Blockchain technology and Decentralized Finance (DeFi) is here to stay, regardless of the recent turmoil with FTX which has affected the Web3 industry negatively. Main public blockchains have never been hacked. Smart contracts in real estate have never been hacked. This is still the technology of the future.
Web3 skeptics and proponents of a centralized financial system and central bank control, are rolling out the old argument that cryptocurrencies represent no real value. This is exactly what fiat currencies became when the gold standard was abandoned in the U.S. in 1971. The U.S. dollar is backed entirely by the full faith and trust in the government that issued and keeps printing it. Over the last two years, the US Federal Reserve has printed 81% of all US dollars in existence, from $4 trillion in January 2020 to almost $22 trillion in June 2022.
Sam Bankman-Fried made millions of dollars exploiting inefficiencies in the Bitcoin market. He then founded FTX, a marketplace for crypto investors to buy, sell and store digital assets, and its own sister hedge fund – Alameda.
Over recent months Alameda took out loans to make venture capital investments and fund expenditures. The company accumulated a large margin position on FTX – it borrowed funds from the exchange, and also over-leveraged their balance sheets by holding a large amount the illiquid FTX token – FTT, as collateral. When the crypto market crashed this spring, lenders moved to recall those loans. Funds that Alameda had spent were no longer available so FTX improperly used approximately $10 Billion of customer funds to prop up Alameda.
FTX isn’t DeFi. The catastrophe happened when FTX lent out customer deposits, rather than holding them as redeemable 1:1 deposits. In short, FTX tried to play the role of a centralized bank and the relationship between Alameda and FTX was the problem.
The FTX catastrophe represents a failure of the centralized finance mechanisms that DeFi has been working to replace. Governed by immutable smart contracts, it is impossible for DeFi companies to do anything fraudulent with their client funds. These lending/borrowing platforms are self-regulatory, if you take out a loan you first need to deposit capital at a safe loan-to-value ratio. Should the value of your collateral backing the loan, fall below a pre-set threshold, your loan is automatically liquidated.
The most competitive, market tested DeFi protocols and Smart Contracts contain these self-governing rules that avert scenarios like what’s currently happening at FTX.