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OpenEx Eyes: Crypto “Renaissance” – Analyzing CEXes’ principle of neutrality and risk management from the decline of FTX

OpenEx Eyes: Crypto “Renaissance” – Analyzing CEXes’ principle of neutrality and risk management from the decline of FTX

January 26
20:09 2023

The rapid decline of FTX proves a “law” in financial markets: “traders can’t compete with exchanges on mitigating risks because a real exchange won’t expose itself to trading risks. Traders, however strong they are, always deal with risks.”

The decline of FTX is not mainly due to FTX itself but to the closely integrated Alameda, which is also under the control of the same stakeholder SFB. Judging from the information disclosed, this closed loop of failure started from Alameda’s aggressive investment, poor liquidity of assets held, and a bear market. Then the financial information was revealed, which triggered the market’s crisis of confidence in FTX and led to “a run on a bank”.

The combination of FTX and Alameda once made SFB rise sharply: the exchange set the rules and traded in the market itself, so it naturally had the advantage. For FTX, however, the negative significance of this paradigm is strategic and can be said to be fatal too. Because the neutrality of an exchange is its fundamental principle, violating this is hugely unfair to other investors. Moreover, insider trading is inevitable, which can be a legal issue. It has always been the focus of supervision, determining that FTX is impossible to be whitewashed and recognized by regulation.

The profound lesson we learn from FTX is also reflected in the risk management at CEXes. Crypto assets are characterized by the continuous emergence of technological and application innovations, which quickly leads people to think they are engaged in the technology industry. Most practitioners also have a technology background. However, it is essentially still finance. In particular, the exchange, as a core link on the industrial chain, has a systematic influence on the industry, exercising the functions of asset pricing and risk management. This is certain that we are still in the financial sector, so it is necessary to understand it from a financial perspective accordingly.

OpenEx (OpenEx.xyz) is convinced that innovations such as blockchain, tokens and smart contracts will create a “new world”. However, this new world does not represent the complete subversion of traditional finance but its evolution and transformation. At the same time, it is also a gradual and dynamic process that needs to be coordinated and integrated with conventional finance at some levels.

Therefore, what people should do in CEXes’ risk management is to “embrace tradition” and learn from the risk management system and mode of traditional exchanges. After all, there are so many lessons we can learn from the mistakes of history that there is no need to repeat them. For example, in the view of the traditional financial market, the LUNA model and project were bound to be a Ponzi scheme as they provided more than double-digit fixed income. This is common sense, but it once had been hailed as a star project in the crypto asset industry.

OpenEx (OpenEx.xyz) sees what happened at FTX as an opportunity to send a warning that CEXes should establish a more transparent risk control system supervised by a third party in terms of risk management to restore people’s confidence in CEXes. After all, the No.2 CEX collapsed overnight. This industry does not have assistance from the central bank or the government as traditional exchanges, so it can only rely on the self-discipline of the exchanges and industry.

A “Renaissance” has been called,  as there are two kinds of measures we learn from conventional finance that can solve the problems of transparency and trust: firstly, to solve the problem for the long term. For example, establishing an independent clearing house across exchanges and even across industries is responsible for the margin and clearing of CEXes, which is entirely independent in organizational structure, corporate governance and finance. In essence, it performs the functions of user margin custody, clearing risk management and external supervision of exchanges, etc. This systematic project requires industry consensus on collaboration and time, but it can fundamentally solve the trust issue.

At present, regulation is on its way, and moving closer to supervision violates the fundamental demands of the indigenous people of blockchain for “freedom and autonomy”. It is the best choice to set up an industry-based autonomous organization. Moreover, DAO and other organizational models can be introduced into the governance of clearing houses.

Secondly, there are short-term solutions, such as external audit, insurance, and cooperating with third-party organizations to realize the isolation and custody of user funds from exchange funds; At the level of exchange governance, a risk management committee (or risk management DAO) led by external independent directors and attended by user representatives should be introduced, which plays a role of checks and balances and supervision on founders and CEOs, etc.

The best choice of CZ and Binance is to unite with other top exchanges, make everything possible to acquire FTX, and ensure the repayment of users’ funds, to save the crisis of confidence for the industry and the pressure in regulation in the future, and to promote some measures of industry coordination and self-discipline, such as aforementioned, especially the clearing house.

CEXes’ business philosophy should be to operate the CEXes from the perspective of propelling the industry. If the industry is good, the CEXes will naturally be good.

https://www.OpenEx.xyz/

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