What the crypto industry should do to restore public trust
The past year has not been good for the crypto industry. Carpet sweeps, fraud and theft have caused billions of dollars in losses. Like many other very early crypto people, I have been through several of these cycles in the past and each time we came out stronger.
The big difference now is that we as an industry are no longer just a bunch of paranoid crypto fanatics who have gone back to building and innovating while ignoring the naysayers of the world. Contrary to popular belief, banks and governments are also enthusiastically continuing to build new products and competitive regulatory regimes around the world to support the next cycle.
The underlying technology has proven capable of scaling and has been trusted to hold and transact many billions of dollars in assets, thanks to the security and immutability of the underlying blockchain technology. However, counterparty risk management for crypto is still in its primitive phase, mainly provided by a few loud voices on crypto Twitter providing analysis of crypto products and institutions.
While it may not feel like the time to celebrate, we’ve created a lot of incredible new concepts and products since last crypto winter. To survive 2023, companies must move from creating self-serving innovations to products that are inherently safe for the wider community. In 2023, we have the chance to overcome our trust deficits and cross the chasm to secure widespread adoption.
Looking at innovations in the crypto ecosystem
Our breakthroughs as an industry were the result of hundreds of teams working hard during the last crypto winter to build highly innovative technology and also to solve many of the problems we ourselves had as individuals in the crypto ecosystem,
Decentralized finance (DeFi) developers created return-generating staking mechanisms for coin HODLers and collateralized lending protocols so we can take money off the table and buy real-world assets while avoiding capital gains taxes. Other developers created new, better blockchains and practical layer 2s that allowed us to ship innovative products at scale. Better and more efficient crypto exchanges sprouted up, offering more creatively leveraged ways to trade.
What’s true about all this innovation is that while it demonstrated a lot about the value of our technology, it was also, by necessity, very inward-focused. We solved genuine problems that people like ourselves, who hold cryptocurrencies, had at the time. A common thesis was that we needed to build trustless financial protocols where counterparty risk was a thing of the past, to distance ourselves from early stock market hacks and the exuberance of the ICO bubble.
This development brought an onslaught of outside smart money into the industry to fund big bets on tokens and the industry itself and a new class of financial products that attracted the next generation of retail crypto investors seeking returns and growth. But this caused increased pairing and mixing of tokens with significant counterparty risk (such as FTX) ultimately leading to the failures of 2022.
Building the next generation of crypto use cases
This year will be the first full year of building the next generation of crypto use cases. Many experts in the field, myself included, believe that the best way to drive growth in the industry is to take what we’ve learned from previous cycles and start applying it to practical, real-world situations to fully mature as an industry and finally cross the chasm.
In particular, we are now ready to use tokenization and DeFi to use cases with off-chain assets and liabilities. Examples include centrally issued stablecoins as well as NFTs (non-fungible tokens) that fix an ownable and tradable blockchain-based right to real-world intellectual property. Although centralized stablecoins are primarily used for crypto use, they exemplify linking tokenized rights to off-chain value.
A key skill needed for this is counterparty risk management for transactions, token issuers and DeFi participants. This is still somewhat primitive and often handled by a cadre of pundits on crypto Twitter who pontificate about worst-case scenarios around exchanges and protocols.
This year, the industry has the crucial task of filling critical gaps, including:
- Making stablecoins practical for traditional payment cases.
- Making tokenized securities a reality by embracing securities law and not looking for loopholes.
- Use of NFTs for financial purposes, such as unsecured debt from actual counterparties.
By addressing these and other use cases, the industry can finally see the benefits of the technology developed in the last cycle. It’s a pivotal year for the crypto industry and a chance to show its value to a wider audience.
Rebuilding trust in the crypto industry
Firstly, we need to rebuild trust as an industry; it must be our highest priority. While our layer-1 blockchains are largely trustless, the sector as a whole is not.
We must work to restore trust between each other, our end users and financial regulators. If we as a crypto industry do not take the necessary steps to rebuild trust, others will. The steps we take must come from ourselves rather than imposed by regulators or traditional finance.
Ultimately, trust is essential to making crypto safer for everyone. Not only must we minimize risk, but we must work together to manage risk and continuously improve security. This includes minimizing theft of funds, minimizing loss of funds, minimizing blanket pulling, improving data privacy, minimizing the impact of sanctions risk on critical infrastructure, and improving record keeping to meet tax, audit and other requirements of end users and businesses.
Why has it taken so long to improve critical areas?
While a lot of innovation has happened in DeFi and NFT since last crypto winter, we have been very resistant to changing the core aspects of most crypto transactions. Sending, withdrawing and depositing funds has not changed much since the first crypto exchanges appeared more than 10 years ago. For more complex use cases like DeFi and NFTs, most people still use Metamask or something similar, and the core of the technology hasn’t changed much since the early days of the ICO boom.
Most people who were still in crypto last crypto winter were rightly very paranoid about changes due to a lot of fraud and theft during the ICO boom. Still, the newest wave of crypto users who have joined in recent years have a much greater risk than ever. Many early adopters of crypto see the loss or theft of funds due to the inherent difficulty of using legacy wallets as the cost of doing business. This is not acceptable – we can and must improve this to drive next generation adoption.
Critical steps to overcome the industry’s confidence deficit
Our first focus should be on counterparty risk management. As in traditional banking, everyone from institutions to individual users must know and trust who they are dealing with to minimize the risk of loss of funds, money laundering and exchange hacks. To achieve this, we need to rethink our approach to crypto deposits and withdrawals from exchanges and self-powered wallets. Non-technical users should be able to expect privacy and security in their transactions, and the details should only be shared between the parties involved.
Second, we need to implement higher-level authorization flows that give all transaction participants the right to reject unwanted funds or responsibilities. Finally, contrary to popular belief, exchange host crypto plays a crucial role in ensuring the privacy and security of keys for most users. On the other hand, self-hosted crypto will continue to be critical to maintaining the integrity and security of the industry as a whole. They are the ultimate checks and balances that keep the ecosystem safe and centralized parties accountable.
None of the above should require changes to underlying protocols, but new protocols can easily be distinguished by supporting the above directly.
Infrastructure providers have already taken the initiative to solve some of the problems faced by centralized exchanges. On-chain analytics, for example, offer businesses practical tools to monitor risk and investigate incidents. Meanwhile, multi-party wallet providers (MPCs) simplify key management and speed up the settlement of funds. Regtech solutions also work to make it easier for centralized exchanges to manage the real risk associated with transaction counterparties.
With these building blocks in place, the time has come for us to break away from past mistakes and move forward towards attracting the first billion crypto users.
