Within the crypto community, Binance is ubiquitous. It is the world’s largest cryptocurrency exchange with twenty-four hour trading volumes (at time of writing) of approximately $19.3 billion, dwarfing its competitors. By comparison, its US based rival Coinbase
had trading volumes of approximately $2.7 billion during this period. Although undeniably successful, Binance has come under increasing regulatory scrutiny in recent months as global regulators in
countries as diverse as the US, UK, Japan, Thailand, Malaysia and others have initiated criminal or regulatory proceedings, or banned its operations altogether.
These recent actions against one of the most successful businesses in the crypto world shine a spotlight on a sector that is going through tremendous and rapid growing pains as it transitions into a mature asset class and a more fundamental part of the global
financial services infrastructure. They also showcase the perils of operating a business in a sector where rules have to date been lax or unenforced and where its rising prominence and potential for utilisation by criminal actors is forcing global regulators
to take a closer look, often with extremely punitive consequences on businesses who have been used to operating in a frontier environment.
It bears noting that significant signs of potential regulatory and criminal malfeasance by Binance have been in the public record since at least 2018 when Japanese regulators found that it was operating in the country without appropriate registrations to
accept business from Japanese residents and ordered it to suspend operations. Subsequently in 2020, as described below, Binance was the subject of an in-depth article in
Forbes which described an alleged scheme dating back to 2018 ‘designed to intentionally deceive regulators and surreptitiously profit from crypto investors in the United States’. These warning signs beg the question why global regulators in most countries
took so long to act and what additional controls may be needed to protect consumers and the global financial system in order to tame the crypto frontier.
Moving to Avoid Regulation
Although founded in 2017 and initially based in Hong Kong, Binance was forced to move its servers and headquarters to Japan ahead of the September 2017 ban by the Chinese government on cryptocurrency trading in the country. Its stay in Tokyo was short lived
as by March 2018 Japan’s Financial Services Agency (JFSA) had issued it a formal warning and ordered it to suspend services to Japanese residents. The rationale given by the JFSA was due to Binance operating in violation of Japan’s rules on fund settlement
as it did not have appropriate registrations to accept business from Japanese residents. Soon thereafter, Binance moved to Malta where it set up its new headquarters.
By 2018, Malta had become one of the first countries to develop a regulatory framework for crypto assets and crypto businesses, having issued a series of three bills to govern activity in this area, including a regulatory regime applicable to crypto exchanges
and other crypto businesses and the creation of the Malta Digital Innovation Authority to create crypto policy and enforce standards for the use of crypto technology. However, the Malta Financial Services Authority is on the record as stating it never regulated
Binance or that the exchange had permissions to operate there.
Binance subsequently opened a variety of additional entities, including a Cayman Islands based holding company.
In addition to serving as a traditional crypto exchange, allowing consumers to buy and sell Bitcoin, Ethereum and other crypto currencies, Binance, like many crypto exchanges, allows the trading of highly leveraged crypto derivatives. This included Bitcoin
futures where consumers would make trades with leverage of up to 125 times the amount they put down. Effectively it functioned like a high stakes casino allowing customers to make extremely risky bets on the future performance of cryptocurrencies.
Highly leveraged positions allow for incredible gains in a bull market, but during a market crash they present the opposite scenario. When there is a market crash, investors in leveraged assets are required to put up additional capital or face the liquidation
of their positions. Leveraged positions are also highly regulated and particularly with respect to retail consumers (a significant proportion of Binance’s user base) the prohibitions imposed by regulators in many countries are strict.
During the crypto flash crash on 19 May 2021, when Bitcoin fell during the course of two hours from about $38k to about $30k, the portfolios of many retail traders were decimated. Many investors who had been riding high during the crypto bull-run faced a
liquidation scenario leading to numerous
complaints about the Binance platform (and in fairness other exchanges that allowed similar trading strategies).
Following the consumer backlash, Binance reduced its permissible limit of leverage to 20 times the amount invested.
The Tai Chi Document
A frontier market environment is one of incredible opportunity and where there is a perception that rules don’t exist or won’t be enforced; this can create an environment in which market actors may attempt to find ways to skirt the impact of new law in the
pursuit of profit or faster growth. It could be argued that Binance aimed to channel the crypto gold rush and grow at all costs by moving its operations when needed to avoid the impact of regulations which could dampen its profits.
Forbes, in Michael del Castillo’s article ‘Leaked ‘Tai Chi’ Document Reveals Binance’s Elaborate Scheme to Evade Bitcoin Regulators’, describes Binance’s alleged attempts to intentionally avoid regulations in the US. The expose details a leaked document
reviewed by senior Binance executives that allegedly presents a plan to ‘execute a bait and switch’ to US regulators. According to Forbes, Binance planned for an unnamed US company described as the ‘Tai Chi entity’ to be established as a compliant subsidiary
in the US, which would not allow leveraged crypto-trading. This entity would serve as the figurehead for Binance in the US and a target for any regulatory censure, while maintaining little in the way of assets to be enforced against.
In the background, according to the Forbes article, this leaked document details that the main Binance holding company in the Cayman Islands and other Binance entities would continue to operate and provide services to US consumers from offshore locations
to evade regulations on excessive leverage and other prohibitions. It also called for the use of virtual private networks or VPNs by consumers to help obscure their location and transact on the main Binance exchange, which was viewed as outside the scope of
AML / KYC Risks
There has been an increased global focus on the money laundering risks presented by crypto assets and lightly regulated crypto-exchanges in recent months. Many global regulators have attempted to close the open door on these risks by subjecting crypto exchanges
to aspects of the global financial services regulatory framework that have long applied to traditional financial services.
This includes, for example, the 5th Anti Money Laundering (AML) Directive that was implemented in the EU on 10 January 2020 and brought providers of exchange services between virtual and fiat currencies into scope for its regulatory perimeter and the UK
Financial Conduct Authority’s (FCA) new financial crime reporting requirements for crypto exchanges and wallet providers, that from March 2022 will require them to reduce customer anonymity and provide annually to the FCA some of the same AML and know-your-client
(KYC) information as traditional financial services institutions.
Under this backdrop, it is no surprise that Binance, along with other crypto currency platforms, has faced additional scrutiny. ‘The Binance exchange was
allegedly one of the two leading destinations for illicit bitcoin flows in 2019, with about $770 million moving on to the platform from allegedly criminal enterprises.’ In its pursuit
of rapid growth and the riches of the crypto gold rush, Binance had, according to regulators, failed to put in place the types of controls that would prevent this type of activity from occurring. This in addition to its alleged evasive manoeuvres to skirt
leverage restrictions by moving its operations appears to have given grounds to regulators around the world to take action.
Binance today remains (at time of writing) one of the world’s leading crypto exchanges by volume. In addition to restrictions on leverage, unverified Binance users are now restricted from withdrawing more than 0.06 BTC per day without being subject to robust
KYC checks. While this is a step in the right direction, this would still allow a potential criminal actor to withdraw approximately $2,000 per day from the exchange based on today’s Bitcoin prices.
The regulatory clampdown continues with an increasing number of countries globally imposing restrictions or outright bans on Binance’s operations. However, the realities of the digital economy still allow consumers in countries that have banned Binance to
transact on its platform via VPNs. While the regulatory action is welcome, protective of consumers and helps to mature the industry, it has a long way to go before this burgeoning asset class is properly brought into the fold of mainstream finance.
Regulators need to find ways to address the anonymity preserving features of the digital economy, many of which are desirable, while at the same time promoting standards for consumer protection. Perhaps, rather than the piecemeal approach of individual regulator
clampdowns a more coordinated global strategy is needed to address this new asset class and to prevent a proliferation of other actors operating in a manner that avoids local law requirements.