-flying cryptocurrency exchange with a valuation of $32Billion.

Offering crypto exposure to mainstream users, the exchange had the world’s largest share in global crypto trade, second only to Binance. FTX provided users with innovative services like spot trading, futures, and tokenized stocks along with features like a three-tiered liquidation model and a Centralised Collateral Pool for its token “FTT”. These were just a few of the many trailblazing innovations offered by FTX.

Yet, at the core of FTX’s operations, was a centuries-old CeFi model that used under-collateralized user assets in high-risk financial dealings, conveniently turning its back on principles of transparency and decentralisation. And, ultimately tearing the company to shreds, sending shockwaves across the crypto market around the world.

And, this is why the wreck that unfolded at FTX never would have and never could have materialised in a decentralised and transparent protocol.

Fundamental Issues at Play leading to the Collapse of FTX

There were fundamental issues at play that led to the collapse of the world’s second-largest cryptocurrency exchange:

• A major chunk of the money that flowed through FTX’s books did not fall under the scope of any regulatory authority.
• Some of FTX’s recent deals involving its parent company Alameda Research led to a series of losses that contributed to loosening the financial construct of the company, in the months leading up to the crash.
• According to a report published in the Wall Street Journal, FTX reportedly used customer funds to prop up its sister hedge fund Alameda Research’s high-risk trading operation.

The Timeline of the Fiasco:

• It all started with an article published in CoinDesk on November 2nd,2022, claiming that Alameda, the crypto hedge fund owned by FTX’s founder, Sam Bankman-Fried, held billions of dollars worth of FTX’s native token, FTT, and had been using the holding to wrongfully secure loans. The article closed by explaining how this shared ownership could damage both businesses.
• The slowly creeping crisis was thrown into top gear on November 6th when Binance, the world’s largest crypto exchange, announced that it planned to sell its FTT holdings, dating back to an early investment by Binance in FTX. Making matters worse, Binance CEO, Changpeng Zhao drew parallels between FTX’s token FTT and the Luna token, which was also backed by Binance. The first foreshock was felt after this announcement when people began withdrawing their holdings from the exchange. On the same day, a series of passive-aggressive tweets were exchanged between the founders of Binance and FTX.
• On November 8th, Binance offered a bailout to FTX and published a nonbinding letter of intent to buy FTX. Binance CEO, Changpeng Zhao said in a tweet that FTX “asked for our help” as it faced a “significant liquidity crunch.” FTT plummeted by another 75% on Tuesday after the news of the takeover.
• On November 9th, Binance backed out of the deal and changed course over issues found in the course of the“corporate due diligence” review. On November 9th, U.S. regulators reportedly began investigating FTX. The regulators SEC (Securities and Exchange Commission) and the CFTC (Commodity Futures Trading Commission) started investigating the company’s relationships with its sister entities Alameda Research and FTX US.
• The matter snowballed and things went from bad to worse the following day on November 8th, 2022. The ripples of FTX’s collapse could now be felt all over the industry.
• On November 10th, in a last-ditch effort to save FTX, Bankman-Fried announced that Alameda Research would wind down trading. He tweeted“I fucked up and should have done better, [R]ight now, we’re spending the week doing everything we can to raise liquidity. I can’t make any promises about that. The company was also weighing bankruptcy.”
• The founder of FTX scrambled for help from investors, seeking liquidity as users continued to pull out their holdings. According to Reuters, FTX tried to secure rescue funding of $9.4 billion from investors, including rival exchange OKX, stablecoin issuer Tether, and Sequoia Capital. He managed to secure an arrangement with the blockchain network Tron, to let holders of Tron-related tokens to withdraw their holdings from FTX.
• On November 11th, FTX filed for bankruptcy and Bankman-Fried stepped down the bankruptcy filing proceedings began for FTX, Alameda Research, and roughly 130 affiliated companies.
• On November 12th, another report was published in Reuters stating that at least $1 billion in funds from FTX customer accounts went missing after Bankman-Fried moved $10 billion of customer funds from FTX to Alameda Research.
• On November 12th, the blockchain analytics firm Elliptic announced that it found that $473 million in assets were “moved out of FTX wallets in suspicious circumstances.
• On November 13th, Bahamian authorities got involved and began to investigate the possibility of criminal misconduct. Bloomberg reported that FTX co-founder Sam Bankman-Fried was interviewed by Bahamian police and regulators on Nov. 12th.

What does the collapse mean for FTX users?

As the dust from this massive implosion settles, the most important questions to emerge are how and whether FTX customers will be able to access their money. The answer, according to many industry experts, is that there may be only a very thin possibility of recovery although the exact outcome will depend on the findings of ongoing regulatory investigations. The legal ramifications for FTX remain unclear. However, after FTT (the crypto token issued by FTX), lost more than 90% of its value over the past week, it looks increasingly likely that customers who handed their money over to FTX may not be able to recover any of their funds or even close.

Underlining the Importance of DeFi

Is there a silver lining? Yes! And a “silver lesson” too! If there is a silver lining to come out of the FTX fiasco, it is a reminder of the importance of truly decentralised applications. The FTX disaster has exposed the problems in Centralised Finance and has underlined the need for DeFi.

JPMorgan has stressed on the importance of DeFi in a recent note stating that even though the fall of FTX sent shockwaves across the cryptocurrency markets, this could create a future for accelerated cryptocurrency regulation. In the note, the banking giant also acknowledged the fact that the recent cryptocurrency collapses have not been from decentralised protocols but from centralised players. And, therefore the recent events can awaken and speed up regulations by aiding in the institutional adoption of cryptocurrencies.

While the episode has sent shockwaves across the industry and has struck a sledgehammer on all crypto prices, the truth remains that the FTX collapse was a failure of CeFi, not DeFi — and smart investors, builders, and users are already taking notice.

Closing thoughts:

These are exactly the issues we’re trying to address at TeraBlock!

It is still not confirmed whether FTX had been using customer funds for speculative activities and how much of those funds were lost in the process. However, the fact remains that the deposits made by the users were not supposed to be subjected to that kind of risk. The underlying issues at FTX were extremely appalling but it is even more frightening to consider that customer funds clearly weren’t where they were supposed to be.

The whole liquidity crisis threw light on the fact that FTX operated in a manner that allowed it to gamble with users’ funds. Like most of the other Centralised Exchanges, FTX too, had an extremely closed and non-transparent structure where the control and access to users’ assets rested with the owners of the exchange. This is in stark contrast to how TeraBlock operates. TeraBlock is non-custodial; The platform does not control your funds. TeraBlock users retain complete control and access over their funds at all times.

In fact, these are the very problems that TeraBlock has sought to address over the years through innovation and technology. Decentralisation seeks to address the limitations in legacy Finance and TeraBlock started out as an early contributor to this effort. We are progressing towards a secure and structured DeFi platform that makes it exceedingly simple for beginners to participate in the DeFi revolution.

Our vision is to build a radically transparent and inclusive ecosystem that thrives on decentralisation, one without custodians or intermediaries as gatekeepers and one that can be accessed by anyone anywhere in the world.