:format(jpg)/cloudfront-us-east-1.images.arcpublishing.com/coindesk/ZYNUCETE7RD5ROJYWPT327TZGM.jpg "Crypto: What does more regulation mean for the future of digital currencies?")
The founder of the world's largest cryptocurrency exchange, Binance CEO Changpeng Zhao, called for greater regulatory clarity after a week of turmoil in the cryptocurrency market and a year in which investors lost an estimated $2 trillion (£1.7 trillion).
"We need to increase regulatory clarity and regulatory complexity in the crypto space," Zhao said at the G20 Summit in Bali. But not only do regulators have a responsibility to protect society, the industry must also find new models that can help.
The recent collapse of FTX, which filed for bankruptcy in the United States but was valued at $32 billion earlier this year, had a significant impact on the entire cryptocurrency industry. Even the most well-known digital currency, Bitcoin, hit a two-year low following the FTX issue.
Cryptocurrencies allow traders or investors to buy and sell without a bank or broker. Blockchain technology enables peer-to-peer cryptocurrency transactions on exchanges such as FTX and its rival Binance without these intermediaries.
Instead, transactions are authenticated by consensus by a group of validators, commonly known as miners. Miners do this by solving complex mathematical puzzles, also known as the proof of work system used in Bitcoin and most cryptocurrencies.
But when setting up such trades, Binance and its competitors use the same "limited order book" model as any traditional exchange such as the New York Stock Exchange. This means there is a centralized structure connecting buyers and sellers, market makers provide liquidity, and traders charge transaction fees.
This type of structure somewhat exacerbates recent developments in the crypto space. FTX's centralized model made it possible to provide loans to troubled crypto companies earlier this year. It also uses exchange-traded tokens (FTT) to populate subsidiary ledgers. This increases the risk of a stock market crash.
But a new model, a decentralized exchange, operating under different rules for pricing and governing cryptocurrencies can mitigate this risk. They allow investors to buy and sell tokens at an algorithmically determined price. This automated model does not rely on professional market makers, but individual investors provide liquidity and collect a portion of trading fees.
Another cryptocurrency exchange model
Like many decentralized exchanges, Uniswap, launched in 2018, has a governance token called UNI which allows individual users of the exchange to vote on decisions regarding the operation of the exchange. In principle, there is no centralized organization that can manipulate the system decisions that are chosen by the owners of these coins.
This helps exchange users to monitor what is happening to their funds. It is estimated that up to 49,000 addresses on the Ethereum blockchain hold UNI tokens, and 60% of the tokens are owned by investors.
Another issue that has plagued FTX in recent days is that it is a custodian, which means it has the power to suspend investor withdrawals of cryptocurrencies. FTX's decision to ban investor withdrawals means that many people are denied access to the money they use to trade the exchange.
Decentralized exchanges are not custodians, thus allowing individual investors to have full access to their crypto wallet balance and can withdraw or deposit cash or stop trading at any time without the risk of freezing their assets on the exchange.
However, one drawback of decentralized exchanges compared to centralized models like FTX and Binance is that they do not allow traders to exchange fiat (traditional government or state-issued currency) for crypto; Only different cryptocurrencies can be traded on the exchange. The transaction size depends on the size of the liquidity pool. Therefore, if the pool is too small, it may be difficult for the trader to complete the desired trade.
Which type of exchange will dominate cryptocurrency trading in the future depends on several factors.
While some customers withdrew their crypto deposits from FTX last week, around 60% of the outflow went to FTX competitor Binance. In the short term, investors leaving FTX on Binance will increase their share of the cryptocurrency trading market. This additional liquidity on Binance will help it continue to dominate as it can offer lower transaction fees.
However, when activity is concentrated on a smaller number of exchanges, more customers are exposed to the risk of failure by a single crypto provider or wholesaler. And the industry has only become more concentrated after the recent market failure. Higher concentration means higher risk of infection.
And over time, decentralized exchanges will become more competitive and can lower their transaction fees as well. This is partly due to the development of “scalable solutions”: protocols (or sets of rules) that increase transaction activity and speed without compromising decentralization. This will also help reduce the amount investors have to pay to verify their transactions on the blockchain, making trading cheaper.
New rules
And while traditional financial markets are heavily regulated, cryptocurrencies are not, which is likely to change after the recent FTX battle as well as this year's events. The importance of developing a more formalized structure for the cryptocurrency market is becoming increasingly clear.
Regulators have already started looking into FTX's lending products and how it will handle customer funds after the collapse. But what else can they do?
1. Closer oversight of crypto assets
As the CEO of Binance recently hinted on Twitter (above), one way to avoid a repeat of the FTX debacle is to monitor crypto exchange assets in real-time, rather than relying on (in some cases) wildly inaccurate annual reports.
It's already possible. Independent third parties can provide "proof of backup". This means that organizations issue audit reports to enable independent verification of exchange balances and track the flow of money in and out of investors' wallets. This indicates the possibility of system failure due to unforeseen actions such as: B. Using reserve currency to lend to crypto companies, as explained in FTX.
2. Best crypto risk rating
Financial regulators should also adopt a proper risk assessment system for cryptocurrencies. This should include independent audits and stress testing of on-chain data (transaction information on the blockchain network).
Regulations may be enacted to limit the use of exchange tokens for lending to crypto companies. Enhanced customer protection can also prevent exchanges from delaying withdrawals, leaving traders unable to access funds held by troubled exchanges.
Even in the midst of a “crypto winter”, all cryptocurrencies are not lost. Appropriate regulations and new models could help the industry recover and strengthen, perhaps even encouraging the adoption of more decentralized financing in mainstream financial markets.
This article has been republished by The Conversation under a Creative Commons license. Read the original article. 
Cita : Crypto: What does more regulation mean for the future of digital currencies? (2022, November 15) Retrieved November 15, 2022, from https://techxplore.com/news/2022-11-crypto-future-digital-currencies.html
This document is protected by copyright. Except for reasonable use for personal or research purposes, no part may be reproduced without written permission. Content is provided for informational purposes only.