Stop Making Worse Banks
The tendency to recreate unregulated TradFi patterns in crypto is destroying people's livelihoods and blockchains' reputations.
Recently, the massive crypto exchange FTX became insolvent, revealing it had a hole in its balance sheet worth billions of dollars due to bad investments made with funds deposited on the platform. This isn’t even the first big crypto platform to fail in such a spectacular fashion, with Three Arrows Capital (3AC) suffering a similar fate months before. All of this underscores the need to avoid recreating worse banks. As the saying goes: not your keys, not your coins.
Traditional financial (or “TradFi”) institutions have a largely bad reputation in the crypto space. The unique ability of blockchains to automate settlement of transactions in a decentralized, permissionless way provides ways to break out of prior financial constraints, which is, largely, a good thing. However, this only remains true if crypto is not used to speed run the failings of the past couple of centuries of the fractional reserve banking system.
Decentralized finance (or “DeFi”) is supposed to be about transparency and self-custody: you control your assets, and you can audit on-chain the financial platforms you use for things like lending or exchanging tokens. Protocols such as Aave have weathered devastatingly rough financial times for this reason. However, FTX essentially functioned as an opaque pseudo-bank, where your balance was not something on-chain but rather an IOU from Sam Bankman-Fried.
Of course, this is how banking works most places as well — and many bank collapses in the past have worked in a similar fashion. However, banks are regulated by the government, and, in the United States, FDIC insured. This, at least, provides some measure of assurance your balance will be there when you need it. The FTX Super Bowl ad featuring Larry David called the platform an “easy and safe” way to get into crypto. That safety was greatly overstated.
This is explicitly not to frame regulation as a panacea to these sorts of problems — rather, platforms like FTX replicate patterns that have, in the past, required heavy regulation to maintain even some semblance of safety and fairness. And that has not stopped banks from continuing to engage in practices to maximize the amount of money they can extract from customers like re-ordering transactions to maximize the amount of overdraft fees they receive.
What blockchains enable is a level of transparency and smart contract-mediated neutrality and automation not even possible in TradFi — yet the urge so many have is to just reinvent the wheel but worse. This costs the victims of these platforms’ collapse absurd amounts of money and absolutely destroys the reputation that crypto and blockchains have.
Centralized exchanges (or “CEXes”) like FTX should be seen as off- or on-ramps only: if you need to go from cryptocurrency to good ole fashioned dollars or vice versa, they make it much more straightforward to do so. However, users should immediately move funds either to their bank account or a crypto wallet to which they control the keys — ideally a hardware wallet if the amount is large or going to be held long-term.
This sort of self-custody can feel more intimidating and riskier for new users, but it enables you to avoid losing your balance when the next liquidity crisis hits. Don’t delude yourself into thinking any exchange, no matter how large and well-reputed it is, will truly safeguard your money — that was FTX, after all.
For added security with on-chain holdings, smart contracted-based wallets are a much safer solution. Sometimes called “multisigs,” given that they usually take multiple sets of crypto keys signing a transaction for it to be valid, though this is cumbersome for day-to-day use. However, they are the typical solution for “DAOs” — decentralized autonomous organizations — to maintain their treasuries.
If you’re looking for a bank account, just open a bank account. That’s not where crypto shines. And making this mistake repeatedly proves costly in a myriad of ways. It is imperative that we focus on bringing out its strengths, which will require both building in better, more transparent ways and educating people about how best to maintain their crypto holdings.
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