Binance Looks Like FTX but Worse
Reading Time: 10 minutesThe Feds Are Going After Binance. It Looks Like FTX but Worse., The feds are going after the world’s largest crypto exchange. Their allegations are ugly., Binance was sued by the SEC. It looks like FTX but worse.
The Securities and Exchange Commission has not pulled its punches against the volatile, scam-ridden cryptocurrency economy over the past two years, tackling everyone from big-name corporations and executives to celebrity investors while seeking to create new regulations in the free-for-all space. This has made the regulatory agency a keen enemy of Bitcoin purists, crypto truthers, and dudes really into pixelated art—and now it has made its biggest crackdown yet. On Monday, the SEC filed more than a dozen charges against the international crypto exchange Binance, its United States–based affiliate Binance.US, the parent company of Binance.US, and controversial Binance CEO Changpeng Zhao—accusing the mercurial entrepreneur and his enterprises of misleading investors, operating in the U.S. securities markets without being properly registered, and, on top of all that, engaging in securities fraud.
This development wasn’t unexpected. Binance has faced international lawsuits and probes many times before, and in March, the supposedly more crypto-friendly Commodities and Futures Trading Commission filed a civil lawsuit against it for allegedly flouting market-manipulation and money-laundering laws. Still, the new SEC charges are a big, big deal. Not only because they portend a showdown in federal court against the world’s largest crypto exchange—but because of what they portend for the future of crypto regulation, and because they make a strong case that Binance wasn’t so different from the industry competitors it previousy condemned as crooks and scammers.
You may recall that FTX and Alameda Research—the once-ascendant crypto firms launched by disgraced crypto mogul Sam Bankman-Fried—unraveled in November thanks in large part to Changpeng ‘CZ’ Zhao and his public bearishness on those companies. Specifically, he’d cast public doubts on the legitimacy of FTX’s finances and backed out of a deal to purchase that crypto exchange after it took a market hit from other damning exposés. The rest was history.
If the SEC’s complaint against Binance is sound, it may turn out CZ was doing a little projection, and that his own huge exchange was engaged in some of the same alleged criminality that earned SBF an ankle monitor and an upcoming federal trial of his own. Plus, considering that the FTX fallout helped plunge the crypto market into a recessionary hole it’s yet to climb out of, it’s more than certain these Binance charges will wrack the digital-asset economy even further. Already, in response to the news, various cryptocurrencies have plunged in value—not at all surprising, since many of them were traded on Binance itself.
So, what does this all mean in the near term? Is Binance the new FTX? If so, is the crypto economy doomed? And is CZ the new SBF? Are there too many acronyms?? (Absolutely.) Here are the key charges from the SEC’s 136-page lawsuit, and what they mean for both crypto and the rest of the economy.
The SEC complaint takes aim at four separate entities, though it later shows how all of them are interconnected in bizarre ways. To understand, it’s worth getting into the structure of Binance itself, a limited liability company that Chinese-Canadian businessman Changpeng Zhao registered in the Cayman Islands on July 2017, that quickly became the world’s largest crypto exchange by volume, and that granted CZ staggering wealth. Binance operated as something of an all-of-the-above crypto firm: an exchange through which ordinary crypto investors could trade hundreds of different currencies with one another, a virtual ‘wallet’ for users to store their coins, a conversion service to turn digital money into fiat funds, an investment market by which users can earn yields from currencies they trade, an incubator for enterprising users to launch new currencies of their own, in-house tokens for users to invest in the company, and much, much more. In this way, it operated in a similar fashion to large exchanges like Coinbase and the now-bankrupt FTX, offering crypto enthusiasts a host of similar services and enticing incentives.
The problem, as you may already have gleaned, is that … no one monetary exchange should have all that power. There’s a reason that, in the U.S. and other nations with firm regulations, financial institutions established for different purposes (e.g., depositor accounts, hedge funds, investment firms) are kept separate from one another: Consolidating all these companies in one setting would majorly up the monetary risks inherent to an already-risky industry. What’s more, different cryptocurrencies, none of which is government tender, may serve different purposes—Bitcoin is mined and traded in a specialized ecosystem, ‘altcoins’ like Ethereum operate by their own bylaws, and in-house tokens shouldn’t be used outside of their house. An ecosystem in which billions of dollars’ worth of these non-fiat financial instruments can be splattered across myriad services proffered under one roof that’s mostly held in check by its owners is, well, maybe not the safest way to gather tons of money. (Indeed, the SEC now makes clear, Binance ‘unlawfully offered three essential securities market functions … without registering with the SEC.’)
Right out the gate, Binance had faced worldwide skepticism and probing, and its offices hopped around various countries—China, Japan, Malta—in order to evade regulatory scrutiny, especially after it became susceptible to multimillion-dollar hacks. In June 2019, the U.S. announced a ban on Binance’s stateside operations, spurring the company to launch a U.S.-specific outpost, called Binance.US, that would separate itself from Binance’s worldwide operations and comply with American law. That led to the establishment of BAM Trading Services—which would purportedly run Binance.US sans any influence from the LLC—and a new parent company for the Delaware-based BAM Trading, known as BAM Management and likewise based in Delaware.
The concept of a U.S. company established as a distinct individual, away from international waters, may have reminded you of how FTX had its own special FTX.US outpost that SBF (unconvincingly) claimed was not tied to FTX international. Keep that in mind as we go along.
The SEC charges four entities: Binance (the international corporation), BAM Trading Services, BAM Management, and CZ himself.
That whole thing about BAM Trading’s Binance.US having to be disconnected from the CZ-run Binance? Yeah, that’s not what happened, according to the SEC. For one, the agency alleges that CZ had singular ownership over everything. BAM Management, per the filing, ‘was wholly owned by BAM Management Company Limited, a Cayman Islands company, which in turn was wholly owned by CPZ Holdings Limited, a British Virgin Islands company that was owned and controlled by Zhao.’ As such, ‘Zhao continues to own 81 percent of BAM Management.’ Further, CZ ‘was Chairman of BAM Trading’s and BAM Management’s Boards of Directors at least until approximately March 2022,’ and he ‘also owns several entities that have regularly traded on the Binance Platforms.’ (In a bit of cheek, the commission adds that ‘Zhao has never been associated with any entity registered with the SEC.’)
OK, so CZ had a lot of ownership stakes, but did he use that to exercise undue influence? He did indeed, says the SEC. ‘Zhao and Binance were intimately involved in directing BAM Trading’s U.S. business operations and providing and maintaining the crypto asset services of the Binance.US Platform,’ the regulators write. ‘When the Binance.US Platform launched in 2019, Binance announced that it was implementing controls to block U.S. customers from the Binance.com Platform. In reality, Binance did the opposite.’ (To the point that when two Binance.US chief executives attempted to separate U.S. ops from the international sphere, Zhao dismissed them both. He much preferred to have BAM Trading folks consult with him on everything, even an ‘$11,000 purchase of Binance-branded hooded sweatshirts.’ It fits with CZ’s reputation for handing out ‘direct feedback’ and monitoring his employees closely.)
How did CZ buck the controls? By having Binance and Binance.US do business with companies that—surprise!—were owned and operated by Zhao himself. The SEC spotlights two particular culprits: the British Virgin Islands–based Merit Peak, and the Switzerland-based Sigma Chain, both of which are ‘crypto asset trading firms’ that list Zhao as their ‘beneficial owner’ and are staffed with ‘several Binance employees.’ CZ used those firms to get Binance.US off the ground and keep it going when times were lean: Per his orders, Shanghai-based employees of the international Binance branch ‘deposit[ed] cash injections from Merit Peak when BAM Trading operating funds were low,’ to the tune of millions. At one point, Binance international ‘transferred $17 million from BAM Trading’s bank accounts to Merit Peak’ without informing BAM Trading executives. (Binance.US’ then-CEO reportedly wrote in an email, after that transaction, ‘haha [I’m] on a wild goose chase to make sure we have knowledge of where $17M is moving around.’) Further, Merit Peak also served as a holding base for more than $20 billion worth of customer funds from both Binance and Binance.US, which were ‘commingled’ all together and then transferred to prop up the value of BUSD, the company’s own U.S. dollar–backed ‘stablecoin’—which, as Bloomberg reported in January, at one point could not account for up to $1 billion in missing fiat-money collateral that BUSD needed to, um, exist in the first place. Convenient for some savior money to come from a CZ-linked company then, eh?
What about Sigma Chain? Per the SEC, that company ‘artificially inflated the trading volume of crypto asset securities on the Binance.US Platform.’ The examples the commission lists are a doozy: The day after Binance.US opened for business, ‘Sigma Chain accounts and other accounts owned by Zhao and/or associated with Binance senior employees constituted more than 99 percent of the initial hour of trading volume in at least one crypto asset.’ It didn’t stop there: ‘Between January 1, 2022 and June 23, 2022 alone, Sigma Chain accounts engaged in wash trading in 48 of 51 newly listed crypto assets.’ (A fun side note: In one instance, after BAM Trading transferred $45 million from a trust company to Sigma Chain, the latter company used $11 million of the sum to ‘purchase a yacht.’)
If you aren’t familiar with the concept of wash trading, it’s basically a form of self-dealing in which a financier buys and sells a security all by themselves so as to showcase misleading transactions and values to potential investors. Pushing up the value of currencies traded on your platform through companies you own without disclosing that fact: not good! And yes, as you may recall, SBF was accused of carrying out similar deceptions, using the hedge fund Alameda Research—which, he always stated, was not associated with FTX—to trade and artificially pump the value of FTX’s own in-house token, FTT. Folks, don’t do this.
For all the money Changpeng Zhao dumped into his own businesses, he also raised a lotta outside money—which, as those examples of asset inflation demonstrate, was likely accomplished through a lil’ deception. In the SEC’s telling: ‘Between at least September 2021 and April 2022, when soliciting investors … BAM Trading and BAM Management falsely touted the trade surveillance and other measures purportedly in place on the Binance.US Platform to detect and prevent manipulative trading.’ The result of this misrepresentation? ‘BAM Trading and BAM Management raised at least $200 million selling preferred shares to Equity Investors, including almost $40 million from six investors in the United States.’ Ah.
It wasn’t just ‘let’s not and say we did’—it was ‘let’s use every means possible to say we did.’ For one, Binance.US had its trading volume and coin values recorded on the popular crypto-chart website CoinMarketCap, and it made sure to ‘monitor the posted information, at times communicating with CoinMarketCap to correct certain information reported to the market.’ Now, who runs CoinMarketCap? ‘Since in or around April 2020, Zhao has owned CoinMarketCap through a Binance affiliate.’ Oh, OK then. (Notably, at his reputational peak, SBF made a hefty personal investment in the Block, a crypto news site and price-chart platform that claimed to be ‘independent.’ Eesh!)
One of the big implications of this case may be that the crypto world, from here on out, cannot avoid having their treasures regulated as financial securities much longer.
In simplest terms, a security is a financial instrument with some sort of monetary worth: a stock, a bond, an option. The SEC emphasizes throughout its complaint that Binance, CZ, BAM, and all affiliates provided improper securities services and trafficked in various securities without proper registration or disclosure. This doesn’t just constitute the common currencies traded on Binance and Binance.US that ‘have been the subject of prior SEC enforcement actions.’ (In some useful alphabet soup that spills out from the filing: ‘SOL, ADA, MATIC, FIL, ATOM, SAND, MANA, ALGO, AXS, and COTI.’) It also, per the SEC, includes the specific trading offers and in-house tokens proffered by the Binance ecosystem. In addition to the BUSD stablecoin, there was the in-house token BNB and its ‘BNB Vault,’ characterized as a ‘ ‘yield aggregator’ whereby investors can lend their BNB to Binance to earn investment returns’; the ‘Simple Earn’ features, which ‘pay interest to investors who lend their crypto assets to Binance for fixed or flexible lengths of time’; and the ‘staking-as-a-service’ program, which was marketed ‘to the public as a way to earn ‘passive income.’ ‘ Because all these services were ‘offered and sold as investment contracts,’ they fall under the definition of a security as defined by the SEC, and require oversight as such.
Not that CZ or his crew ever seemed interested in compliance. As the commission notes up top, ‘Starting in or around 2018, determined to escape the registration requirements of the federal securities laws, Defendants—under Zhao’s control—designed and implemented a multi-step plan to surreptitiously evade U.S. laws. As Binance’s Chief Compliance Officer admitted, ‘we do not want [Binance].com to be regulated ever.’ (Another damning quote from this COO, dating back to December 2018: ‘we are operating as a fking unlicensed securities exchange in the USA bro.’ All righty!)
Notably, SBF took a different approach to regulation in wanting to figure out some sort of securities classification for cryptocurrencies, which pissed CZ off, along with several other crypto and Bitcoin folks.
Now that we’ve taken this journey, what does all this mean for the suffering crypto economy? Is this FTX 2.0?
A few possibilities: Various digital assets, which already underwent some hard crashes last year, are not gonna make some miraculous recovery, especially since they’re falling in value yet again thanks to the SEC action (and thanks to Binance’s ample holdings of Bitcoin). Other exchanges may benefit from panicked customers withdrawing their digicoins from Binance—although that depends on whether Binance can pay out all the yields that stem from the ensuing bank run, whether other crypto exchanges will weather the fallout of Binance-fueled pandemonium, and whether public crypto corporations can weather the ensuing plunge in stock values. (According to CoinDesk, the Binance withdrawals may add up to the largest of their kind since the March collapse of crypto bank Silvergate—which, by the way, also helped to facilitate transactions between Binance and Binance.US, according to previous reporting from Reuters.) The company’s efforts at switching up leadership to appease investors will probably fall flat. And the hit on the stablecoin BUSD will have ripple effects across the blockchains and currencies that carry BUSD links and backing, since it’s pretty much certain now that BUSD has nothing there. So: The market may be in for an FTX-style wallop indeed. Binance is attempting to head off the turmoil, releasing a statement accusing the agency of ‘regulating with the blunt weapons of enforcement and litigation,’ while CZ is retweeting his defenders. Both Binance and Binance.US still seem to be operating as of now, but we’ll see long the company’s sponsored tour with the Weeknd lasts.
Plus, with the formerly dominant Binance squarely in the crosshairs, crypto enthusiasts hoping for regulators to get off their back are gonna be sweating a little bit. And with CZ’s charges, another crypto figurehead has fallen from the moon to the earth, just like SBF, Do Kwon, Justin Sun, and others. One can’t help but recall one of Zhao’s April 2019 statements: ‘CREDIBILITY is the most important asset for any exchange! If an exchange fakes their volumes, would you trust them with your funds?’ Still a good question!
Reference: https://slate.com/technology/2023/06/binance-sec-crackdown-ftx-cz-sbf.html
Ref: slate
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