The CFTC’s charges against Binance are pretty rough. But can the little details in the lawsuit really prompt crypto to end business in America?
The US Commodity Futures Trading Commission (CFTC)’s recent act of enforcement can possibly end up with Binance shutting down all US operations.
The CFTC filed the lawsuit in Chicago federal court against Binance Holdings Ltd. and its CEO Changpeng Zhao on Monday, alleging that the firm and Zhao repeatedly broke American rules on derivatives trading. According to the CFTC, Binance should have registered with the agency years ago and continues to violate the CFTC’s rulebook, and contains many recounts of internal conversations and documents that may end up damning the crypto trading giant.
In response, Binance published a statement calling the move “unexpected and disappointing”, and cited its ongoing efforts in cooperating with regulators. Additionally, Binance mentions that it has heavily invested in its compliance team “to ensure we do not have U.S. users active on our platform.”
Binance launched its American-oriented arm, Binance US, in 2019 to provide US traders an opportunity to trade crypto legally under American law and regulatory oversight as regulations get tighter within the country.
About the lawsuit
The CFTC’s lawsuit alleges that Binance committed multiple trading derivatives violations. Amongst the charges include not being properly registered to offer derivatives to US-based clients, negligence of adequate supervision of trading activity on the exchange, insufficient anti-money laundering (AML) and know-your-customer (KYC) procedures, and trading against its own customers for personal gain.
Zhao, otherwise known as CZ, is listed as a defendant, in addition to ex-chief compliance officer Samuel Lim. In the lawsuit, the CFTC lists Binance’s many operations: Cayman Islands-registered Binance Holdings Limited, and Ireland-registered Binance Holdings (IE) Limited, and Binance (Services) Holdings Limited.
In addition to allegations that Zhao, Lim, and Binance’s senior management have failed to properly supervise Binance activities, while at the same time violating US laws, the CFTC claims that Binance has instructed American customers in using virtual private networks (VPN) to obscure their digital footprint, and also directing US-affiliated “VIP customers”, typically institutional market participants, to open Binance accounts under the name of shell companies.
Additionally, the CFTC brought up Binance’s own documents from August 2020 which indicate that the trading platform earned $63 million from derivatives transactions, with around 16% of the accounts identified in such transactions being held by US customers.
Yesterday, CZ published a longer, formal response to the CFTC complaint, dismissing the charges as a result of FUD – fear, uncertainty, and doubt. “I observe these policies myself strictly,” he wrote, regarding Binance’s compliance practices. “I also never participated in Binance Launchpad, Earn, Margin, or Futures,” in response to allegations where he personally controlled accounts to trade against Binance’s customers.
But how did the CFTC get to these conclusions? There’s one thing that’s certain: hundreds of Binance’s internal messages, conversations, and documents were shared with the regulator as part of its investigation. While Binance has been under hot fire by US regulators for quite some time now, the CFTC’s lawsuit presents itself to be the most thorough one yet.
As the commission is a civil government agency, it can’t bring criminal charges or seek jail time for firms or individuals. But, cases from the CFTC can bring hefty fines, amongst other debilitating penalties against both companies and individuals.
Was compliance really a joke to Binance?
The CFTC’s filing contains many snippets of internal conversations within the crypto trading company regarding compliance, or lack thereof.
“Defendants have disregarded applicable federal laws while fostering Binance’s U.S. customer base because it has been profitable for them to do so,” the CFTC said in its complaint.
According to the complaint, Binance had not yet filed a single suspicious activity report in the US since at least May 2022.
“The defendants’ own emails and chats reflect that Binance’s compliance efforts have been a sham and Binance deliberately chose – over and over – to place profits over following the law,” Gretchen Lowe, chief counsel in the CFTC’s enforcement division, said in a press release.
Amongst the notable include quotes from ex-chief compliance officer Samuel Lim that refer to transactions thought to be associated with Hamas, a militant offshoot of the Egyptian Muslim Brotherhood. In 2019, Lim reasoned that these small transactions weren’t much to think of, as no one “can barely buy an AK47 with 600 bucks,” according to the CFTC’s complaint.
This isn’t the only time that Lim has made comments that can present Binance’s case in a bad light. In February 2020, Lim allegedly remarked that customers from Russia were using Binance for sketchy purposes: “Like come on. They are here for crime.”
Beyond that, the CFTC alleges that Binance’s compliance team, including a money laundering reporting officer, have complained that Binance’s infrastructures were presented with an unusually hard task: “I HAZ NO CONFIDENCE IN OUR GEOFENCING,” a employee told Lim in a chat message.
Lim has not yet responded for comment.
CFTC declares BTC and ETH as commodities
In the complaint, while only mentioned as a small blip, the CFTC calls both bitcoin and ethereum commodities.
It may seem small, but calling both of these assets commodities will play a major role to how crypto businesses can legally run in the US from this point onwards.
While US regulators are at war with crypto, these very regulators are in a silent war of sorts within themselves: as the US Securities and Exchange Commission can willingly just call any token a ‘security’, the CFTC has decided to call BTC, ETH, and even LTC commodities.
Certain digital assets, including LTC as alleged herein, are “commodities,” As defined under Section 1a(9) of the Act, 7 U.S.C. § 1a(9.
Litecoin is a Commodity. Nice to know we all agree on that now. pic.twitter.com/l1D0TDDnxK
— Litecoin (@litecoin) March 27, 2023
Commodities can be thought of as finite resources, and often apply to natural and/or agricultural resources, and are looked after by the CFTC. Securities are investment instruments that yield returns from a common enterprise or company, such as shares in a company that trades on the stock exchange, and are looked after by the SEC.
In the past, SEC Chairman Gary Gensler has argued that every other cryptocurrency that’s not bitcoin is a security. But where does this put ethereum? What makes bitcoin so special?
Since ethereum’s recent move from proof-of-work to proof-of-stake, the SEC has developed a view that ethereum’s new consensus mechanism makes it a security. Despite this, the CFTC has maintained its stance that ETH still is a commodity after the Merge.
Not to mention, Gensler hasn’t been firm enough to name ETH under his definition of securities. In September, Gensler skirted around the issue, telling The Wall Street Journal that proof-of-stake assets can count as securities under the oft-used Howey Test.
But now, there’s plenty of scrutiny over the Howey Test not only from the crypto industry, but also from SEC Commissioner Hester Peirce. The Howey Test, originating in 1946, has been called outdated, and many are of the view that a new Howey Test should be drafted in order to accommodate for the digital age and economy.
But this doesn’t mean any indication of developments on a statutory definition for which crypto asset is a commodity or a security.
Will crypto businesses go nomadic as well?
You’ve heard of the phenomenon of young crypto professionals leaving home base for a digital nomadic lifestyle. But what happens if crypto firms do the same thing? Binance can be a case study for that.
Many firms in the US are considering leaving due to uncertainties on every front, but if one were to go the extra mile, saying that they don’t have a set headquarters like Binance, they can be hit by the same scrutiny the CFTC gives Binance.
The CFTC alleges that CZ, in a 2019 internal meeting, that Binance’s strategy was to conduct operations through various business entities registered in different jurisdictions to “‘keep countries clean [of violations of law]’ by ‘not landing .com anywhere. This is the main reason .com does not land anywhere.’”
Binance has been in the midst of naming an executive headquarters for quite some time now, but still remains silent on a firm location, despite calling the process “very simple. It’s not that complicated.”
While it’s common for non-US businesses to try and stay lowkey with US regulators as they deal with American customers, having no headquarters is a flimsy excuse, and is unlikely to stand up as an argument in court.
If anything, laws regarding jurisdictional strategy for companies hoping to avoid the burdens of US regulators would end up changing, possibly starting with increasing the intensity of reviewing compliance.
So are the CFTC Binance allegations the end of crypto in the US?
Sure it can result in a bunch of bad press that will result in unfavourable market prices, but it wouldn’t knock down the entire crypto industry.
Mark Lurie, CEO at Shipyard, which creates white-label software for decentralised exchanges and unique use cases, says that interpreting the CFTC’s allegations as an attack on crypto is a misunderstanding. Rather, these “allegations are not about issues that exist ‘in a grey area of regulation,’ but rather about evasion of cut-and-dry, well-understood regulations and rules that exist for pretty good reasons.”
In any case, it can possibly mean that the US will finally create clearer policy for better crypto compliance within the US.
If crypto firms are left to infer and guess from unclear information just like Binance has, it can just lead to mess upon mess – and it isn’t a good look for an industry just in its infancy.
But it doesn’t mean that new policies should be written down ASAP. Now, it’s just up to regulators to assume the huge responsibility they must take in order to appropriately and adequately set measures that wouldn’t create more damage and failures in the crypto industry.