Week In Crypto: FTX Execs Plead Guilty To Fraud, Binance Financials Probed As Auditor Quits

December 22, 2022
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Breaking news as two top executives associated with FTX plead guilty to criminal fraud charges. Meanwhile, Sam Bankman-Fried’s extradition to the US is confirmed and doubts are raised over Binance’s elusive balance sheet.

Two top executives associated with FTX plead guilty to criminal fraud charges, Sam Bankman-Fried’s extradition to the US is confirmed and doubts are raised over Binance’s elusive balance sheet.

Caroline Ellison, former CEO of the FTX-linked trading firm Alameda Research, and Gary Wong, co-founder of FTX, have pleaded guilty to criminal fraud charges filed by the US Department of Justice (DOJ).

US attorney Damian Williams of the Southern District of New York (SDNY) announced the guilty pleas in a statement given late on Wednesday (December 21), after expanding its case against former FTX CEO Bankman-Fried.

"Last week, we announced charges against Samuel Bankman-Fried for a sweeping fraud scheme that contributed to FTX's collapse, and for a campaign finance scheme that sought to influence public policy in Washington,” said Williams.

“As I said last week, this investigation is very much ongoing and is moving very quickly. I also said that last week's announcement would not be our last, and let me be clear once again, neither is today's.”

After expanding its charges to include Ellison and Wong, Williams said that both are now cooperating with DOJ officials at the SDNY.

This could mean that they are prepared to provide evidence against Bankman-Fried, whose extradition to the US was also confirmed by Williams.

“If you participated in misconduct at FTX or Alameda, now is the time to get ahead of it. We are moving quickly, and our patience is not eternal,” said Williams.

“Bankman-Fried is now in FBI custody and is on his way back to the United States. He will be transported directly to the Southern District of New York, and he will appear in court before a judge in this district as soon as possible.”

Williams added that many individuals in the Bahamas and in the US contributed to the “swiftness” of Bankman-Fried's return, despite it being more than 40 days since FTX filed for bankruptcy.

Binance withdrawals accelerate as auditor quits

Binance, the world’s largest crypto exchange, is facing an uncertain future following a series of multi-billion-dollar withdrawals and an unhappy break-up with Mazars, the auditor of its “proof of reserves”.

Last Friday (December 16), Mazars said it had decided to “suspend” its work with all crypto firms, citing the failure of its audits to calm the markets in the wake of the FTX collapse.

As reported by Bloomberg News, Mazars also said it was concerned about the intense scrutiny it had come under from the media.

To date, Mazars had only produced one audit each for Binance, KuCoin and Crypto.com, but it has since deleted all three of these audits from its website.

Binance’s relationship with Mazars began only last month, when the exchange unveiled its new proof of reserves concept on November 10, a day before FTX filed for bankruptcy.

As part of its “commitment to transparency”, Binance published its own audit detailing the crypto-assets it holds on behalf of customers across five major blockchains.

The audit was not exhaustive, but it covered all tokens held on the Bitcoin, Ethereum, Binance Smart Chain (BSC), BNB and Tron blockchains, which make up the vast majority of the crypto universe.

At the time, the combined net balance of these holdings came to 575,742 BTC ($9.7bn), a figure that was later replicated by Mazars in its own audit of Binance’s proof of reserves.

Based on these figures, Binance sought to demonstrate that it has no liquidity issues, and is in no danger of an FTX-style withdrawal freeze and subsequent collapse.

But despite these assurances, Binance users began to withdraw their funds in large numbers through late November and into December.

On December 13, for example, blockchain analytics firm Nansen claimed that over $3bn in crypto-assets had been withdrawn from Binance via the Ethereum blockchain alone. And over a three-day period, over $6bn had left the exchange.

Binance CEO Changpeng Zhao downplayed the significance of these withdrawals, describing them as “business as usual” and noting larger withdrawals had taken place in 2020 and 2021.

He also downplayed a brief suspension of USDC stablecoin withdrawals on December 13, saying this was caused due to the untimely opening hours of a New York bank that was required to process the transactions.

A media appearance to forget

Against this backdrop, on December 15, Zhao fielded questions about Binance’s financial health during an interview with CNBC.

He argued that there are no systemic issues with withdrawals at the exchange, with the USDC case being a one-off issue.

“If 100 percent of users withdrew 100 percent of their assets, we would be fine,” said Zhao.

On the wider question of Binance’s total liabilities, including not just customer assets, but other business liabilities, CNBC host Andrew Ross Sorkin asked why Binance has not hired a Big Four auditing firm to put their stamp of approval on Zhao’s claims.

“We are working with firms to audit the financials, the liabilities, etc,” said Zhao. “Very simply, Binance does not owe people money and does not have loans from other companies.”

But asked whether Binance has “the files and the data” required to work with a Big Four firm, Zhao said that “many of them don’t even know how to audit crypto exchanges”.

As CNBC host Joe Kernen pointed out, however, rival exchange Coinbase works with Deloitte, a Big Four firm, for auditing and accounting purposes.

Questions were also raised about Binance’s exposure to FTX. In July 2021, for example, Binance sold an equity stake in FTX that it had held since 2019 back to FTX, for a fee equivalent to $2.1bn.

The fee was paid using a mixture of Binance’s own stablecoin (BUSD) and the ill-fated FTX exchange token (FTT), which, as Zhao admitted, “is now worthless”.

It is unclear how much of the fee was paid in FTT, but Zhao said it was a “big chunk”.

With FTX’s former CEO now facing fraud charges - and Ellison and Wong having pled guilty to fraud - Zhao was asked whether he would be able to return that $2.1bn to FTX customers if ordered to do so by US regulators.

“I think we’ll leave that to the lawyers,” he responded. “I think our legal team is perfectly capable of handling it.”

Under US Bankruptcy Code, if a fraudulent transfer has taken place, or a recipient should reasonably have known that they were handling a fraudulent transfer, any gains from the transfer that accrued within a two-year lookback period can be returned to creditors.

Neutered audits

One day after Zhao’s appearance on CNBC, the news broke that Mazars had suspended its role as Binance’s proof of reserves auditor, and had deleted the entire section of its website that was devoted to crypto firms.

Ultimately, this attracted even more attention to Mazars’ work, as copies of the audits had already been saved and published on other websites.

Among those who commented publicly on Mazars’ audits was Michael Burry, the ‘Big Short’ investor who is best known for predicting the subprime mortgage collapse that led to the 2008 financial crisis.

In a tweet linking to Bloomberg’s article on Mazars’ break-up with Binance, Burry pointed out that an audit that looks only at an exchange’s reserve assets tells us little about its overall financial health as a business.

“This is the problem. In 2005 when I started using a new kind of credit default swap, our auditors were learning on the job. That's not a good thing,” he said.

“The same goes for FTX, Binance, etc. The audit is essentially meaningless.”

Although he did not comment on it specifically, had Burry looked at Mazars audit of Crypto.com, he would have found it to be even more opaque than that of Binance.

In the Crypto.com audit, holdings of customers’ crypto-assets are given a “reserve ratio” - a percentage that is supposedly held in kind by the exchange - but the actual number or value of tokens held is redacted, supposedly for security purposes.

“The nominal amounts of assets and liabilities are not disclosed in this report due to confidentiality reasons,” the report states.

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