Could Midas’ Pivot to CeDeFi Signal the End of Decentralized Finance?

Uphold Head of Research Martin Hiesboeck says that centralized crypto exchanges (CEXs) remain a good bet in spite of the recent market collapse. The rampant hacking in DeFi makes mass adoption of decentralized finance an “impossibility,” he argued.

Hiesboeck spoke as the multi-billion-dollar collapse of FTX exchange in November due to a liquidity crisis brought increased attention and scrutiny to CEXs. Confidence has hit rock bottom and investors are moving assets off centralized exchanges.

Investors withdrew more than $5 billion from Binance within days of FTX’s demise, worried whether the world’s biggest crypto exchange by volume was the next to fail. It was a time of unprecedented fear, uncertainty and doubt, or FUD.

Amid the chaos, Binance executive Patrick Hillman commented that centralized exchanges are seeing their last days. He pointed out that the platforms may not be around for another decade because of the severe loss in investor confidence.

Also read: Crypto Price Charts Added To Twitter

Hiesboeck: Centralized crypto exchanges not going anywhere

Hillman’s comments reflected the general market sentiment at the time, which continues to this day. However, Uphold’s Hiesboeck told MetaNews that CEXs are here to stay. He argued more crypto assets have been lost from misplaced private keys than any exchange collapse.

He quotes industry data which says that 20% of all Bitcoin (BTC) is lost due to users losing passwords to their wallets. That represents a range of between 68,110 BTC and 92,855 BTC worth – or between $1.15 billion and $1.57 billion at existing market prices.

“That’s only known Bitcoin,” Hiesboeck said. “True cryptocurrency lost irrecoverably being sent to wrong addresses, without tag, etc. is over $30 billion!” He added that exchanges are compliant to security laws, which gives users a guarantee on the safety of their investments.

“It [compliance] helps to keep security breaches to an absolute minimum. Whereas, in DeFi, all hackers need to do is get into a vulnerable wallet on its own without a platform to protect it,” said Hiesboeck.

Hacking makes DeFi impossible alternative

Decentralized exchanges, or DEXs, and other forms of decentralized financial offerings have been proposed as alternatives to centralized exchanges because of their supposed ability to avoid a single point of failure.

Hiesboeck explained that centralized platforms carry an enhanced ease-of-use and security benefits that DeFi cannot provide. He said the “cumbersome management of illegible wallet addresses and 12-word recovery keys is anathema to mainstream adoption.”

“Ongoing hacks in the DeFi make mass adoption of decentralized finance an impossibility,” Hiesboeck detailed. “Security must be improved exponentially before it becomes suitable for everyday usage. This will likely mean having wallet addresses tied to real world identities.”

“The notion of ‘not your keys, not your coin’ is ridiculous. Exchanges don’t hold on to private keys because they need to, but because it makes it easier for the user. There’s no need to memorize 12 random words or countless passwords, which is a huge barrier to entry in DeFi for those who aren’t crypto-native.”

DeFi is a part of cryptocurrency that has broadly remained true to the foundational ethos of Bitcoin of decentralization and privacy, maintaining cynic detachment from governmental oversight. Unchecked, however, such liberties come with great risk.

According to blockchain security firm PeckShield, hackers have pilfered more than $2.32 billion in over 135 exploits, from the DeFi industry this year. The figure is 50% higher than what was stolen from the entire sector for the whole of 2021.

#PeckShieldAlert Wintermute has lost ~$160M, making it come to #5 on our 2022 DeFi exploit leaderboard
In this incident, exploiters immediately put the most stables into 3CRV pool to avoid blacklisting, while ～50% of Top 10 exploiters transferred to Mixer before Tornado sanction pic.twitter.com/RxMPOIypSz

— PeckShieldAlert (@PeckShieldAlert) September 21, 2022

Over the years, online thieves have employed a variety of tactics to carry out their work. The most used methods of attack include honeypot, exit scam, exploit, access control, and flash loan, says the REKT Database.

Catching up with centralized exchanges

Phil Zimmerer, chief strategy officer at Spool, a DeFi middleware firm, told MetaNews that in order to fully replace centralized platforms, decentralized options need to catch up in terms of convenience, user experience, and features.

“This includes things like performance, execution, spreads, and liquidity but also a replacement for secondary financial services, such as simple ‘earn’ programs offered by centralized exchanges,” he said.

“To make this happen, decentralized financial protocols need to become more accessible and manageable, which requires infrastructure to be built first.”

Strategists at top bank JP Morgan argue that because of their demonstrated efficiencies, CEXs are likely to remain the preferred platform among users. In a note to clients, they argued that DEXs’ slower transaction speeds, pooling of assets and order-traceability features are likely to limit institutional participation.

Marcello Mari, CEO of SingularityDAO, told MetaNews that now is the right time for conversations around the utility of centralized exchanges in a cryptocurrency world designed to avoid fiat-like monetary system.

More regulation

It is obvious that after the spectacular collapse of the FTX exchange governments are going to tighten regulation. We asked Martin Hiesboeck, the Uphold Head of Research, whether he believes that state regulation would help bring transparency into the crypto sector.

“Absolutely,” he declared. “The cryptocurrency industry needs more transparency, and regulations which force them to do so ensures that platforms cannot skirt around their security responsibilities.”

“Regulations will expose those who aren’t ensuring the best transparency and highest reserves, allowing investors to see who’s the real deal and who can’t be trusted,” Hiesboeck added.

Several exchanges have taken steps to increase transparency and trust amongst their users in the wake of the collapse of FTX, the world’s second largest crypto exchange. Exchanges have started publishing proof-of-reserves, a process that verifies it has adequate cash and crypto in reserve to back customer balances.

“The most important thing an exchange could do to restore confidence and remain relevant is by publishing a proof of solvency. It’s not enough, but it’s a start,” said Hiesboeck.