Crypto’s unfulfilled dreams get a tailwind from the US takedown of Binance, Coinbase

A fundamental principle of this whole cryptocurrency experiment is to highlight the benefits of decentralizing the financial system.

“Governments are good at cutting off the heads of a centrally controlled” network, wrote Satoshi Nakamoto, Bitcoin’s creator, in 2008. “But pure P2P [peer-to-peer] network … appears to be holding up.”

And yet crypto became truly centralized. Binance, Coinbase and – before it exploded – FTX grew to become trading giants, creating a vulnerability if these companies ran into trouble. And they did. Binance and Coinbase face a US regulatory crackdown. As is well known, FTX crumbled last year due to fraud allegations.

However, there is another way, a path mostly known only to traders deeply embedded in the crypto world: decentralized exchanges (DEX) like dYdX or Uniswap. And while there are obstacles to more widespread use—they’re far less user-friendly than centralized exchanges (CEX) like Binance, whose websites and apps resemble the brokerage software of traditional finance (TradFi)—the investigations into Binance and Coinbase could create tailwinds for these geeks, the decentralized financing solutions (DeFi).

“My best guess is that this will further increase DeFi’s market share as protocols are harder to stop,” said Dave Weisberger, CEO and co-founder of CoinRoutes. While it’s not impossible to go after DeFi protocols — the US Securities and Exchange Commission just subpoenaed the decentralized autonomous organization (DAO) behind SushiSwap, another DEX — “protocols are harder to prosecute,” he added.

Howard Greenberg, president and co-founder of the American Blockchain and Cryptocurrency Association, also sees DeFi gaining momentum, claiming that the Commodity Futures Trading Commission’s case announced this week against Binance – which was accused of breaking the law by allowing US traders to access offshore -the exchange – “may push traders to decentralized options.”

Shortly after the news that US regulators had sued Binance, users withdrew $400 million from Ethereum, according to blockchain analytics firm Nansen. This compares with a net outflow of $2 billion over the past seven days.

Until recently, centralized crypto exchanges have been the primary choice for traders looking to buy and sell bitcoin (BTC) and the like. For retail traders, it’s because CEXs can be less intimidating than the apps that serve DeFi. For professionals and institutional investors, there has historically been more liquidity on CEXs, an appealing quality.

Binance, the largest crypto exchange in the world, has a daily trading volume of around $9.3 billion. In comparison, dYdX, the largest DEX, trades around $770 million worth of crypto in a day.

DEXs are inherently more transparent than CEXs, given that the former complete trades publicly on a blockchain. CEXs conventionally did not, in part because blockchains simply cannot process transactions quickly enough. But blockchains are getting faster. Ironically, DEXs can make regulators’ jobs easier.

“CEXs are complete black boxes, which almost always create the uneasy perception of misaligned interests, making the job of a regulator significantly more difficult,” said Berk Ozdogan, head of strategy at Dexalot.

“From a regulatory perspective, trading taking place on public blockchain DEXs means that the effort to prepare formal inquiries, the time needed to conclude the discussions and the trust that needs to be placed in the investigated CEX would no longer be necessary as the activity would be easy available for consideration,” he added.

On DEXs, traders can buy or sell cryptocurrencies without intermediaries, which is typically the part that creates uncertainty due to the limited insight the public gets.

One of the complaints that regulators and even clients of large centralized exchanges themselves have repeatedly expressed is the need for a so-called financial audit, a document that proves the company has exactly the amount of assets it says it has. The closest thing to an audit that most exchanges, such as Binance, have released so far is a proof of reserves document, but it can’t be trusted nearly as much.

That would be one step closer to the transparency requirements that lawmakers crave, but still far from the level of transparency that DEXs, where all movements can be tracked on the public blockchain, naturally provide.

“If we learned anything from 2022, especially with FTX, it’s the fact that custody conditions, especially in the face of a lack of regulation, are very poor,” Ozdogan said. “Too many users have lost assets to bad actors, and in turn, centralized exchanges’ custody has character. In the world of digital assets, one rule reigns: Not your keys, not your crypto.”