Week In Crypto: US Regulator Goes In For The Kill On Binance

March 31, 2023
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The Commodity Futures Trading Commission has filed a major lawsuit against Binance, the world’s largest crypto exchange, seeking its expulsion from the US market and the forfeiture of all its earnings to date.

The Commodity Futures Trading Commission (CFTC) has filed a major lawsuit against Binance, the world’s largest crypto exchange, seeking its expulsion from the US market and the forfeiture of all its earnings to date.

After months of speculation about pending charges, the CFTC has become the first US regulator to file a lawsuit against Binance, its founder and CEO Changpeng Zhao, and chief compliance officer Samuel Lim.

In the CFTC’s 74-page complaint, the defendants are accused of multiple violations of the Commodity Exchange Act (CEA) and CFTC regulations, including illegally soliciting US customers and deliberate non-enforcement of know your customer (KYC) checks.

The CFTC alleges that since its founding in 2017, Binance has structured itself so as to “purposefully obscure” the ownership, control and location of the Binance platform.

The regulator says Binance is composed of more than 120 entities incorporated in jurisdictions all over the world, creating a corporate “maze” that these entities use to commingle funds and engage in other unlawful activity.

Binance’s Terms of Use purports to be a contract between the customer and the “Binance operators” — a term that has no “concrete meaning” in the eyes of the regulator.

Since 2019, Binance has opened offices in jurisdictions such as Singapore, Malta, Japan and the United Arab Emirates, but has “intentionally” never disclosed the location of its corporate headquarters.

Instead, according to communications obtained by the CFTC, Zhao has stated that Binance’s headquarters are located wherever he personally goes at any point in time.

In June 2019, Zhao is said to have told staff that Binance.com must remain distinct from any particular jurisdiction to “keep clean” of national laws.

Binance’s strange relationship with US market

Following its launch in 2017, the CFTC alleges that Binance took a “calculated” approach to soliciting US customers and generating revenue in the US market, despite publicly claiming that US customers were “blocked” from the platform.

In its first two years in operation, Binance did not take “any steps” to limit or restrict the ability of US customers to trade on the platform, in violation of registration and other regulatory requirements.

However, in June 2019, Binance took steps to formalise its US presence by launching Binance.US, a crypto exchange that was purportedly separate from Binance.com.

Binance.com then updated its Terms of Use to state, for the first time, that “Binance is unable to provide services to any U.S. person”.

However, prior to the launch of Binance.US, communications between Lim and Zhao show that Binance knew that a “huge number” of its users could be US citizens.

These users were typically what Binance called Tier 1 customers. As a matter of policy, Tier 1 customers were exempt from KYC checks, but could only withdraw up to 2 BTC per day.

As the launch of Binance.US approached, Lim allegedly told Zhao that these users will have to “get smarter” and, in future, will have to access Binance through VPN, therefore showing a non-US IP address.

Within a month of launching Binance.US, internal documents show that the US market accounted for almost 20 percent of Binance's global trading revenue.

Three months after the launch of Binance.US, Binance announced that it had started blocking US users from trading at Binance.com based on IP address.

But, in reality, the CFTC claims that Binance.com merely added a pop-up alert that asked users to declare whether they are a US citizen, and if they clicked “no”, they would be able to trade on Binance.com.

Binance in no rush to introduce KYC

As major economies went into lockdown in 2020, crypto exchanges began to see a steady climb in trading volumes and new sign-ups. At this point, Lim and Zhao began to discuss updating Binance’s Tier 1 no-KYC policy, but decided against it.

“As a company, we are probably not going to remove no-KYC, because it’s too painful,” Lim told a colleague.

The no-KYC policy for Tier 1 users was allowed to persist until August 2021, when Binance announced that it would begin verifying users based on government-issued ID.

By February 2022, however, Binance disclosed that only 30 to 40 percent of users had completed KYC checks, and contrary to Biannce’s public statements, the CFTC alleges that Binance continued to accept deposits from unverified accounts.

The house v the customers

Among other allegations raised by the CFTC, some of the most serious involve market manipulation, including by Zhao himself.

Since 2019, the CFTC alleges that Binance has used approximately 300 “house accounts” to trade on its own exchange against its own customers.

All of these accounts are believed to be controlled either directly or indirectly by Zhao himself, or by Binance market-making partners Peak Merit and Sigma Chain, which the CFTC says is also controlled by Zhao.

“Consistent with its apparent attempt to keep its proprietary trading activity on its own markets top secret, Binance has refused to respond to Commission-issued investigative subpoenas seeking information concerning its proprietary trading activity,” the CFTC said.

Based on its investigation, the CFTC said that Binance has not subjected any of its house accounts to any anti-fraud or anti-manipulation controls.

In January this year, Binance announced a new policy designed to prevent employees and their family members from insider trading, but the CFTC said that, in practice, Binance’s house accounts are exempt from that policy.

The CFTC’s insider trading allegations are similar to those made by US regulators against FTX, which is accused of using its affiliate, Alameda Research, to trade against FTX customers using customer funds.

Is this the end of Binance in the US?

The CFTC is seeking to obtain an “order or permanent injunction” against Binance and all of its affiliates from trading in the US or soliciting US customers.

In addition, the CFTC is seeking an order directing the defendants and any third-party “transferees or successors” to disgorge all benefits, including profits, revenues and salaries, that accrued from their unlawful conduct, if proven.

Finally, the CFTC wants Binance to pay penalty fees and make “full restitution” of every customer or investor whose funds were received or utilised as part of Binance's unlawful activities, if proven in court.

Effectively, should the CFTC’s lawsuit be successful, it would mean the end of Binance in the US market and most likely in other markets globally.

So far Zhao has responded defiantly, describing the CFTC lawsuit as “unexpected and disappointing”.

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