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The CFTC accused Binance and its founder, Changpeng Zhao, of violating US laws on Monday. In this article, we will delve into how Americans are currently approaching cryptocurrency regulation, the specific accusations against Binance, and the implications for the largest cryptocurrency exchange.
2021: Cryptos + American Elite = Love
As of November 2021, Bitcoin’s value has skyrocketed nearly tenfold in just a couple of years, reaching an astounding $60,000. Daily news is entirely focused on the latest and greatest crypto projects, with everyone chatting about the most fashionable concepts, such as DeFi, NFTs, and Web3. It seems that these thrilling technologies will inevitably take over the world!
At this moment, it comes as no surprise that American politicians are actively considering ways to take advantage of the blockchain trend. Distinguished government officials, dressed in their most expensive suits, have begun meeting with the most esteemed crypto enthusiasts, including Sam Bankman-Fried, CEO of FTX, which was then one of the largest crypto exchanges. Sam’s generous political donations to both sides of the aisle – totaling over $40 million – certainly helped to boost his interests.
At one point, the US government went as far as to seriously consider Bankman-Fried’s proposal to alter the fundamental principles of derivative calculations and implement them directly on the blockchain, utilizing “the most advanced and reliable” risk management technologies from FTX. Of course, today, it would be embarrassing to even utter such a suggestion. Nevertheless, during this period, publicly befriending eccentric-looking crypto geniuses, billionaires, and philanthropists was still deemed prestigious and entertaining.
In 2022, it turned out that not everything was so rosy in the crypto kingdom…
The situation changed dramatically in 2022. It was revealed that Sam Bankman-Fried was not the endearing oddball he once appeared to be, but rather a cynical fraudster who had embezzled roughly $8 billion of his clients’ funds from the FTX exchange for personal gain. Moreover, the majority of other well-known crypto projects that were once in the spotlight just a year prior had steadily declined by 2022. For instance, there were the cases of Terra/Luna involving Do Kwon, who was caught with a fraudulent passport, and Alex Mashinsky’s Celsius, who was also accused of fraud.
This turn of events dealt a severe blow to American politicians’ sentiments. They had genuinely tried to foster a relationship with the crypto community, only to find themselves associated with fraudulent and disreputable individuals in shabby sneakers. In other words, the respectable reputations of these politicians were tarnished! Consequently, the perception paradigm towards blockchain in the minds of American elites made a complete 180-degree turn in 2022. Now, everyone is convinced that cryptocurrencies are inherently guilty, and therefore, they must be suppressed and oppressed with all their might!
In this new trend of rapid criticism of cryptocurrencies with a sharp stick, three American government agencies have particularly excelled:
- The Securities and Exchange Commission (SEC): Practically all cryptocurrencies are believed by these guys to be securities. This belief leads to the conclusion that anyone involved in the issuance or sale of cryptocurrencies is violating US securities laws. Meeting all the requirements for crypto projects is practically impossible, making it difficult to comply with the laws. As a result, the SEC takes the lead in bringing claims against crypto players. This is evident as they bring claims almost every week. Notable players such as Justin Sun (Tron), Coinbase, Paxos (issuer of BUSD), Kraken, Gemini, Genesis, FTX, and Do Kwon (Terra/Luna) have all been targeted by the SEC.
- The Commodity Futures Trading Commission (CFTC): The jurisdiction of these guys pertains to commodities and their derivatives. Bitcoin and Ethereum are primarily regarded by them as commodities, although there is a lack of consensus with the SEC regarding Ethereum. As a result, the CFTC’s inclination to bring charges against prominent crypto players is slightly less. However, they have already pursued enforcement actions against Coinbase and BitMex, among others.
- The US Attorney’s Office: The US Attorney’s Office possesses the real “heavy artillery” compared to all the previous agencies as they have the authority to bring criminal charges resulting in imprisonment. This office has been involved in several high-profile cases against Tether, Bitfinex, Alex Mashinsky (Celsius), Sam Bankman-Fried (FTX), Coinbase insiders, and others.
So, it is the CFTC that is accusing Binance of poorly distinguishing Americans from everyone else.
The significant news this week is that the CFTC has filed charges against Binance, which is the world’s largest cryptocurrency exchange, as well as its founder Changpeng Zhao on March 27th.
A significant part of the charges against Binance pertains to the fraudulent practice of permitting Americans to trade crypto derivatives on their platform. This action is exclusively allowed for entities that are officially registered with the CFTC, and registration with the CFTC is a complex process. Consequently, most crypto exchanges establish a separate legal entity exclusively for the US market and entirely suspend all derivative trading there. Therefore, individuals can merely buy and sell Bitcoin on the platform, but they are not authorized to leverage or trade futures.
Indeed, Binance restricted American citizens and/or residents from registering an account on the international version of the exchange, and consequently, they were not granted access to derivatives. However, the primary issue was that Binance’s significant revenue came from clients who traded substantial volumes with leverage. Amongst these clients, the most prominent ones were large trading hedge funds. Unfortunately, all of these clients traded from the United States, posing a problem as the trading of derivatives in the US is strictly regulated.
Can you sense the direction of the wind? Binance took steps to retain its major clients, one of whom accounted for 12% of the total exchange turnover. To achieve this, Binance permitted trading firms to establish accounts on behalf of a registered legal entity in the Cayman Islands.
However, the actual traders were physically located in New York or Chicago despite the accounts being registered in the Cayman Islands. Due to Binance’s stringent security measures, their IP addresses were frequently blocked, making it difficult for them to operate on the platform.
Changpeng Zhao and his colleagues were forced to devise a “VIP Client Policy.” Essentially, the policy entailed suggesting to clients that they utilize VPNs to conceal their IP addresses, as though it were a given that they would know how to do so.
It is not permissible to provide users with instruction on circumventing our controls. However, if they are capable of finding a solution themselves, then it is considered acceptable.
Quote from Binance’s internal VIP guide.
What other transgressions (found and not found) have been attributed to Binance?
To be honest, the passion for derivatives described above doesn’t seem like such a terrible thing to me personally. Well, yes, the guys from Binance were a little creative in their approach to the geographical classification of clients – not very pretty, but not “terrible” either.
Interestingly, Binance does not appear to be actively engaging in truly questionable practices that could potentially prompt an investigation by the CFTC. The text does not suggest anything along the lines of “you are embezzling billions of client funds! Your exchange is not a legitimate entity, but a black hole!” It was precisely instances such as these that caused the FTX exchange to implode in a dramatic manner, rather than the nuances of client onboarding.
A few more points that the CFTC doesn’t like about Binance:
- One such issue is the exchange’s inadequate measures to combat money laundering. As of May 2022, Binance has yet to report any of its clients to American authorities.
- Moreover, Binance’s employees communicate with one another via Signal, an encrypted messenger that cannot be easily monitored by American authorities. This has only further incensed the American regulators who are unable to access the internal correspondence.
- In addition, Binance is trading on its own exchange against its own clients using Changpeng Zhao’s personal funds, and the CFTC has not been given any information regarding these transactions.
So, if we summarize all the claims, it turns out to be something like: “What are they doing behind closed doors that they’re not telling us about? Uncle Sam, help us rein in these suspicious guys!
The day after, Changpeng posted his official comment, but it contained nothing of particular interest – he claimed that Binance is doing great, everything is fine, they’re the best, and everyone else is lying. However, intuition tells us that in the battle against American regulatory authorities, Mr. Zhao will have limited options. The CFTC officials are fighting on their “home turf,” making it difficult for Binance to fend off the accusations. As a result, the chances of successfully defending themselves appear slim.
The investigations may lead to the CFTC imposing substantial fines on Binance, with the amount left to their discretion. Additionally, they may even go as far as prohibiting Binance.US from operating within the United States altogether. While this may not be ideal, it’s worth noting that Binance’s American subsidiary only contributes to 5% of its total turnover. Therefore, it may not be as catastrophic as it initially seems.
In my opinion, the ongoing situation is unfavorable for Binance’s business. Nevertheless, there are no significant additional fundamental threats to the stability of the cryptocurrency exchange presently. It’s worth noting that American regulators have been scrutinizing major crypto projects for quite some time, so it was only a matter of time before they turned their attention to Binance.
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