This has been a watershed year for cryptocurrencies, with the FTX, Terra-LUNA, and Three Arrows Capital sagas all receiving extensive coverage. As we go over the details of what happened, we must keep in mind the questions that keep coming up: What does this mean for the sector? Is this good or bad for the market once the dust settles?

First, let us recognize the destruction that these mistakes have caused countless people. No one wants to see early adopters and those working hard to advance this ecosystem suffer — they deserve better.

Having said that, and while investor confidence is temporarily shaken, Alex remains convinced that digital assets are here to stay. Existing use cases, such as cryptocurrencies and tokenization, are expanding. Several new use cases are expected to emerge in the coming years, becoming essential to our daily lives.

The events of 2022 demonstrated that institutional-grade infrastructure, including but not limited to custody, prime brokerage, robust collateral, and counterparty risk management, is required for the industry to thrive safely and sustainably.

Risk management and regulatory response

The regulatory response, arguably an imperative for our industry, will be the first immediate consequence of recent events. Centralized intermediaries are perceived to be opaque, and there will be calls for industry participants to be more transparent in their practices, whether it is reserve reporting or demonstrating separation of client and principal balances.

Centralized intermediaries in the digital asset space will almost certainly face stricter oversight, audits, and risk controls, especially those that serve consumers. On the other hand, this will necessitate an industry-wide examination of the risks and dynamics of decentralized protocols and organizations.

The second consequence is concerned with risk management. Asset price volatility may have drawn institutional and retail investors to the asset class. This, in turn, necessitates the development of robust risk management tools that enable stress testing and exposure management. Many token-based entities must carefully assess the risks and balance-sheet implications of using tokens they created as collateral. Treasury procedures and reserve requirements in the industry will be scrutinized.

Market development

Further regulation will likely result in a market bifurcation between institutions and retail investors, with institutions driving the majority of activity and retail enjoying better protection, implying restricted access to specific products and services. Furthermore, regardless of regulations, the market should evolve to force the separation of exchanges' current "one-stop-shop" role in custody, execution, market-making, and lending.

As with any asset class, BTC, ETH, or XRP will continue to rise and fall, trading similarly to a normal asset class, albeit possibly with sudden bouts of volatility induced by market events. The fact that we have already seen booms and busts indicates growing maturity, and what arises from the current period should lead to greater resilience.

However, for asset class implementation to occur on an institutional scale, institutional grade infrastructure — meaning safe, sturdy, and ultimately compliant — will be required, along with more advanced risk management practices and business conduct that inspires trust from customers, institutions, and society in general.

While the digital asset space is frequently thought to be distinct from traditional finance, inventions can be built on top of known best practices, and lessons learned during the previous boom and bust cycles can be implemented to avoid repeating the same mistakes.

Why do you think digital assets need better infrastructure and risk management? Let us know your thoughts by sharing this article on social media.

Nov 20, 2022
Digital Lifestyle

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