FTX demonstrated what can go wrong when a crypto exchange is given the latitude to operate in an opaque fashion and with minimal external oversight. It changed what is now expected of other exchanges, too.
Within a week of FTX’s collapse, Binance, the world’s largest exchange, had proposed a new minimum standard. In a blog post published on November 15, 2022, Changpeng Zhao, then Binance CEO, set out a series of best practices for exchanges that boiled down to: Don’t gamble, don’t borrow, and don’t cheat. Zhao said that Binance would begin to publish a transparent “proof of reserves,” a kind of internal audit that would demonstrate the exchange kept enough in its coffers to meet withdrawals. A number of its peers, from Bitfinex and Crypto.com to Huobi and OKX, followed suit.
It was a start, but an imperfect one: Proofs of reserves provide only a snapshot of assets at a particular moment in time, not a real-time picture, creating room for numbers to be fudged. They also don’t illustrate an exchange’s liabilities, so they provide only a partial indication of financial health.
There are a lot of exchanges even with FTX out of the picture, says venture investor William Quigley, who also cofounded the Tether stablecoin. But there is an opening, he says, for an exchange that can demonstrate it stores customer assets responsibly, protects against market manipulation, and follows rigorous compliance procedures. “That’s an area ripe for improvement,” Quigley says.
New players are pitching more technically elaborate methods of proving that customer funds have not been FTX-ed. Backpack is developing a new proof of reserves, updated automatically on a daily basis, explains Ferrante, whereby the availability of funds for withdrawal is demonstrated “cryptographically” as opposed to through an opaque internal audit. To prevent funds from being quietly shifted about, the exchange will operate under a system whereby each crypto token transfer must be authorized by multiple parties. The aim is to ensure “there is no single point of failure,” says Ferrante, and the exchange has “multiple levels of defense.”
Other competitors, like OPNX, an exchange launched in April by Kyle Davies and Su Zhu, the cofounders of bankrupt crypto hedge fund Three Arrows Capital, are trying to scoop up former FTX customers with a different approach. OPNX provides regular crypto trading, but also lets customers trade their bankruptcy claims. Instead of waiting out a lengthy bankruptcy process, someone with money locked up on FTX could choose to sell off their claim for a certain number of cents on the dollar, swapping maximum recovery potential for immediate access to funds.