The charges against Binance are stiff, and the penalties could be business-ending. Here’s what you need to know.
The Commodities Futures Trading Commission’s enforcement action against Binance could shutter the crypto behemoth if the regulator’s requests for injunctive relief and penalties stick—but there’s a lot more to the Commission’s lawsuit to unpack.
The CFTC filed its lawsuit against Binance on Monday morning, which the company has said was “unexpected and disappointing,” citing its ongoing cooperation with regulators. The company also said in its statement that it has invested heavily in its compliance team “to ensure we do not have U.S. users active on our platform.”
The lawsuit alleges that Binance committed multiple trading derivatives violations, including not being properly registered to offer derivatives to U.S. clients, not adequately supervising activity on its exchange, insufficient anti-money laundering (AML) and know-your-customer (KYC) controls, knowingly evading or helping U.S. clients evade regulators, and perhaps most damning: trading against its own customers.
Zhao himself is specifically named as a defendant in the CFTC lawsuit along with Binance Holdings Limited (registered in the Cayman Islands), Binance Holdings (IE) Limited and Binance (Services) Holdings Limited (both registered in Ireland), and ex-chief compliance officer Samuel Lim.
Zhao dismissed the 74-page complaint as “FUD” (a popular crypto acronym for fear, uncertainty, and doubt) by writing “4” on Twitter Monday.
At the start of the year, he said “4” would be his shorthand for telling followers to “ignore FUD.” He’s made ample use of it since then: On March 24, when a glitch caused a temporary issue with withdrawals and spot trading; on March 5, when The Wall Street Journal reported that private transcripts showed Binance intentionally avoided U.S. regulators; on March 3, when the U.S. Securities and Exchange Commission tried to block Binance US from acquiring bankrupt crypto broker Voyager Digital; in February, when New York firm Paxos cut ties with the company in anticipation of being sued by the SEC over its role in issuing Binance USD (BUSD) tokens; and in January, when Forbes reported that the exchange had seen outflows totaling $12 billion in two months.
Late Monday evening, Zhao published a longer response in a Binance blog post. “I observe these policies myself strictly,” he wrote of Binance’s compliance practices. “I also never participated in Binance Launchpad, Earn, Margin, or Futures,” he added, in a nod to the allegations that he personally controlled accounts used to trade against customers.
It’s clear from the CFTC’s complaint that hundreds of internal messages, conversations, and documents were shared with the commission as part of its investigation. This isn’t the first time Binance has been the subject of a lawsuit, but it appears to be the most thorough. As former CFTC trial attorney Braden Perry told Decrypt in an email: Enforcement agencies like the CFTC don’t like to lose.
Compliance was (allegedly) a joke
The CFTC lawsuit contains lots of snippets from internal company chats about compliance, or lack thereof.
In one section of their complaint, U.S. prosecutors quoted messages from Lim referring to transactions thought to be tied to Hamas, a militant offshoot of the Egyptian Muslim Brotherhood. In the 2019 messages, he reasoned that small transactions weren’t worth worrying about because someone “can barely buy an AK47 with 600 bucks,” according to the CFTC’s complaint.
Then in February 2020, Lim allegedly said of customers from Russia: “Like come on. They are here for crime.”
The commission alleges that employees who were tasked with making it appear that Binance was taking compliance seriously, like a money laundering reporting officer, complained that they had been stuck with a sisyphean task. “I HAZ NO CONFIDENCE IN OUR GEOFENCING,” the employee told Lim in a chat message.
Bitcoin and Ethereum are commodities, CFTC says
In its only direct mention of Bitcoin and Ethereum in its complaint, the CFTC calls both of the assets commodities.
The years-long investigation and filing of Monday’s lawsuit already implies that the CFTC thinks it has jurisdiction over Binance’s dealings with U.S. investors. But the regulator explicitly calling BTC and ETH commodities could wind up being very significant for the industry.
The lawsuit also makes mention of Litecoin (LTC), which has fallen a long way from its all-time high market capitalization of $27 billion to a $6 billion on Tuesday afternoon. The team behind the main Litecoin Twitter account shared a screenshot of the lawsuit and quipped that “it’s nice to know we all agree on that now.”
There’s been a sparring match brewing between the SEC and CFTC over how to classify, and therefore regulate, cryptocurrencies—especially ETH. In the ongoing legal battle between the SEC and Ripple, a 2018 speech made by SEC corporate finance director William Hinman in which he argues that ETH is likely not a security has featured prominently. Ripple’s lawyers won their fight to get access to SEC emails about the speech, but the commission moved to have them sealed.https://decrypt.co/cryptocom/bitcoin
“This is not a new stance for the CFTC,” attorney Braden Perry told Decrypt in an email. “But what is significant is the CFTC’s commitment to ETH as a commodity based on the SEC’s recent view that ETH’s move from proof-of-work to proof-of-stake was akin to a security.”
Perry, a former CFTC trial attorney and compliance officer, deals with regulatory and enforcement matters at Kansas City-based Kennyhertz Perry law firm.
It’s worth noting that SEC Chair Gary Gensler has been pretty indirect in his characterization of ETH as a security. In September, he told The Wall Street Journal that proof-of-stake assets could qualify as securities using the Howey Test.
The test originated from a 1946 Supreme Court decision and has been used as the basis for determining what falls under the SEC’s purview. It’s drawn a lot of scrutiny from the crypto industry and even SEC Commissioner Hester Peirce.
The ETH detail in the Binance lawsuit could be seen as a counterpoint to the suggestion that ETH became more like a security when it switched to proof-of-stake. That doesn’t settle anything, though. There won’t be much real clarity around how U.S. regulators classify ETH until there’s a statutory definition or judicial ruling, Perry said.
The traveling headquarters
The CFTC also called Binance’s bluff on its elusive headquarters in its complaint.
The Commission alleged in its lawsuit that Zhao said during an internal meeting in 2019 that the company’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.’”
For years, Binance avoided naming an executive headquarters. It has offered up feints that it would be naming one “soon,” but never followed up with a location.
“We haven’t announced it yet,” Zhao said during a 2022 episode of the gm from Decrypt podcast. “We will announce that in due time. But it’s very simple. It’s not that complicated.”
It’s not unusual for companies to look for ways to do business with U.S. customers in a way that limits their interactions with the country’s regulators, who have a reputation for being some of the most onerous in the world. But even if the no headquarters, no violations tactic is novel, it’s unlikely to stand up as an argument in court, according to Perry.
“Many crypto companies are based overseas attempting to avoid regulation, but this is the first time I’ve heard of a ‘traveling headquarters’ located where the CEO is at a particular point in time,” he said.
Yamina Sara Chekroun, who heads up U.S. legal affairs for non-custodial payment service Ramp, agreed that the lawsuit will change the jurisdictional strategy for companies hoping to avoid regulatory burdens.
“While it is far too early to comment on what the outcome of this case might be given how factually intensive this analysis will be, this is a signal to the industry that jurisdictional controls are going to be closely monitored and enforced and that global actors may be brought to answer in US courts,” she told Decrypt on Telegram, adding that she thinks most firms will increase the intensity with which they review compliance issues.
Should crypto worry?
But if you ask Shipyard CEO Mark Lurie, crypto at large should not be worried about the allegations that the CFTC has made against Binance.
Shipyard creates white-label software for decentralized exchanges, like a programmatic way to detect wallet addresses that have been added to the U.S. Office of Foreign Assets Control sanctions list.
“Interpreting this as an attack on crypto would be a mistake,” he told Decrypt over Telegram. “The allegations are not about issues that exist ‘in a gray area of regulation,’ but rather about evasion of cut-and-dry, well-understood regulations and rules that exist for pretty good reasons.”
But it’s still a slipshod way to get the industry into compliance, Perry said. Leaving crypto firms to infer what they should and shouldn’t be doing can be messy for a burgeoning industry.
“This is dangerous territory for the regulators,” he said. “A hasty attempt to reign in every potential for wrongdoing or anticipated event would likely fail and cause more damage than good to the cryptocurrency community.”