Crypto exchanges have always been one of the most important elements of the digital asset ecosystem. They’re also one of the most vulnerable: a point of centralisation and a weak link in the blockchain world.
This year brought that home to the crypto community with a force we haven’t seen since the fall of MtGox, once the largest bitcoin exchange, back in 2014. This time, it was FTX that collapsed, and the effects have reverberated through the sector. There have been repercussions for many other major exchanges – including Binance and Coinbase – and leading blockchain corporations.
Here’s an overview of what went wrong, and how it has shaped the crypto space over the past year.
Crypto was already cooling off since bitcoin’s peak of $69,000 in November 2021. The implosion of the $60 billion Terra stablecoin ecosystem in May this year accelerated the falls, and kicked off the bear market in earnest. Digital assets prices crashed across the board.
Unlike other years, 2022 did not see a large number of serious exchange hacks. At the start of the year, Crypto.com – one of the world’s most popular crypto apps – suffered a breach in which almost 5,000 ETH and over 400 BTC were stolen, with total losses of more than $30 million. However, it wasn’t hacks that posed the biggest threat to exchanges. It was contagion, made worse by a lack of transparency.
Crypto hedge funds and other organisations had been dealt huge losses when Terra crumbled. Any organisation with exposure to these, or that relied on BTC and other digital assets maintaining a certain price level, were impacted. These included lenders and brokers such as Celsius, BlockFi, Voyager and Genesis, all of which either received bailouts from other crypto organisations, or filed for bankruptcy.
The second wave of bankruptcies occurred in November, when rumours began to circulate about the solvency of Alameda, the trading arm of FTX – both founded by billionaire Sam Bankman-Fried (SBF). Following Binance’s statement that it would be selling its reserves of FTT, the native token of FTX, the exchange experienced a run on withdrawals and could not cover its obligations. In little more than a week, it had filed for bankruptcy. It turned out that FTX’s customer funds had been used to prop up Alameda, which had suffered devastating losses in the bear market. SBF has now been arrested and faced multiple criminal charges related to fraud and other offences. He faces up to 115 years in jail if convicted.
During the chaos of FTX’s final hours, when users were desperately pulling out funds, someone stole almost $500 million from the exchange’s cold wallet. This may have been a hacker, but looked like an "inexperienced insider", who funded a wallet with TRX from their personal Kraken account to pay transaction fees.
Decentralised exchanges (DEXs) do not suffer the same problems as CEXs, being fully transparent and allowing users to maintain full control of their funds. DEXs have gained some traction as a safer alternative to centralised exchanges (CEXs). However, they are less convenient for regular users, and cannot be used to on-ramp fiat, so are less popular than major centralised platforms.
Nonetheless, leading platforms like dydX and Uniswap currently manage daily volumes of a billion dollars or more, despite the bear market. Of the centralised exchanges, only Coinbase and Binance do more, and several other DEXs see nine-figure daily volumes. CEXs end the year ahead of DEXs, then, but the top DEXs compete favourably with all but the biggest CEXs.
With the market already in cooldown mode since the start of the year, the Terra and FTX scandals saw heavy falls in crypto prices as organisations that had been affected sold whatever assets they could to cover their obligations.
Although the blockchain itself is transparent, the opacity of centralised crypto organisations meant that the wider community did not know where there was contagion, and which companies would go bankrupt next. Rumours and FUD (Fear, Uncertainty and Doubt) spread on social media about who the next victims would be.
Over the course of the year almost half a million BTC left exchanges. Partly this was driven by longer-term holders, who tend to buy when prices are falling in a bear market, and withdraw their coins to cold storage. Partly, it reflects evaporating confidence in centralised exchanges (CEXs). Users were uncertain which exchanges they could trust, and withdrew their crypto in large numbers to store it themselves.
The largest exchanges (according to CoinGlass) held a total of 2.35 million BTC at the end of 2021, falling to a low of 1.88 million on November 17, 2022, shortly after the collapse of FTX, when fears that other exchanges were insolvent drove record withdrawals.
Gemini experienced massive withdrawals when it came to light that Genesis, Gemini’s chief lending partner, owed Gemini Earn users a total of $900 million. Coinbase Pro was similarly affected as rumours of the crypto giant’s insolvency swirled, based on its crashing share price and Coinbase bonds trading at just 50 cents on the dollar. Without hard evidence and reassurance one way or the other, traders weren’t taking any chances.
Binance was a net beneficiary of this trend, initially seeing inflows of around 100,000 BTC from FTX. The exchange held the confidence of the community while FTX was collapsing, and further gained their respect when it published proof of reserves – an attempt to cryptographically guarantee it was fully capitalised. Critics, including Kraken CEO, Jesse Powell, quickly argued that giving a statement of assets was meaningless without also stating liabilities, driving another flurry of withdrawals. The possibility of Binance executives, including CEO Changpeng ‘CZ’ Zhao, being charged with money laundering after a long-running investigation by the US Department of Justice, only added to users’ reluctance to trust the platform.
Since then, some confidence has come back to the CEX sector but self-custody remains popular.
After these scandals and exchange failures, many users will be cautious about trading on CEXs. DEXs, while more secure and transparent, are less convenient and can only be linked to the fiat world via centralised intermediaries. Users have a few alternatives for buying and selling crypto.
One is to use peer-to-peer exchanges like LocalBitcoins, which match buyers and sellers directly. These will often have trusted users or escrow processes to avoid non-payment by one or other party. If you have relevant skills, you could also earn crypto by freelancing on a platform like LaborX, or pick some up by playing P2E games in partnership with CGU.
Alternatively, if you want to remain firmly within the framework of TradFi, you could buy and sell shares in a company that is heavily exposed to crypto, such as Microstrategy or Coinbase. These are a kind of proxy for owning crypto itself but are broadly correlated to crypto assets.
If you do want to use an exchange, it is safest to use a regulated platform with a strong track record of security, like Coinbase or TimeX, and withdraw your assets to an external wallet that you alone control, after you have finished trading.
The turmoil in the crypto markets over the past year, and particularly the high-profile failure of FTX, means that more regulation is on the way. For a start, CEXs will not be allowed to operate outside of the regulatory frameworks imposed on the TradFi system for much longer. It should not be possible for CEXs to avoid audits and operate in the chaotic and secretive manner that allowed FTX to hide wrongdoing from its users. We can also expect greater self-regulation from exchanges, with proof-of-reserve measures that are fit for purpose being used more widely.
Additional regulation may be on the way for parts of the DeFi world, as shown by the US authorities sanctioning Tornado Cash, a decentralised mixer. Stablecoins will almost certainly come in for regulation after the collapse of Terra and its algorithmic ‘stablecoin’ UST (currently worth $0.02). DEXs may be targeted in the future, potentially to restrict their use by criminals seeking to launder money.
What the episode won’t do is solve all of the regulatory grey areas around crypto, because FTX’s bankruptcy was very simply a straightforward, old-fashioned case of fraud, dressed up with a little new technology. At its heart, SBF is alleged to have misappropriated customers’ money and lied to them about the state of the exchange. It doesn’t concern the nature of crypto itself. As Bernie Madoff’s lawyer, Ira Sorkin, explained: ‘It's alleged that he used money obtained from investors and made material misrepresentations to them as to how that money was going to be used or invested. That's it.’