With the cryptocurrency market on the brink of a new era, will emerging proof-of-reserve systems be sufficient for protection?
The cryptocurrency market is going through one of its toughest times. The collapse of the FTX exchange was a heavy blow for the market, which was destroyed by the eruption of the Terra crisis. Currently, the crypto market is feeling the bear trend most deeply. After these processes, Binance came up with an idea to restore credibility in the market. The idea was that exchanges go for proof of reserve. Also, Binance announced today its new proof of reserve system, Proof of Reserve (POR). But will all these efforts be an adequate safeguard for the next collapse?
Market Crashes and Exit Liquidity
The collapse of Luna, the decentralized smart contracts platform and stablecoin issuer, was one of the most important crypto events of the year. The project, which entered the top 10 according to the market value ranking, managed to rise to the level of 120 dollars. As a network structure, the problems in the system connecting Luna and UST coins made the project history.
The reflection of this collapsed Luna project to the investors was quite heavy. In the instant crash, $40 billion in the market just evaporated with the Luna reset. So just one cryptocurrency has destroyed $40 billion of its investors.
Luna Foundation, which wanted to save UST, whose peg broke down, started to sell all its reserves. They did not hesitate to sell even Luna, especially Bitcoin. The foundation, which has hundreds of thousands of Bitcoins in its hands, dealt a heavy blow to the market. That crash evaporated billions of dollars from the entire market. The fall of Bitcoin, the shake-up of stablecoins and the reset of Luna allegedly destroyed over $100 billion. Of course, there are winners as well as losers. We can say that this money has been in the hands of someone. However, this did not prevent the collapse of the industry.
On the other hand, the collapse and subsequent bankruptcy of FTX also went down in history as an important event. This event was enough to evaporate over $70 billion from the cryptocurrency market. Binance CEO Changpeng Zhao mentioned the problems experienced on the FTX side and stated that he will sell the FTTs he has. In the process that started after this discourse, the dirty basket of FTX and Alameda emerged. FTX traded user assets to save its sister company, Alameda. In the resulting balance sheet, it was understood that billions of dollars were wasted. The fall of this news and the collapse of FTX evaporated $10 billion in one day. The crypto industry has taken one of the hardest hits of the year. Projects in which Alameda and FTX invested began to collapse one after another. Some filed for bankruptcy and investors suffered.
So, Will Evidence of Reserves Cover the Billion-Dollar Collapses?
With the onset of proof of reserve, many cryptocurrency exchanges have begun to disclose some of their holdings. According to Nansen data, Binance, which is referred to as the world’s largest cryptocurrency exchange, has a proven reserve of $64 billion. Other exchanges have reserves between $6 billion and $1 billion.
The statement from Coinbase also drew attention. The exchange stated that it has 2 million Bitcoin reserves. Its value is approximately 30 billion dollars.
However, let’s say that in a market crash, billions of dollars evaporate and panic selling begins. In this case, will the reserves remain intact?
Capturing a transaction volume of approximately 10-15 billion dollars per day, FTX was also holding customer assets. However, the effect of the collapse and the panic process caused instant exits in the stock market. Unable to meet its collateral and deliver assets to its customers, FTX had to halt transactions.
Considering this process, it seems that no stock market is guaranteed in a possible collapse. Because here, rather than the effect of the collapse, the panic experienced by the investors is more effective.
Exchanges in a Possible FTX or Luna Crash
In the future of the crypto industry, we may see a crash story again. This is always on the table. In such a case, an average of $50 billion could evaporate. Although this evaporation moves from the losing side to the winning side, it creates a domino effect in the collapse of the market.
In a possible collapse of $ 50 billion, the processes that all other exchanges, including Binance, will go through, stand out.
The principle structure of cryptocurrencies is directly proportional to the number of coins and the amount of dollars invested in the coins. A coin with a market cap of $100 million has an asset of $50 million. In this principle, which is accepted with the logic of liquidity, the logic of the trader is valid. While those who want to buy coins have to leave dollars in the liquidity pool, those who want to buy dollars leave coins in this liquidity pool. The decrease in the dollar and the increase in the amount of coins in the liquidity pool mean that the project price also decreases.
Cryptocurrency exchanges also run their algorithms on this principle. For each listed coin, the coin and its corresponding dollar amount are in the pool. A person who wants to buy A coin from the stock market leaves dollars on the stock market and receives his coin. In this case, the dollar transferred to the stock market is added to the liquidity pool of A coin. In the reverse transaction, the stock market gives dollars and takes the coin and adds it to the liquidity pool.
In the event that a listed coin explodes, the liquidity pool of that coin is almost completely emptied by investors. Only the amount of coins remains in the pool and the price value of the project is reset. The possibility of such a situation is always on the table. If this happens, the effect of panic can be up to 10 times.
In this case, the reserves of the stock markets will begin to melt. In particular, there will be serious pressures on the stablecoin reserves of exchanges. Because, users will try to get their dollar equivalent by leaving their coins in the pool. The fact that such a panic and collapse cannot be covered by any stock market has also emerged after recent events.
What Should Exchanges Do?
FTX, one of the world’s largest cryptocurrency exchanges, has more errors behind its collapse. The company’s executives traded in leveraged trades quite often. They had to show customer funds as collateral. Because in the bear market, they were an audience that liked to open long-term trades.
This new model and move put forward by Binance is very promising in terms of the market. Of course, this requires impeccable management.
Because the proofs of reserve offered by the exchanges are actually seen as consisting entirely of customer funds. We can say that the liquidity pool in the stock market responds at a ratio of 1:1. The panic and money outflow caused by the possible collapse will cause the exchanges to stop the withdrawals if the 1:1 ratio is distorted.
In decentralized exchanges, this works literally at a 1:1 ratio. Let’s take the Pancakeswap exchange as an example. The projects that come out here are released by adding dollars and coins to the liquidity pool. In this case, the assets of each user are kept in the pool with the same amount of money. Selling pressure lowers the price, while buying pressure raises the price. But by no means is this pool available for other operations.
Using a simple algorithm, exchanges have to hold assets that correspond to the coins they distribute to users. They also have to secure them against any hacking incidents. For this, although proof of reserve will come, it will not be enough. For example, when the managers of exchange A open a trade with these assets, a crack occurs in the pool. This crack means not being able to pay the user 1:1 in a possible crash.
Precautions should be taken before the Dominoes are toppled
To protect the crypto ecosystem, which is a global industry, it can be useful to resort to traditional methods. Exchanges should reflect the amount of coins corresponding to all dollars from their users in a 1:1 ratio. Even if this reflection gives confidence, on the other hand, it is necessary to secure the safe.
The centralization of the crypto industry, which started as a decentralized journey, also comes to the fore here. Because the stock markets can strengthen the effect of the collapse in the slightest algorithm deviation. The FTX event was one of the most important warnings of this.
Entrusting assets to a global medium rather than relying on individuals and institutions can solve the entire problem. For example, the World Central Bank’s monitoring and control of stock market reserves could also help deal with a potential collapse with less hassle.
Of course, here are some steps that stock markets should take. Binance has BNB, BTC and BUSD savings in its bailout fund. In fact, stablecoins should be completely included in the recovery fund created by exchanges for the crypto industry. This should be chosen from the most reliable stablecoins. Because in the collapse of the market, stablecoins will remain as pegs, while cryptocurrencies may decline.
Conclusion
The crypto industry, which has become a new industry, will continue to exist in the future. The FTX and Luna events this year have been one of the factors that have made the crypto industry a more reliable and protected industry. In this way, change and control began. In the next few years, we are very likely to see the crypto industry on a whole new level.
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