The King is dead, long live the king. On Tuesday, November 21, Binance, what was the world’s largest cryptocurrency exchange, and the CEO, Changpeng Zhao (CZ), both pled guilty to having engaged in criminal activity. With the U.S. government finally prosecuting the largest crypto-criminals, perhaps now cryptocurrencies can emerge from the shadows and grow towards their potential.
Digital assets and blockchain technology have been touted as revolutionary, and perhaps that is true. The ability to transmit cryptocurrency, “money”, at any time, nearly instantaneously, and without middlemen certainly has appeal. Even the idea of a digital asset as an investment, without further utility, is a valid potential use case. The problem with the digital asset class was that the potential was overshadowed by some participants.
Many of the early-movers in the cryptocurrency industry have been alleged to violate financial rules and regulations, and in the case of Binance and FTX founder Sam Bankman-Fried, proven to have engaged in criminal activity.
The newest generation of participants in the digital asset space are different. There are firms seeking to develop the technology and work within the established financial services industry. Perhaps the developments will be more evolutionary than revolutionary. By working within the rules these firms will bring about changes that may be adopted by more people and the greater economy, and perhaps equally importantly, accepted by the U.S. regulatory authorities.
Cryptocurrency and digital assets are not new, but perhaps the milestone events of the collapse of FTX, and what may be the end of Binance, are the beginning of a new era. With the removal of those seeking to skirt or disregard the law, legitimate businesses now have the opportunity to thrive. We may be seeing what in hindsight will be revealed as the real beginning of the digital asset class.
The Monitorship
As part of the plea arrangement with the government, Binance agreed to pay $4.3 billion, the largest penalty in US Treasury and FinCEN history, and Changpeng Zhao stepped down as CEO and will be subsequently sentenced to fines and a prison sentence that may be as long as ten years.
Binance was permitted to continue operations, but under numerous conditions, some of which are specified in the consent agreement with the Financial Crimes Enforcement Network (FinCEN). Those conditions are what are likely to fatally cripple the company.
The settlement agreement with Binance includes a complete exit from the United States, and a five-year monitorship where the U.S. Treasury Department will retain access to books, records, and systems of Binance. The Monitor will provide reports that will be made available to FinCEN, Office of Foreign Assets Control (OFAC), the Commodity Futures Trading Commission (CFTC), and the Department of Justice. Interestingly, the Securities and Exchange Commission (SEC) was not a party to the settlement, and Binance still must address the SEC concerns.
The monitor agreement also specifies additional scrutiny of the top 35 customers by revenue both immediately, and annually throughout the term of the monitorship. Plus, Binance must review all transactions from 2018 through the end of 2022 and file all Suspicious Activity Reports that should have been filed during that period.
The Case for the End of Binance
Binance engaged in criminal conduct. In addition to numerous law-abiding customers, Binance actively solicited those engaging in questionable or criminal conduct.
In his remarks announcing the Binance settlement, Attorney General Merrick B. Garland quoted a February 2019 Binance internal chat when one compliance employee wrote that they needed a banner that said: “is washing drug money too hard these days – come to Binance; we got cake for you.”
Who will be the Binance customers of the future?
Criminal customers do not want their activities shared with the U.S. government. People engaged in tax evasion or avoidance definitely would prefer not to have the IRS privy to their trading activity. Entities not resident in the USA also do not generally wish to have their activities and information shared with the U.S. government, often for entirely legitimate reasons.
Under the terms of the settlement agreement customers of Binance will likely have more of their information shared with multiple U.S. government agencies than those customers would experience at any other exchange provider – including those based in the USA.
That means the big question is what type of customer will continue with Binance?
What advantage will Binance hold over competitors that overcomes all the baggage that comes with remaining a customer of Binance? Will those advantages be enough to overcome both the scrutiny of the monitor and the stigma that may attach to customers who elect to interact with an organization that pled guilty to serious criminal charges?
If the competitive advantage of Binance was that they were willing to circumvent compliance obligations, what is their leading differentiator going to be now?
What did Binance Do?
Binance pled guilty to having engaged in criminal conduct from the very beginnings of the company. These were not victimless crimes.
The Department of Justice (“DOJ”) press release of the settlement noted “The violations include failure to implement programs to prevent and report suspicious transactions with terrorists — including Hamas’ Al-Qassam Brigades, Palestinian Islamic Jihad (PIJ), Al Qaeda, and the Islamic State of Iraq and Syria (ISIS) — ransomware attackers, money launderers, and other criminals, as well as matching trades between U.S. users and those in sanctioned jurisdictions like Iran, North Korea, Syria, and the Crimea region of Ukraine. By failing to comply with AML and sanctions obligations, Binance enabled a range of illicit actors to transact freely on the platform.”
The DOJ continued, “Binance willfully failed to report well over 100,000 suspicious transactions that it processed as a result of its deficient controls, including transactions involving terrorist organizations, ransomware, child sexual exploitation material, frauds, and scams.”
Outside of the settlement announced this week by the DOJ, the SEC still has thirteen outstanding charges against Binance and CZ. The charges include operating unregistered exchanges, broker-dealers, and clearing agencies; misrepresenting trading controls and oversight on the Binance.US platform; and the unregistered offer and sale of securities.
The Future
The digital asset class may have the potential to bring substantial benefits to the world’s financial system as claimed by the proponents, or it may not. The development of the asset class was held back by bad actors such as Binance, and we have not given cryptocurrency a real chance to prove value.
Binance was cheating, and they rigged the game. They were not playing by the same rules as legitimate businesses. Consider the impossibility of winning a game of the family favorite Monopoly when playing against someone who takes money from the bank at will. The honest players are quickly forced out of the game, or they quit in frustration. Binance may not have stolen money from customers, but through the lack of a level playing field they certainly grew at the expense of legitimate competitors. The harm to competitors, and the digital asset class itself, is unmeasurable.
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