Binance – The Last Dance?

  • The fully centralised Binance crypto exchange faces major regulatory challenges and legal issues in the US, EU and China.
  • Regulators want to see Binance.US as an independent business, and C.Z. is not ready to migrate from an international to an American business model.
  • The Tai Chi document reveals plans that undermine the ability of US enforcement to detect illegal activity.
  • Could the fall of Binance be the next black swan event in the crypto industry?

As we know, the cryptocurrency market is growing at an unfathomable pace, topping $2.6tn in combined market cap. Innovation is constantly breaking barriers in the decentralised financial space, giving people equal opportunities to participate in capital-efficient models. While the crypto markets are getting more innovative and dynamic, it is constantly engaged in a tug of war with regulators, facing critical challenges in the form of fresh regulatory frameworks and legal provisions. One company that repeatedly made headlines over the scrutiny of regulators is Binance.

Binance is one of the largest and most widely accepted crypto exchanges in the world. The platform is superior in terms of liquidity, as it offers a wide variety of assets, trading tools and easy-to-navigate interface. In 2021 alone, the Cayman-based crypto exchange was responsible for $7.7tn in exchange volume. The trading platform also boasts an estimated user base of 28.6 million placing it miles ahead of other popular centralised exchanges in terms of adoption.

While the exchange enjoys such heavy traffic, underneath the surface lies another story. Binance is under heavy regulatory scrutiny, with policymakers and regulators putting serious pressure on the business. It started with concerns around user protection, where the exchange locked out or froze users’ accounts for unconventional reasons. This raised many regulators’ eyebrows in multiple countries.

In the United States, the Commodity Futures Trading Commission is investigating the exchange for possible market manipulation, when trading on customer orders before execution. While the company touts its “decentralised model” with teams spread across the world, it ultimately is still a centralised exchange with access to customer data and the necessary tools to take advantage of customers’ trading information. Besides the insider trading concerns, the legitimacy of Binance’s headquarters is also under question.

How it all started: The ‘Tai Chi’ Document

In October 2020, Forbes and two journalists, Michael del Catillo and Jason Brett, worked on a story proving that the largest cryptocurrency exchange in the world designed its corporate structure to evade regulators and execute a bait and switch plan.

According to the findings revealed by Forbes, the document was approved by senior executives of the company, including the founder Changpeng Zhao (CZ). The source told Forbes that Harry Zhou, co-founder of Koi Trading, was the one behind the Tai Chi document. The corporate structure mentioned in the document allowed Binance to funnel money from an established company in the US to its parent company. The US-based company was referred to as the “Tai Chi entity.”

The Tai Chi entity was used as bait. It enabled the parent company to avoid regulatory inquiries. While this entity is bearing all the fines and investigation, the parent company is receiving steady revenue using an unnamed Delaware C-corporation. The alternative used was Binance America, where BAM Trading was licensed with the help of Binance's wallet and trading technology. This way, Binance was liberated from US enforcement.

The leaked document also mentions the possibility of heavy usage of virtual private networks (VPNs). As it helps traders mask their location, Binance can avoid dealing with legal issues in different jurisdictions.

These were some of the main objectives pointed out in the document. Many legal firms in the crypto industry started looking at Binance under a microscope and found the crypto exchange was showing many red flags in terms of money laundering and tax evasion. The connecting dots, regarding some of these issues, seem to point to a more hairy situation than the rosy picture that Binance seeks to paint. The implications could have a ripple effect for Binance across multiple countries.

Outside of regulatory frameworks, Binance is also facing a leadership problems. The founder of Binance, CZ, stepped down as CEO, due to the structural remodelling of the company. He mentioned in his open letter that Binance was ramping up its compliance team and partnerships to meet the regulators' expectations. Nonetheless, we continue to see countries ban Binance operations or warn about illegal activities.

Upper Management Problems Continue

Heavy regulatory focus on Binance.US made CZ step down, but no one expected the next hire would also leave so abruptly. Brian Brooks, who previously worked as the chief legal officer at Coinbase, was bought on to replace CZ. It was widely assumed that Brooks was a great recruit, as he had vast experience in dealing with regulatory bodies. Those assumptions were quickly proven wrong.

The predecessor, Catherine Coley, was forced out to hire someone with a very strong regulatory background. That happened to be Brooks. But three months into the job, Brooks followed Coley out the door. It was understandable to hire a CEO to build a strong regulatory compliance regime for Binance.US, but when Brooks resigned, it showed us that something was fundamentally going wrong within the company.

It could have to do with the regulatory concerns he had to deal with right after joining the company. Many departments at the state and national level were conducting investigations into whether Binance allowed Americans to participate in illegal trades. The situation Brooks stepped in was already pretty bad. And on top of that, he had had several arguments with CZ leading up to his resignation. Brooks wanted to kill the narrative about Binance.US being the alter ego of Binance, so he decided to raise a fresh round of venture capital and solely focus on expanding in the US.

The pre-IPO fundraising round fell through and no money was raised. Brooks reached out to GreatPoint to present his pitch, but the venture capitalists were not ready to make the deal for two reasons, which were C.Z.'s 90% ownership and possible money laundering violations. Some experts also felt that the company could not function independently when its core functionality was driven by the same technology.

Another reason for Brooks's departure was strategic differences. When he wanted to complete the migration from the international domain to the American one, CZ rejected this and Brooks decided he could no longer solve the company's regulatory issues.

All of this has created uncertainty for the company. Several regulatory bodies have been watching Binance's leadership standards closely. The CEO of Digital Asset Research, Doug Schwenk, wants Binance.US to be a separate business that follows a new set of compliance policies.

Binance Regulatory Crisis could become a Black Swan Event

It has been observed in many instances that Binance cannot be supervised. In multiple countries, Binance fails to comply with regulations and policies, forcing governments to ban operations. Recently, the exchange had to shut down crypto-derivative products for customers in Australia and Brazil, as Binance failed to comply with regulations. It also closed crypto trading in Singapore dollars.

The legal authorities also determined that 50% of the bitcoin involved in criminal activities came from Binance. As a result, worldwide regulators are issuing warnings around high-risk products and services that Binance offers to traders and retail investors.

In July, Binance received a criminal complaint from Thailand's financial watchdog for allowing users to trade assets without a license. A month before, Thai law firms gave a warning, but Binance did not provide a response. In the US, there are several ongoing investigations led by the Justice Department and the IRS. In the UK, the Financial Conduct Authority banned Binance for not meeting the anti-money laundering requirements. Other countries expressing their regulatory concerns towards Binance include South Korea, Malaysia and China.

If the regulatory pressure is limiting Binance’s capabilities as a centralised exchange, then the consequences will be severe. On 1 November, 2021, Binance suspended all crypto withdrawals for an extended time without giving proper reasoning. This is one of many instances where Binance restricted users from accessing their accounts and funds. A year ago, it froze accounts and announced funds were safe, but many users could not withdraw or transfer assets for weeks and months. In some cases, users lost access to millions worth of crypto, which they had bought in 2017. For Binance, regulatory compliance has become a blocker, not an enabler of innovation. They are constantly involved in an aggressive enforcement battle that is limiting the exchange’s ability to drive widespread adoption.

While crypto aims to be superior to the traditional financial system, it is still a top priority, for anyone involved, to comply with existing legal frameworks. It is not an option, but a necessity. So if Binance keeps failing to meet core compliance standards, then it produces a ripple effect, impacting the entire crypto ecosystem. Not to forget, the native token of Binance, BNB, could plummet in ways no one would ever imagine. And it most probably wouldn’t end there. If the world’s largest crypto exchange fails, users would also lose trust over other centralised exchanges. Irrespective of the market conditions, an event of this magnitude could potentially cause a major setback to the crypto industry.

While Binance is still the largest crypto exchange in the world and has one of the top cryptocurrencies in BNB with a market cap of over $100bn, it doesn’t negate the fact that regulatory concerns have disrupted the availability, accessibility and equity of crypto financial services to millions of users. If this persists when the number of active users goes from 100 million to a billion, then the magnitude of regulatory concerns will be immeasurable.

Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.

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