Why the collapse of CeFi institutions proves crypto’s core pillars

cointelegraph.com:

The crypto space endured a series of unfortunate events in 2022, beginning with the Terra debacle and ending with FTX’s chaotic death spiral. These events heightened consumer skepticism and hesitancy toward crypto platforms; yet, the industry is holding steady today. The market is even trending upwards at the time of writing.

Crypto’s current potential trajectory toward a recovery signals two key takeaways: The space is resilient and here to stay, despite multiple setbacks. Secondly, centralized, or CeFi entities (such as exchanges or trading and lending platforms), have proven they can be a weak link and we must find ways to address their shortcomings.

Many factors played a role in the failures of centralized entities. While the market downturn and contagion played a role in many of these collapses, the root causes can be boiled down to two main issues: centralization and imprudent decision-making.

When users deposit crypto on a CeFi exchange, they are relying on the custodial services of that platform. In essence, they are giving up intrinsic control of their digital asset holdings and in certain instances are loaning their crypto to the CeFi entity. In such cases, users become “unsecured creditors,” meaning they are indirectly lending their money without receiving any collateral or protection.

These exchanges can use those funds for balance sheet operations, collateral for large loans, trading, etc., which is where firms such as FTX have proven to be extremely careless. The FTX implosion resulted from misappropriation of customer deposits and both irresponsible leverage and risk management.

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