CEXs Need To Regain Customer Trust

There's a cruel irony in the world's most famous crypto exchange being one that's no longer going. Ask any nocoiner to name a CEX and, once you've explained to them what this abbreviation means, odds are they'll say FTX. Not Binance, Coinbase or BitMEX – FTX. It might be bankrupt, defunct, and the source of criminal complaints and lawsuits galore, but there's no denying its notoriety.

This is understandable. It's human nature, after all, to obsess over bad actors ahead of good governance; scandal is what makes the headlines. Financial prudence and capable stewardship do not make for great bylines. It's been almost a year now since the collapse of FTX, during which time industry players have had more than enough time in which to pick up the pieces and regroup. So where do centralized exchanges go from here and what must they do to restore customer trust?

Solving the Solvency Problem

It's not enough for exchanges to be solvent — they also have to prove it. In the rush for CEXs to provide proof of reserves post-FTX, there were accusations of deposits being moved around to meet attestations. Even tier1 exchanges known to have billions of dollars of assets on hand were not immune from these claims — even if they were largely ungrounded.

The first step toward restoring customer trust is avoiding the sort of fractional reserve banking that's claimed casualties in TradFi for years and more recently in crypto. The second step is being able to prove to customers that their deposits are fully covered and there's no yield chasing or other funny business going on.

Since the collapse of Terra, Celsius, et al., DeFi yields have largely dried up, so that problem's effectively taken care of itself. But when bullish conditions return, and there's easy money to be made, CEXs must resist the urge to dabble in the sort of practices that caused all this mess in the first place.

Be Honest About Your Business

Cryptocurrency exchanges provide a range of products and services including spot and derivatives trading, staking, launchpads, currency conversion and digital banking. They are entitled to charge a fee for all of these services. This is the foundation of how a profitable business is established. By being upfront about their fees and charging a fair amount for the services they render, CEXs can demonstrate that they are profitable and have no need to engage in risky practices.

Greed has been the ruin of many a trader and the same applies to exchanges. It's imperative that CEXs refrain from profit maximization above all else. There is more than enough business to be had from crypto users, and there is sufficient profit to be made through service fees from running a CEX. Any exchange that starts trading against its customers, reinvesting their deposits or levying opaque charges is sowing the seeds for mistrust and potential ruin.

Security Is Everything

The centralized exchange business, like the banking industry, runs on trust. Every time you deposit funds into a CEX, you're trusting them not to run off with your money or lose it to hackers. This trust, and the assumption that the exchange will operate in good faith, underpins everything else. Integral to establishing this trust is the implementation of robust security measures. These are a protection for the exchange just as much as its customers and a clear deterrent to hackers.

Multisig and third-party wallet auditing are a must to prevent single points of failure. Hot wallets should not be accessible to a rogue employee or determined hacker who phishes their way in. While it is impossible to eliminate all theoretical attack vectors, wallet technology has passed the point at which CEXs should be routinely losing funds due to poor opsec or employee error.

These provisions should be coupled with regular security audits, which not only identify any weaknesses but reassure customers that their funds are safe and that the exchange is committed to maintaining that state of affairs.

Trust Takes Time

Like money, trust is hard to earn but easy to lose. And once it's gone, it can't be restored in a hurry. The passage of time and the establishment of a robust and transparent business model will ultimately be the key to centralized exchanges gaining the trust that creates loyal, lifelong customers.

When the market heats up again, as it surely will, CEXs will be needed more than ever before. Blockchain network fees are unpredictable, throughput is still suboptimal and for all the progress that's been made in L2s, rollups and other on-chain innovations, the fact remains that most trading is best suited to the purpose-built environment of a professional CEX.

If centralized exchanges can get their house in order now, they'll be well placed to reap the rewards when new money enters the game. By that point, FTX, just like that other bogeyman of yore, Mt. Gox, will be little more than a bad memory.

(Stephan Lutz is the group CEO and CFO of BitMEX.)