Lessons From FTX About Decentralization

With the recent collapse of FTX, it has become clear that there are still many aspects of cryptocurrency and decentralization that ordinary users are not fully aware of yet. As the latest, and biggest, company to fall this year it is becoming more important to continue emphasizing some important caveats regarding blockchain technology and the companies associated with it. 

Decentralization still confuses many

Not Your Keys, Not Your Crypto is a core principle of blockchain technology that is often ignored for a variety of reasons that generally relate to a lack of understanding. Decentralization has a variety of benefits, but its most important quality of all is how a user holds total ownership over their wealth. 

By design, the only way to access a stored amount of value on a blockchain is by holding the private keys to a wallet and, because of this feature, it is impossible for anyone else to take hold of this liquidity so long as they do not have the associated private key.

However, opening a wallet can be a difficult task for many who do not have the appropriate access to a computer, lack the knowledge, or simply do not have the time; but by not doing so, users are left wide open to a variety of risks that are unnecessary and can cause investors to lose everything as we saw with FTX. 

Exchanges are not brokerages

The problem with leaving liquidity on an exchange is clear; it does not belong to you until it is held by your private key. Until liquidity is moved off a centralized exchange, it fully belongs to that exchange because they hold the private keys to your custodial wallet. 

This problem becomes an issue quickly after an exchange like FTX has a liquidity crisis. Exchanges can lock withdrawals which can cause users to lose access immediately to their liquidity when an exchange becomes insolvent. 

Unlike brokerages, which can go under without sacrificing the stocks in your portfolio, crypto exchanges have far less risk mitigation procedures because crypto is an uninsured currency that is not protected by any sort of institution. 

It is extremely important for users to remove their crypto from an exchange as soon as they make a purchase because they do not truly own their crypto until it is placed into a non-custodial wallet. 

Always use a wallet - hot or cold

Unfortunately, one of the most common suggestions for removing crypto from an exchange is that a user needs a cold wallet to do so. This is only half true. Cold wallets, while secure, are not the only option for users. 

Any decentralized wallet will do fine for a user on any blockchain so long as the private keys are not visible to any other person. While cold wallets are typically safer because users can disconnect their private key from the internet, hot and warm wallets like Metamask and Phantom work just as well. 

In fact, one of the major benefits of a hot wallet over a cold wallet is that they are free to use. Cold wallets are a piece of hardware and require a purchase to acquire whereas hot wallets like Trust Wallet can be downloaded and used for free which means that there are fewer reasons to keep liquidity on an exchange when better, more decentralized options are available. 

Many tokens are scams

On a separate note, one major lesson to learn from all of this is that tokens created by exchanges or other companies/corporations are not inherently valuable unless there is a verified reserve, liability, and audits.

Earlier in the year, we saw this happen to TerraLuna which pegged its TerraUSD tokens to an algorithm that, once broken, caused the entire protocol to fall apart. This was a similar event to what just happened with the FTT tokens created by FTX which had no real valuation and were being used as collateral to trade customer funds. 

Not Your Keys, Not Your Crypto

This cannot be stressed enough - cryptocurrency was created as a means for people to own their wealth without any third parties or middlemen standing in the way; and while exchanges and protocols all make it easy or lucrative for users to store their assets on different platforms, it brings a centralized third party back into the equation and removes the key benefit of cryptocurrency - ownership. 

Although everyone invested in crypto has been adversely affected by the fallout of FTX’s insolvency, those who understand decentralization to the fullest and practiced it by taking their funds off of centralized exchanges at all times have been less affected because they were not locked out of their assets.