It’s just over a year since Bitcoin and Ether reached their all-time highs. Following a long period of online development, 2021 saw an explosion in mainstream awareness, and it seemed as if the moon was the limit for crypto. Celebrity endorsements, pop-culture references, and partnerships with the world’s most popular sports franchises followed. But, even during this purple patch, some skeptics said that the growth was unsustainable and predicted an eventual downfall.
At first, it seemed as if the momentum would carry into 2022. Hopes were high, and crypto companies were throwing obscene amounts of money at marketing. This year’s Superbowl alone featured commercials from Crypto.com, Coinbase, and eToro, which seemed to signal that crypto had finally become mainstream. But then Q2 happened, and things started to go downhill.
First Terra, then Luna, and eventually FTX. Market sentiment is now at an all-time low, and those who haven’t already abandoned ship are conflicted. The noise from the outside is louder than ever, and the industry is at a pivotal point. It can either sink or swim. However, rebuilding the trust that this year’s events have destroyed is crucial if the sector is to survive.
Even before this year’s collapses, a lack of proper regulations was a primary concern in the space. For institutional investors, insufficient legal frameworks surrounding crypto are a deterrent. Those operating in multiple jurisdictions face even further issues due to the massive variations in regulations across different nations. While some governments have been quick to embrace the transformative potential of crypto and blockchain, others have taken the opposite approach.
Those countries that have shown a willingness to adopt crypto have seen their local ecosystems prosper. We have seen significant steps toward practical regulations globally in the past twelve months. Europe’s MiCAR aims to provide uniform rules for crypto markets to bring stability and greater integrity to national ecosystems.
As markets grow, so do the risks, including manipulations and fraud, and recent turmoil has highlighted these risks. Also, with the emergence of stablecoins- whose value is linked to the value of fiat, crypto, or other assets- there is an even more significant correlation between crypto and traditional financial systems. For these reasons, regulators must work with the crypto industry to build more defined frameworks in which everyone, from institutional to amateur investors, feels confident.
Proof of Reserves
Due to the FTX implosion, Binance, Crypto.com, and many others have promised to reassure their users with proof of reserves. These independent audits enable centralized exchanges to publicly attest to their reserves’ value and prove their solvency. Essentially they prove that tangible assets back the balances a CEX holds. This is an excellent first step, but it won’t restore faith.
Many companies have already announced their intent to provide quarterly proof of reserves, but some argue that this doesn’t allow enough transparency. There are fears that exchanges could arguably borrow funds in time for the audits while not genuinely holding sufficient assets. Others, such as Kraken CEO and co-founder Jesse Powell called the efforts “pointless” as companies don’t include liabilities. According to Powell, proof-of-reserve audits must consist of the “sum of client liabilities, user-verifiable cryptographic proof that audit included each account in the sum, and signatures proving the custodian’s control over the wallets.”
FTX also serves as a warning that there are inherent flaws in crypto’s structure. The traditional finance market has its weaknesses but does an excellent job of maintaining strict boundaries between lines of business. For example, trading, financing, and custody are usually separated and subject to appropriate checks and balances. Crypto is intended as an evolution to traditional finance but can still adopt some of its better practices.
Like the financial collapse of 2008, the crypto crisis has left a bad taste, and it could potentially take years to regain previous levels of trust. However, people didn’t automatically stop using banks or fiat currencies, and it’s unlikely that they will stop using blockchain or buying crypto due to FTX. To rebuild trust, the industry must face the catalysts head-on rather than distancing itself from them. The public won’t be on board straight away. However, if we can demonstrate that developers and founders still operate in good faith to create valuable solutions, it will inevitably rebuild confidence in crypto.
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