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The CoinDesk Market Index, a broad-based index designed to measure the market capitalization weighted performance of the digital asset market, was trading flat.

Equity markets broke a recent trend upward with the Nasdaq dropping 1.1%, and the S&P 500 and Dow Jones Industrial Average declining 0.8 and 0.6%, respectively after online retailer Amazon pushed forward with layoffs, part of a larger cost-cutting campaign tied to the company’s pessimistic expectations for the months ahead.

While some analysts remained horrified by FTX's self-inflicted downfall, with an Arcane Research newsletter calling the "situation a mess," and noting that one of the largest crypto companies in the industry was playing with customers’ money," others saw it as a potential building block for the young, crypto industry.

Venture capitalist Kevin O’Leary told CoinDesk TV’s First Mover program that FTX’s collapse doesn't mean it will be the end for crypto and described the debacle as a “defining” moment that will “stabilize” the industry. “This does not kill crypto,” added O’Leary, who said that he had considered rescuing FTX before SEC chief Gary Gensler highlighted anew the industry’s lack of regulation. “There’s going to be a silver lining to this disaster. There’s no question about it. It’ll be called regulation.”

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By Sam Reynolds

Imagine for a moment if there were a class of companies whose sole job was to safeguard customers’ assets being held by an exchange or other institution from theft, hacks or misuse by executives. And imagine if these companies were registered with the government, insured and regularly audited, with the results available for the public to inspect.

Now imagine if the majority of exchanges didn’t use these services because it slowed their business down.

Welcome to November 2022.

“If you use an external independent, licensed custodian, we would never have gotten into this situation because they couldn't have had access to customer deposits,” Alessio Quaglini, CEO of Hex Trust, said in an interview with CoinDesk.

Quaglini said that with a custodian, clients’ assets are legally and technologically segregated, available for public monitoring via block explorers, and insured. Assets are disclosed, as are liabilities.

To put it bluntly: the funds would have been safe from outsider threats, insider threats, and Alameda Research.

“The ledger would have been at least managed by an independent party versus the kind of internal ledger that they were using between FTX and Alameda,” said Quaglini. “The frosting on the cake was the ‘hack’ where employees were leaving, nobody knew who was in charge of what, and then all of the sudden funds disappear because you don’t know who’s in control of the private keys.”

Despite all the due diligence that was allegedly done on FTX by some of the world’s most important venture capital funds like Sequoia, Softbank, and Temasek, this issue never came up. Caught in the Bankman-Fried cult of personality, these VCs never thought it necessary to have some safeguards in place to protect customer funds — which would have certainly been a requirement in the TradFi world.

“Investors are guilty in this case of throwing money [at FTX] without asking for really basic things like segregation [of] clients’ assets. The fact that investors were not demanding this was quite embarrassing,” said Quaglini.

In July 2020, the Office of the Comptroller of the Currency (OCC), greenlit nationally chartered banks in the U.S. to provide custodian services for crypto. In the days following that announcement, crypto raced from $9,514 to over $11,000.

Institutional capital was accustomed to having custodians, and this was the key to unlocking this narrative. This is how the asset class hit $1 trillion, and another Mt. Gox was prevented.

Some exchanges have their own custodians, like Coinbase and Gemini. These are separate entities from the main exchange, licensed appropriately under local law (Coinbase and Gemini both have New York licenses).

But FTX did not.

Nor does Binance.

Without custodians, and their requirements for public disclosure, we have no way of checking who’s solvent and who’s insolvent. Publicly known wallets can help, but that’s not the full picture. The public will have to take the word of executives at face value, and pray that Crypto.com’s balance sheet is as strong as it claims.

Exchanges are now effectively operating as unregulated banks with fractional reserve banking minus the capital requirements, regulations, or ironically, transparency.

Something has to change. Hopefully, it's not stringent regulation that strangles the industry.

Binance’s Changpeng Zhao wants to establish an industry association to promote best practices as part of his recovery fund. But will this include the use of licensed custodians? Time will tell. So far, all he’s been calling for is self-custody.

Important events.

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CoinDesk TV

In case you missed it, here is the most recent episode of "First Mover" on CoinDesk TV:

FTX Fallout Worsens as Exchange Sees Mysterious Outflows Exceed $600M; Kevin O'Leary on Crypto Outlook

As if things weren't bad enough for bankrupt FTX, the cryptocurrency exchange was drained of some $600 million in an apparent hack. Hacken CEO Dyma Budorin joined "First Mover" to discuss the details. Also O'Leary Ventures Chairman and Shark Tank star Kevin O'Leary, one of the high-profile investors in FTX, joined First Mover Plus, bankruptcy expert Thomas Braziel gave his assessment of FTX and what to expect in court.

Headlines

Solana Foundation Invested in FTX, Held Millions in Sam Bankman-Fried-Linked Cryptos on Exchange: The foundation addressed the fallout of the FTX debacle in a blog post.

Morgan Stanley Says There Is Still Much Leverage in the Crypto Ecosystem: Retail investors may start to sell if bitcoin trades below $10,000, the report said.

Bitcoin Miners' Balance Slides as FTX Collapse Weighs on Crypto: Data tracked by Glassnode shows, the number of bitcoin held by miner wallets has dropped to a 10-month low.

FTX Collapse Exposed 'Weaknesses' in Crypto, Janet Yellen Says, Bloomberg Reports: The U.S. Treasury Secretary said the crypto sector is in need of "very careful regulation" while some lawmakers are already preparing to propose tougher rules.

FTX’s Failure Is Sparking a Massive Regulatory Response: Lawmakers, regulators and criminal investigators are looking into FTX’s collapse, and Sam Bankman-Fried’s tweets aren’t helping.