Crypto exchanges want to prove that the market can thrive after the FTX collapse. Despite their efforts, future failures may be inevitable.

FEW WERE PREPARED for the dramatic collapse of crypto exchange FTX on November 11. The incident has left hundreds of thousands of customers without access to their funds, and the ripple effects have wiped billions of dollars from the market, as well as casting doubt over the integrity of other crypto companies.

FTX was so deeply embedded in the cryptosphere that many firms (including crypto lenders Genesis and BlockFi) have spent the last week hurriedly calculating their own financial exposure to the collapse, in fear they may be dragged down in the swell. Others, however, have sensed opportunity in the crisis and are readying plans to prevent further contagion. “We actually think this is a very good cleansing period,” said Changpeng Zhao, CEO of Binance, during a Twitter Spaces Q&A earlier this week. “The weak projects are gone, and the industry is much healthier.”

Zhao, who goes by CZ, says he has a plan to navigate the fallout of the FTX saga and rebuild trust. With one of Binance’s main competitors no longer in operation, the company’s voice as the world’s largest crypto exchange has become all the more influential. In a series of tweets published since November 8, CZ announced that Binance will publish a transparent “proof of reserves,” to demonstrate it keeps enough cash on hand to fund withdrawals, and launch a recovery fund to help prop up legitimate projects in distress.

On November 15, he followed up with a blog post setting out best practices for exchanges, which can be boiled down to: Don’t gamble, don’t borrow, and don’t cheat. “We cannot let a few bad actors sully the reputation of this industry when it’s still in its infancy,” CZ wrote.

In the past week, many other crypto exchanges have followed suit. Bitfinex, Crypto.com, Huobi, OKX, and Kucoin have all either released or promised to release proof of reserves. Some, like Kraken and Coinbase, sought to highlight that they have been publishing accounts for a while now. Practically all of them have either pledged support for CZ’s recovery fund or promised further investment in crypto startups.

The mood among the exchanges is subdued but optimistic. They hope that more transparency will allow them to continue to appeal to crypto newcomers, while limiting the risk of being accused of FTX-style accounting.

“This has been a major setback for the crypto industry,” says Blair Halliday, UK managing director at Kraken, an exchange that currently processes $600 million in crypto transactions per day. “[But] we believe sensible industry measures, such as proof-of-reserves audits, will be a crucial starting point to regaining the loss of trust in the ecosystem.” Similarly, Paolo Aroino, CTO at Bitfinex (which hosts $100 million in daily trades), says only the exchanges with a track record for responsible governance will survive, but that “the cryptocurrency industry will emerge stronger” from the ordeal.

However, there are industry leaders who believe that the FTX collapse should be seen as an opportunity for a deeper reevaluation, and a return to the founding principle of the cryptocurrency movement: decentralization.

“It’s a good learning moment for the industry,” says Hayden Adams, creator of UniSwap, the world’s largest decentralized exchange (DEX). “The fact that [FTX founder Sam Bankman-Fried] had the ability to do [what he did] speaks to the fact he was building a centralized product over which he had full control.”

Unlike traditional exchanges, which let people swap regular currency for crypto and store assets on behalf of customers, DEXs never take control of customer funds, and trades are made on a peer-to-peer basis. According to Adams, this decentralized model eliminates the middleman risk that contributed to FTX getting itself into hot water in the first place.

UniSwap is still a work-in-progress from a user experience perspective. “If you were to compare us to the internet, we’re still in the era of dialup,” says Adams. But he believes that DEXs will in time supplant exchanges like Binance as the go-to vehicles for crypto trading.

None of the measures that crypto exchanges are putting in place will ward off the period of heightened regulatory scrutiny now expected to begin.

To date, efforts to regulate crypto companies have moved too slowly, partly as a result of the complexity of the underlying technology, says Charley Cooper, former COO of the Commodity Futures Trading Commission (CFTC) in the US. But the scale of the FTX collapse is likely to light a fire under regulators around the world.

Some have pointed out that high-profile collapses have happened multiple times in traditional finance, which could provide a useful precedent for regulation in crypto. Justin Sun, founder of the TRON network and member of the Huobi Global advisory board, says crises in financial institutions have typically been followed by “enhanced regulations and scrutiny [that] served to strengthen the industry,” and that “it is almost certain the virtual assets industry will head down the same path.”

The EU has been working for the last two years on a new set of laws that will apply to crypto organizations, known as the Markets in Crypto Assets (MiCA), designed to protect both consumer funds and financial stability. The details have now been finalized and are ready to be put to a vote in February 2023.

If passed, MiCA will stop crypto companies from using tricks of accounting to blur the line between their own and clients’ funds, an offence that appears to have played a significant role in the downfall of FTX. “If MiCA was enforced, [the FTX collapse] would not have happened in this way,” says Stefan Berger, a German member of the European Parliament (MEP) who is leading the effort on the new legislation. “The FTX case is the Lehman Brothers moment for crypto. What the cryptosphere now needs is trust, and to build trust you need clear rules and regulatory clarity.”

Meanwhile, in the US, the Biden administration in September outlined plans to regulate the crypto industry for the first time. The new framework aims to crack down on fraud and guarantee financial stability, while leaving sufficient leeway for innovation and entrepreneurship. This is a difficult balance to strike, however, and questions remain over which regulatory body should take the lead, the Securities and Exchange Commission or the CFTC.

The crypto community is divided on whether more regulation is a good thing: Those attracted to cryptocurrency for its role as a barrier to government overreach will wince at the prospect of tighter regulation, but others have concluded that companies need rules to create stable platforms and provide consumers the protection they deserve.

Bankman-Fried, the founder of FTX, has himself been an outspoken advocate for tighter regulation and spent plenty of time on Capitol Hill. Specifically, he supported a bill called the Digital Commodities Consumer Protection Act, yet to be written into law, which may impose tighter restrictions on DEXs, among other things.

But a report from Vox yesterday called Bankman-Fried’s faith in regulation into question. “Fuck regulators,” he said in a private exchange with a reporter over Twitter. “They make everything worse.” Perhaps regretting his candor, Bankman-Fried has since walked back his comments, claiming that some regulators have “deeply impressed” him. But whatever his true beliefs, it would appear that, by a roundabout route, he will end up playing a central role in transforming the regulatory landscape.

“Ironically, Sam may be successful in his quest for more aggressive government regulation of the crypto industry,” says William Quigley, cofounder of the stablecoin Tether. “But for all the wrong reasons.”