The Biggest CeFi Debacles of 2022 and the Lessons They Teach Us

2022 was an eventful year for the Web3 space. From FTX to Celsius, some of the biggest names in crypto experienced security breaches, scams, and market crashes. Participants lost money and were left wondering– can crypto really become part of our financial future?

In this article, we'll take a look at some of the most notable CeFi missteps and explore what lessons we can learn as we move toward a decentralized future.

2022's Biggest CeFi Debacles

1. FTX

Let's start with the elephant in the room: FTX. When it crashed in November 2022, it was one of the world's largest crypto exchanges. Turns out that the founder, Sam Bankman-Fried, and his team were transferring customer funds to Alameda research (a trading firm also operated by Bankman-Fried) to finance high-risk trades and provide liquidity when needed.

Binance, one of FTX's competitors, disposed of the FTX tokens acquired from Bankman-Fried in 2021, giving rise to worries about the firm's stability. This resulted in a decrease in the value of FTX tokens and numerous customers withdrawing from the exchange. The rest unfolded fairly quickly: FTX filed for bankruptcy, Bankman-Fried resigned, and many people lost a lot of money. The company lost over $8 billion of its customers' money, to be exact.

2. Celsius Network

Celsius was another centralized crypto lending platform. Following its release in 2017, the platform grew rapidly due to its generous interest offers. By spring 2022, they claimed to have over 1.7 million users, $8 billion in loans, and to be offering users up to 17% APY on crypto deposits. A few months later, after the markets tumbled (including Ethereum and Bitcoin values), Celsius faced a liquidity crisis; its assets under management fell by 50%. They informed users that they were pausing withdrawals, swaps, and transfers between accounts. Shortly after, Celsius's token CEL decreased in value by a third. Unsurprisingly, locking users out of their own money sent a massive red flag through the community and beyond.

By July, the company had filed for chapter 11 bankruptcy. Filings showed that the company owed $4.7 billion in liabilities to users. As of January 2023, a U.S. bankruptcy judge ruled that because of the terms of use Celsius investors accepted, their deposits belonged to Celsius. In other words, users aren’t getting their money back.

3. Terra (LUNA)

Do Kwon and Daniel Shin founded Terraform Labs in 2018 and created the blockchain network, Terra. It issued LUNA tokens, similar to Ethereum or Bitcoin. They also introduced the UST coin, an algorithmic stablecoin backed by Luna. By April 2022, LUNA's value had increased 135% in just two months due to users staking UST on Anchor protocol for a 20% yield. Some saw this as a red flag and identified it as a possible Ponzi scheme.

A month later, UST was unstaked from Anchor Protocol causing millions of it to be liquidated and driving its price down to $0.91. The cause was debated but this sparked panic selling of UST, which led to more LUNAminting and soon a surplus. Exchanges delisted UST-LUNA pairings, and Luna became worthless, leading to losses of over $300 billion across the crypto market; firms filing for bankruptcy and numerous individual savings lost online.

By September, Kwon had an arrest warrant issued against him for alleged market manipulation. Today, Luna is considered the largest crypto crash ever.

Lessons Learned for 2023 & Beyond

For some people, the takeaway from these debacles might seem simple: The world of Web3 is too risky, and not worth it. However, given that the biggest issues were on centralized exchanges, much of this fallout reinforces the benefits of DeFi. In this op-ed, Sam Forman of a protocol called Sturdy Finance elaborates on this point, asserting that shady centralized actors have continued to impede crypto’s growth and distract from its core ethos.

Adherence to this ethos could’ve prevented most of the aforementioned debacles. The blockchain technology that underlies decentralized exchanges is the ultimate security mechanism. It is an immutable, distributed ledger whose data can never be changed or erased — providing users with complete transparency in their transactions. It also serves as an automated referee between parties participating in a transaction, making sure that all rules are followed and that no one can get away with fraud.

So, on DeFi exchanges, users make trades in liquidity pools managed by smart contracts. In contrast to FTX and Celsius, DEXs can’t lend out customer money – this is spelled out in the code.

Plus, when taking out a loan on decentralized platforms, the user must deposit enough to cover the loan value. When this is no longer possible – either due to a decrease in collateral value or an increase in the asset borrowed - the loan is automatically liquidated. This addressed the doomed cycle where bad loans are used as collateral on other loans and eventually collapse.

Lastly, decentralized exchanges don’t rely on a single point of failure – no single team can take control or manipulate the platform. The underlying code is open-source and easily auditable, minimizing the risks. Users have ultimate control over their funds and can make as few or as many trades as they want, whenever they want.

2022's crypto mishaps caused financial losses, project collapses, and lingering mistrust. But when we examine the details of the year's biggest debacles, it's clear that they highlight the importance of transitioning to decentralized exchanges and projects. What could be more secure than a lending system with transparent mechanics, solidified in code and auditable? With the right protocols and policies, DeFi can offer users a safe and reliable space to grow their wealth.