Swarm Markets: Crypto Has A Security Problem – What’s The Solution?

“The winter is coming.” A phrase many became familiar with through HBO’s Game of Thrones, which refers to a long, dangerous and turbulent time ahead. In the world of crypto, winter has arrived, and after a year of struggle, it finally seems that there is light at the end of the tunnel. But what is to prevent this kind of downward spiral from happening again?

In the crypto world, the domino effect is evident. When one digital currency collapses, there is a ripple effect that affects others. Even if they have nothing to do with the affected, all cryptos feel the effects of it. Swarm markets is a licensed DeFi platform — a unified exchange for securities and crypto.

The platform’s co-founder, Timo Lehes has over 20 years of experience in the fintech field, and experienced the impact of the financial crisis in 2008 firsthand. Drawing parallels with that event, Lehes has noted that the civil impact cryptocurrencies have on each other is hindering their mainstream adoption. Fearing a repeat of what happened in 2008, investors are wary of investing in the digital world.

So what is the solution? Lehes told The Fintech Times that the introduction of real assets to the blockchain was a must to tackle crypto’s security issues:

Crypto has a security problem – here’s a solution

The events of the last few months – which began with Celsius and now continues with FTX – has exposed one of the biggest flaws in the crypto sector since its inception. It is the failure of security and transparency.

Crypto began with small, often ideologically driven projects over a decade ago. In the intervening period, it has grown exponentially to represent a diverse range of ideas, technologies and innovations.

But a unifying issue has been revealed in recent months. Crypto, by and large, has created a market from scratch of digital currencies and tokens, starting with Bitcoin, then Ethereum and later protocols like Maker, Uniswap and many more.

domino effect

Although Bitcoin and protocol tokens do different things and have different value cases while underpinning key functions in many projects, the market itself has become too highly correlated with itself. When a crypto asset sneezes, the rest of the market tends to catch a cold. There is also a tokenomics issue, where in some cases tokens can be produced or “printed” at will.

This year we have seen that projects or platforms have not provided proper security for their tokens or underlying, mostly return-bearing, services. Lack of transparency, or even sometimes sheer lack of coherence, has exacerbated this problem to catastrophic proportions.

Celsius and FTX, via their affiliates, appeared to have surrendered their positions and failed to provide security, either in shortage or quality. Inherent in this were systems, risk management and transparency failures that caused significant collapses.

Crises like Celsius and FTX have done a lot of damage, which will only be repaired if the sector looks to adopt solutions to this security problem. Not only do we need to diversify the type of security available within the crypto ecosystem, but the market needs transparency and better protocols to verify that assets are where we think they are.

Prevention of disaster

Some firms offer new ideas as proof of reserves. However, these solutions only provide single snapshots rather than providing consistent evidence of security.

As consumers have limited abilities to truly assess the validity of financial audits, regulators will continue to step in to protect the consumer. The regulators will come to this conclusion in the same way they did for the banks during the financial crisis and act accordingly. It is incumbent on the sector to be wise about this and provide better solutions that return confidence to the market.

For us, this means creating security. The sector needs more trust in chain security issuance, attestation, certification and redemption to facilitate trade, lending and investment. That always means more cooperation with regulators and trusted third parties to monitor ongoing security commitments.

History does not repeat itself, but it often rhymes

The platforms at the center of this year’s chaos offered tokens, products and services freed from any tangible security. The highly correlated assets sent leveraged positions spiraling as soon as these tokens came under real pressure from global investment market pressure.

This led to carnage as user confidence disappeared – essentially creating digital runs on the exchanges. It has also led to a resurgence of self-storage by crypto holders.

These are new platforms, but this problem is one that banks faced in the bad old days of casino banking. For years, large financial institutions gambled with customer deposits, while collateral and risk management obligations imposed by regulators were negligible.

This ended after the Great Financial Crisis (GFC). Legislators and regulators got tough on banking with measures such as Dodd-Frank in the US and EMIR or Basel II in the EU and the UK.

In a sense, crypto has now had its own GFC. The net result will be the same for the sector as it was for the banks in 2008-09 – more regulatory oversight, capital and security obligations.

Enter digital assets

Amidst the noise of high-profile collapses and market problems in the crypto space this year, the quiet work of building a new and profoundly important market for digital assets is well underway.

There will likely be a marked shift away from the speculative asset bubbles of the early days of crypto towards institutional use of DeFi technologies. To digitize assets that plug into the deep liquidity of traditional markets, participants must be able to verify their existence on demand.

Reliable and transparent infrastructure must be combined with reliable actors, such as a regulated institution or auditor, who do not own the security, but can attest to its existence. Timestamps and records can be facilitated by immutable blockchain technology.

There is already a growing list of large institutions looking to create ecosystems for digital assets to work within, which could be the defining trend for the future of DeFi.

The use of stablecoins and wider digitization of RWA is the future of the crypto sector. The endgame of this will be the union of traditional asset classes and institutions with modern digital blockchain technologies led by the DeFi sector.

It is through this kind of innovation, pulled together with sensible regulation and the wider adoption of RWAs, that crypto can move forward from the winter of 2022, and towards its defining role in the technological future of global financial infrastructure.