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As the fallout from the FTX fiasco continues, Stockhead spoke with DigitalX’s Jeremy Balding and Pratik Kala again to get their updates on this, and more.

DigitalX is one of Australia’s leading blockchain technology and investment companies, Balding is its Head of Fund Management and Kala is the firm’s Digital Asset Investment Analyst.

“We will see regulations being introduced at a faster rate around the world”

Hello to both of you. So a bit happened with the FTX situation since we spoke about a week ago. What do you think of all this now?

Jeremy Bald: The last time we spoke with you about this, we mentioned that we didn’t think the FTX situation was going to be that bad. Well, it turned out to be worse than we all expected.

There is still much to do on regulations globally over the coming months. We are pleased to see the Australian Treasury Department committing to introduce exchange and custody regulations in parliament next year. This is crucial for investor protection and confidence in the sector.

And then, of course, we just need to see what’s yet to come in terms of FTX exposure across the industry, and how the industry shapes up accordingly.

[Update: further significant players in the space have now shown to be affected by the FTX contagion effect, with Genesis’ lending unit, for example, pausing withdrawals.]

In terms of regulations, what do you think needs to be done? Can Australian regulators play a big role?

JB: Australia can certainly play an important role in crypto regulation. The government is working on its token mapping exercise and has already consulted the market on a few of these topics. But it’s definitely time to speed things up and provide investors with the protections that I think the industry and investors want and need.

I think we will see regulations being introduced at a faster pace globally. This in turn should lead to greater confidence in the industry, which should lead to the next rally in digital assets.

The FTX fiasco might have been avoided with better licensing regimes

Do you think the crypto world is looking to the US to lead the regulatory conversation?

Pratik Kala: Europe is currently leading the charge with its MiCA (Market in Crypto Assets) regulations. They seem to be the most advanced in formalizing their position.

But obviously the majority of crypto streams are denominated in the US – so it would be nice to have some clarity from the US, which will allow for some sort of transparency for the industry going forward.

One of the reasons some of these exchanges were forced to move overseas was regulatory uncertainty – FTX was in the Bahamas and others were in the British Virgin Islands, Seychelles and Panama.

The only 100% regulated exchange in the US at the moment is Coinbase; and even they got into trouble due to unclear rules about what they can or can’t list and what is or isn’t a title.

Hopefully, everything that’s happened over the past week will be the wake-up call for regulators to move forward.

But in the meantime, crypto platforms just need to carry on and mitigate risk as best they can?

JB: The view we have always held is that although we operate in an unregulated market, we are self-regulating. And I just think it has to be industry-wide, whether it’s a centralized organization or a decentralized application.

And for example, exchanges could do a better job of blacklisting certain wallets – where do the hacked funds go? Someone’s wallet. The industry as a whole should act faster to ban these wallets from entering apps.

They shouldn’t have to wait to be told to do so. They should just take proactive steps to try to self-regulate and prevent those funds from moving around.

Proof of reserves, proof of liabilities

We also talked last time about the idea of ​​“proof of reserves” for crypto exchanges and how it could be a great thing for better industry transparency. But there have been rumors that some exchanges supposedly rigged their audits?

PACK: So overall this is a great initiative and it’s time for more exchanges to talk about the reservations they have on their books. Proof of Reserves is basically cryptographic proof where you list all your cold wallets so that the assets they hold and the overall balances are public.

The alleged tampering comes from the fact that some of these exchanges have snapshots of proof of reserves, which is like a monthly audit, so to speak.

How can this be played out in a deceptive sense?

PACK: Let’s say they end up having a shortfall of $100 million. They could conceivably call another exchange and with some help, right before the audit preview, fill in that $100 million for the audit. After the audit snapshot, these funds can be returned. This is speculation at the moment and nothing has been confirmed.

What we need is Direct proof of reserves which are updated in blocks – not a monthly audit. But here’s the thing, the industry also needs proof of accountability.

Can you explain this a little further?

PACK: Let’s just say a platform has $10 billion in its wallet. He could have remortgaged some of these assets to outside lenders or taken out other loans. Unless they are also disclosed, a clear conclusion about reservations can never be fully drawn.

Hopefully, as the industry matures, one of the big four auditing firms will look at all of this and perform a more formal audit using technology that can offer real-time proof of reserves and a proof of claims system. passive.

Make it a cold one

There has been a lot of talk throughout the entire FTX drama about how retail investors should consider withdrawing their funds from exchanges and storing them in a cold wallet. DigitalX stores funds in cold wallets, right?

JB: Absolutely, and we use institutional grade cold storage for our purposes. We only leave a small amount of assets on the exchanges for a short period of time – the minimum amount of time needed.

PACK: An institutional-grade cold wallet manages keys offline and uses “isolated” devices (not connected to the internet) to securely sign transactions. Several rounds of approvals are required before anything can be unlocked.

JB: But for retail investors, I’d say it’s definitely time to explore self-custody and cold storage options. I think there’s been a huge surge in cold storage device sales over the past week, for obvious reasons.

Expect more spinoffs over the next few weeks

What short-term expectations do you have for the market?

PACK: I expect more spinoffs over the next few weeks. And until this is completely settled, it is very difficult to say because some companies have not yet declared publicly whether or not they have exposure to FTX.

We saw that BlockFi and Voyager, which FTX was supposed to bail out [after Voyager’s Terra Luna-contagion liquidity issues earlier this year], have a lot of FTX exposure, and there will be more.

So there is still a lot of uncertainty in the market. And, of course, there’s also the fact that Bitcoin’s hash rate has reached all-time highs and many miners are struggling as a result of all this as well. If some of the miners were also managing their treasuries with FTX in an already tough and competitive market, then we might see more forced selling.

We need the dust to settle before we can have more clarity.

“Crypto is here to stay”

Do you think the market has at least shown some resilience after its initial dump on FTX news? On the price side, it seems to be holding up for the moment.

JB: To some extent, yes. I think some of this can be attributed to the industry-led bailout of Binance. They stepped forward and tried to offer liquidity lifelines to certain protocols. I think that helped stabilize the market a bit.

PACK: And then the second point is that people thought the Crypto.com exchange also potentially had liquidity issues – their CEO basically tempered those fears, and last time I checked their withdrawals were being processed as expected. This has restored some short-term confidence, but we still have to wait for other industry players to reveal the extent of their exposure.

JB: The ecosystem has held up pretty well throughout this. It’s really a single player who embezzled funds and became insolvent – yes, there are repercussions to that. But the technology and crypto itself is still strong and here to stay.

It is important to make the distinction that FTX is not a blockchain company – people don’t build on it. This is an exchange only.

PACK: And completely centralized. By comparison, decentralized finance apps have seen a huge surge in the past three or four days, as this is where people have fallen back as a source of truth and trust.

Code is king in DeFi

Why then is DeFi considered a trusted source?

Because it is not run by humans and personal relationships. It is managed by code, which is built into the protocol, which simply executes, no matter what someone has to say. Basically, no one can manipulate it – it just runs set parameters and people have found some trust in this industry.

But DeFi is far from perfect, right?

PACK: Yes. DeFi has suffered from a whole bunch of hacks this year. Absolutely. The whole industry just needs to up its game in terms of security, build safer bridges, etc.

So DeFi isn’t perfect, but amidst all the carnage of this specific situation, it works perfectly well based on the rules it was programmed for.

But at the end of the day, it’s code and code can have bugs – there has to be a lot of work on a centralized front and on a decentralized front as well.

At Stockhead, we tell it like it is. Although DigitalX is a Stockhead advertiser, it did not sponsor this article. None of the content in this article represents financial advice.

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