The Commodity Futures Trading Commission (CFTC) today issued a complaint against Binance, the largest crypto exchange in the world, alleging that the firm put profits over compliance and committed “numerous violations of the Commodity Exchange Act (CEA) and CFTC regulations.” Also mentioned were Changpeng Zhao, the Binance founder and CEO, and former Chief Compliance Officer Samuel Lim, who is cited widely throughout the complaint and allegedly orchestrated much of the malfeasance. Today’s filing is the latest in a series of questionable behaviors by the company.
However, while the CFTC is seeking disgorgement of profits, civil monetary penalties, registration bans and a permanent injunction against violations of the CEA and CFTC regulations, the long-term impact of this filing is unclear.
Specifically the document, filed today in the federal courthouse in Chicago, alleges that the company offered crypto derivatives, such as futures or options contracts, with leverage for assets such as bitcoin, ether, and litecoin to U.S. persons without registering with the CFTC as a futures commodity merchant (FCM). Even though Binance is not based in the U.S., in fact it has no official headquarters, if it services U.S. customers it must comply with U.S. law. Also implicit in these charges is the CFTC’s belief that the assets are commodities as opposed to securities.
Futures contracts require two parties to settle a transaction at a given date, while options give purchasers the right, but not the obligation, to complete a trade. Leverage allows users to borrow funds in order to take on more risk, which could increase gains or losses. In crypto, just like traditional markets, derivatives volume usually outpaces that of spot markets. Because of the sophisticated nature of these products, the CFTC requires operating entities to register as FCMs so that they can be closely monitored.
Binance.US, the American franchise of Binance.com, which is owned by Zhao (widely known as CZ) and licenses its technology from the main exchange, does not offer such products and was not named in the complaint. However, a 2020 Forbes investigation revealed that Binance initially set up Binance.US as a “tai chi'' entity that would distract U.S. regulators from the main exchange’s activities in the country.
The colorfully worded 75-page complaint argues that Binance not only serviced U.S. customers in contravention of U.S. laws and regulations, but it willfully failed to follow through with efforts to block American customers and even provided guidance on how its employees could conceal them from regulators and assist them in maintaining access to the platform. It suggests that this was all done to satisfy Zhao’s desire to maintain market share in a key jurisdiction.
“Cz doesn’t wanna do us kyc on .com,” said Lim in a January 2019 text conversation in the complaint, referring to the exchange’s homepage for its international exchange Binance.com. Additionally, “Lim acknowledged in February 2020 that Binance had a financial incentive to avoid subjecting customers to meaningful KYC procedures, as Zhao believed that if Binance’s compliance controls were “too stringent” then “[n]o users will come.” Another passage in the complaint reads, “i think cz understands that there is risk in [conducting KYC checks], but I believe this is something which concerns our firm and its survivability. If Binance forces mandatory KYC, then [competing digital asset exchanges] will be VERY VERY happy.”
With regard to not following through on public plans to ban U.S. customers, the complaint noted that in September 2019, “Binance claimed it had begun to block customers based on their internet protocol (“IP”) address. In reality, Binance simply added a pop-up window on its website that appeared when customers attempted to log in from an IP address associated with the United States.” However, the pop-up did not stop customers from logging into accounts.
The most striking parts of the complaint illustrate steps that Binance allegedly took, directed by Lim and under the guidance of Zhao, to help its most important clients in the U.S. maintain access to the platform.
For instance, the company’s VIP Handling Policy “instructed its personnel to “[i]nform the user that the reason why he/she cant use our www.binance.com is because his/her IP is detected as US IP. If user doesn’t get the hint, indicate that IP is the sole reason why he/she can’t use .com” [emphasis in original]. Lim flagged a passage in the VIP Handling policy for his colleagues that further explained: “We cannot teach users how to circumvent the controls. If they figure it out on their own, its fine.”
The firm also helped institutional customers set up shell corporations or transfer U.S. trading accounts to individuals located in jurisdictions beyond the reach of American law enforcement. In one such instance in December 2020, “Binance sent Trading Firm A an email that stated that Trading Firm A had “identified [itself to Binance] as a U.S. Person.” Following numerous telephone conferences with Binance personnel concerning their “corporate structure,” Trading Firm A, again with the assistance of Binance personnel, opened a “new” account held by a different nominee shell entity in April 2021.”
Despite the numerous details in this complaint, its long-term impact remains to be determined. Unlike former FTX CEO Sam Bankman-Fried, who was extradited to the U.S. in December 2022 and is under house arrest in Stanford, California while awaiting trial, neither Zhao or Lim are in the U.S. or within easy reach of its law-enforcement agencies. Zhao’s location is typically kept secret, unless he is making a public appearance, and Lim is reportedly in Singapore.
Perhaps the most analogous case is the CFTC’s October 2020 action filed against the crypto exchange BitMEX, which invented the crypto derivatives business, and its three founders Arthur Hayes, Benjamin Delo, and Samuel Reed. That complaint is substantially similar to the one filed today against Binance in that its chief allegation is that the company targeted U.S. customers without registering with the agency, that it took steps to avoid removing those users from its platform and that it failed to implement an effective anti-money laundering program in violation of the Bank Secrecy Act (BSA).
The civil case was concluded when BitMEX agreed to pay a $100 million civil penalty, the largest in crypto history, remove all U.S. customers from its platform, and implement proper anti-money laundering and know-your-customer safeguards. Hayes and Delo resigned from the company and pled guilty to federal charges of violating the BSA. They each paid an additional fine of $10 million and were sentenced to two years probation.
This case was successful from the perspective that it ended BitMEX’s stranglehold on the crypto derivatives market, of which it controlled almost 100% through August 2019. However, its absence led to the ascendance of other off-shore unregulated or loosely exchanges such as Binance, Deribit, and ByBit, that now dominate the industry. According to data from The Block, BitMEX’s biggest month in bitcoin futures was $143.9 billion in July 2019. Binance has passed $1 trillion in monthly volume twice and last month crossed the 50% threshold of total volume for the first time.
Binance appears ready to pay fines. The company is “working with regulators to figure out what are the remediations we have to go through now to make amends for that,” said Binance Chief Strategy Officer Patrick Hillman to the Wall Street Journal in February. He noted that the outcome would “likely be a fine, could be more.…We just don’t know. That is for regulators to decide.”
However, for a fine to have teeth it may need to be substantially larger than the $100 million doled out to BitMEX. Analysis from Forbes Director of Data and Analytics Javier Paz suggests that Binance has made more than $17 billion in revenue from its derivatives business. If 18-20% of that business came from the U.S., which are revenue percentages listed in documents obtained by the CFTC in the complaint, that would indicate that the company has made more than $3 billion in fees from U.S. derivatives customers since it launched the service in 2019.
Even then things may not be that simple, as Binance is reportedly also being investigated by the U.S. Department of Justice stemming from potential violations of the BSA, and the Securities and Exchange Commission is reportedly looking at whether the company violated securities law when it sold its Binance coin cryptocurrency to raise funds in a 2017 initial coin offering.
The Binance developments are transpiring in the backdrop of a regulatory crackdown in the U.S. against the crypto industry. Banking and securities regulators, and even the White House have questioned the value and utility of crypto and are urging private-sector entities to use extreme caution before providing services to companies in the industry.Barney Frank, the former Massachusetts congressman who co-sponsored the Dodd-Frank reforms after the 2008 global financial crisis and who sat on the board of Signature Bank, a New York lender that serviced crypto companies and was closed this month by regulators, suggested in recent interviews that the entire industry is being targeted.
