The most powerful man in crypto has much to worry about

“I’m not an anarchist,” Changpeng Zhao once said. “I don’t believe human civilisation is advanced enough to live in a world with no rules.”

But now that the US Commodity Futures Trading Commission has sued Zhao and his Binance cryptocurrency exchange for alleged violations of derivatives regulations, the world is finding out how the most powerful man in crypto responds when he himself is the one being accused of breaking the rules.

The outcome may help shape the future of the crypto industry as its major players grapple with the pressing dilemma of the day: whether to resist increasingly aggressive efforts by the US government to bring the industry into compliance with financial laws, or cooperate in an attempt to salvage operations in the world’s largest economy.

A Binance spokesman called the CFTC’s actions “unexpected and disappointing”, saying the company had “made significant investments over the past two years to ensure we do not have US users active on our platform”, including more money spent on compliance tools and increased staffing in that area. The firm intends “to continue to collaborate with regulators in the US and around the world. The best path forward is to protect our users and to collaborate with regulators to develop a clear, thoughtful regulatory regime,” the spokesman said.

As for CZ himself, his first public response was to tweet “4”, an apparent reference to a previous post of his laying out his “Do’s and Don’ts for 2023: “4. Ignore FUD, fake news, attacks, etc.”

Getting past a lawsuit by the CFTC will be harder to do than ignoring “FUD”, the acronym for “fear, uncertainty and doubt” that’s so often pointed at crypto projects. And indeed, CZ followed up his initial reaction with a lengthier blog post in which he echoed the Binance spokesman on compliance efforts and cooperation with regulators, while adding that the CFTC’s suit “appears to contain an incomplete recitation of facts, and we don’t agree with the characterisation of many of the issues alleged in the complaint”.

VPNs

At the heart of the suit are allegations that Binance failed to register as a US derivatives exchange and intentionally structured its businesses and transactions to avoid those registration requirements. The agency alleged that CZ and senior managers took steps to violate US laws, including instructing US customers to use virtual private networks, or VPNs, to obscure their location and directing “VIP customers” to open Binance accounts under the name of shell companies. The CFTC also said Binance’s own documents for the month of August 2020 showed that the platform earned US$63-million in fees from derivatives transactions, and that about 16% of its accounts were identified as being held by US customers.

Among other things, the complaint seeks a permanent injunction to stop Binance from continuing to commit violations and prohibit the defendants and related parties from trading digital assets and other commodities. It also seeks to recoup trading profits, revenues, salaries and other money derived by Binance as a result of the violations.

“It’s a set of very strong allegations,” Tim Massad, the former chairman of the CFTC who is now director of the Digital Assets Policy Project at the US Harvard Kennedy School, said in an interview. “They are seeking a permanent injunction against the defendants, so that would include CZ personally as well as Binance, from essentially doing business in the US, basically from ever registering in the US or engaging in commodities transactions in the US.”

CZ in his response said Binance “does not trade for profit or ‘manipulate’ the market under any circumstances”. He said the company has affiliates that provide liquidity for less-liquid trading pairs that are “monitored specifically not to have large profits”. He also said he strictly observes Binance’s trading policies, including those for anyone with private information such as details on listings. In closing, CZ said that “we do not expect everything to be easy”, but that “we do not shy away from challenges”.

The blog post suggests Binance is ready to dig in for a legal fight. In the meantime, it continues to cultivate its global operations in international market hubs that are more friendly to crypto.

Zhao, who has an estimated net worth of almost $28-billion, bought a home in Dubai in 2021 in what he said was a show of support for a city he describes as “very pro-crypto”. The founders of Three Arrows Capital moved to Dubai after that crypto hedge fund collapsed. Meanwhile, CZ’s former main rival Sam Bankman-Fried of FTX is under house arrest as he awaits trial on fraud charges that could put him in prison, in theory, for more than a century.

Even before the news of the pending action from US regulators, CZ appeared to be cosying up to his hosts. The homepage of Binance’s non-US website last week was dominated by a celebration of the start of Ramadan, complete with an Advent-like calendar. “Check back daily to discover all kinds of special promotions, gifts and events,” it reads. “There’s $535 000 worth of rewards to be shared!”

On Wednesday, the first day of the Muslim holy month, it linked to a video interview with CZ himself. In that conversation, CZ said he is now based in the Middle East, without naming Dubai specifically, and praised what he called the region’s business-friendly atmosphere. He also acknowledged some regrets.

“With hindsight, there’s a lot of things we would do differently,” he said. “We probably would have, should have, engaged with the regulators globally a lot earlier. More educational efforts earlier. I probably should have learnt Arabic earlier.”

One question is whether the risk of trying to defend Binance’s US business in court is more trouble than it’s worth for Zhao. While his exchange’s dominance over the global crypto market and associated derivatives has continued to grow since FTX’s failure, accounting for around 60% of the market as of mid-February according to data from CryptoCompare, its smaller US site has struggled to gain that type of market share in the US. The Binance US exchange was the fourth most active crypto exchange in the country over the past 24 hours, with volume about half that of leader Coinbase Global.

The action against Binance is the latest turn in the collision course between major national governments and crypto advocates’ vision of a system where money can be freely exchanged around the world without “censorship”. The roots of the crackdown lie in last year’s failure of Terra’s stablecoin to maintain its $1 peg and the bankruptcy of FTX, which combined to vapourise almost $2-trillion of digital wealth. Yet a tense geopolitical environment, marked by financial sanctions targeted at Russia and Iran, is adding fuel to the scrutiny.

“Binance now faces investigations into criminal sanctions evasion, money laundering conspiracy, unlicensed money transmission, questions about its financial health and increased scrutiny over its intentionally ‘opaque corporate structure’,” US senators Elizabeth Warren, Chris Van Hollen and Roger Marshall wrote to CZ and the head of Binance US earlier this month, summarising a long list of critical articles about the firm and requesting balance sheets and other information on the businesses. The collapses of crypto-friendly banks Silvergate Capital and Signature Bank are also ratcheting up the scrutiny.

Force the issue

And while CZ once modelled his aspirations for the Binance US exchange after Coinbase’s successful transition to a public company, that exchange, too, has been mired in state and federal investigations, including the company’s disclosure last week that it had received a notice that the US Securities and Exchange Commission plans to bring an enforcement action.

“In one week, the CFTC has sued Binance and the SEC has indicated that it will sue Coinbase,” said John Coffee, a professor at Columbia Law School who specialises in securities regulations and corporate law. “In both cases, they could force these firms to leave the US and make their markets only abroad. Yet we still do not have a clear definition of the extent to which cryptos constitute securities. These cases will force that issue to the front burner.”

CZ has made his thoughts clear regarding government efforts to rein in the crypto industry. At an interview at the Bloomberg New Economy Forum in Singapore in November 2021, he said he believed the US was trying to protect the status of the dollar, which he said “is a strong tool to organise the world, even stronger than the military”. Yet he compared those protectionist efforts to Eastman Kodak’s failed attempt to defend its film business from digital competition.

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“What’s better to do is to invest very heavily in the thing that can disrupt you,” he said. “The technology will develop around the world. You cannot erase a concept from 400 million people’s heads.”

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With the US seemingly taking what CZ calls the Kodak approach to cracking down on crypto, the industry is likely to continue being pushed away from the traditional financial industry and into the shadows. Whether or not the most powerful man in crypto goes along for the ride could play a big role in determining what the market looks like when it gets there.  — Michael P Regan, with Vildana Hajric and Allyson Versprille, (c) 2023 Bloomberg LP

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