What did we miss?
We recently published an article “Overview of regulatory requirements for cryptocurrency companies in the U.S.” where, among other things, we touched on the legal uncertainty and regulatory risks associated with providing cryptocurrency services to US citizens, as on Tuesday 21 November 2023, the global crypto community was shocked by epochal news – the US Department of Justice (“DOJ“) reached a resolution with the world’s largest cryptocurrency exchange Binance (Binance.com) in criminal and civil proceedings.
According to a press release on the DOJ’s website (the resolution is not publicly available at the time of this article’s writing), Binance pleaded guilty and agreed to pay more than $4 billion in fines (the largest corporate fine in the history of the crypto industry) to conclude a multi-year investigation by the DOJ and other federal agencies into violations related to the Bank Secrecy Act (“BSA“). The BSA is the primary U.S. anti-money laundering and countering the financing of terrorism (“AML/CFT“) law.
Changpeng Zhao, the founder and Chief Executive Officer (“CEO“) of Binance, also pleaded guilty to failing to maintain an effective anti-money laundering programme in violation of the BSA and resigned as CEO of Binance. He faces a prison term.
Anyone involved with cryptocurrency has heard of Binance. Binance is the world’s largest crypto exchange with more than 150 million users (registered accounts according to the exchange’s own claims) worldwide, the de facto monopoly in the industry, especially after the collapse of FTX in 2022. The platform has established itself as a trusted member of the crypto space, where users can buy, sell, and store their virtual assets, as well as access thousands of trading pairs.
Despite the negative news on 21 November, Binance maintains (according to the CoinMarketCap website) its global leadership in spot and derivatives trading volumes, Binance’s monopolistic status compared to other exchanges is particularly confirmed by its $65 billion market capitalization (according to the Cryptorank website).
The DOJ resolution is part of a major agreement between Binance and other US agencies, namely the DOJ, the Commodities and Futures Trading Commission (“CFTC“), and the Financial Crimes Enforcement Network (“FinCEN“). We wrote about the competence of the above agencies and their role in regulating the U.S. crypto market in our last article on the U.S.
A political decision?
“Binance became the world’s largest cryptocurrency exchange in part because of the crimes it committed – it is now paying one of the largest corporate fines in U.S. history,” said U.S. Attorney General Merrick Garland.
Part of the community considers the criminal prosecution of Binance “politicized” because of the exchange’s refusal to comply with US regulatory requirements and support for decentralization values, the latter of which are incompatible with the legal regulation of digital assets, but these are moral issues.
For example, one of the accusations relates to non-compliance with the Know Your Customer (“KYC“) requirement, KYC is required to identify and verify users, leading to de-anonymisation. Anonymity is one of the key values of decentralization, but it goes against modern financial regulations. Another well-known example is Binance’s refusal to provide US agencies with information about the registration of its main office.
The community also draws attention to the fact that it is the legal entity Binance Holdings Limited, which currently does not serve US residents, rather than its US branch organization Binance U.S., a specially created legal entity to serve US customers, that has been held liable. Binance representatives themselves commented on this in the context that the U.S. is trying to apply its national law outside its jurisdiction thus violating international law.
But what exactly are the federal agencies accusing Binance of and why is Binance Holdings Limited being prosecuted?
Allegations against Binance Holdings Limited
The press release states that Binance violated the AML/CFT rules, specifically such important provisions of the BSA:
- Sanctions Regime
The U.S. said that Binance allowed customers from sanctioned jurisdictions to trade. Because, according to the agencies, Changpeng Zhao knowingly operated a financial platform without basic anti-money laundering measures, the company caused illegal transactions between US users and users in sanctioned jurisdictions such as Iran, Cuba, Syria, and Russian-occupied regions of Ukraine – transactions for which Binance profited with significant fees.
For example, data shows that from around January 2018 to May 2022, Binance processed 1.1 million cryptocurrency transactions worth at least $898.6 million between US-based customers and those residing in Iran.
Binance cryptocurrency wallets were found to be interacting with Bitcoin wallets linked to groups banned as terrorist organizations by the United States and other countries, including the Islamic State, the armed wing of Hamas, al Qaeda, and Palestinian Islamic Jihad. Recently, news broke that Israeli authorities blocked more than 100 cryptocurrency accounts on Binance.
- Unlicensed money services
As we previously pointed out – there are two legal entities Binance Holdings Limited and Binance U.S., the latter was established in 2019, prior to which since 2017 Binance Holdings Limited has been serving U.S. customers without registering as a Money Services Business (“MSB“), then circumventing BSA regulations.
As a result of serving US customers, Binance was required to register with FinCEN as a Money Services Business and implement an effective AML programme that was reasonably designed to prevent Binance from being used to facilitate money laundering. Binance chose not to comply with U.S. law and failed to implement controls and procedures to prevent money laundering.
The US said that Binance, Zhao, and other executives knowingly and wilfully conspired to operate as an unlicensed MSB from August 2017 to October 2022.
Instead of complying with U.S. law, in 2019, Binance announced that it would block U.S. customers and launched a separate U.S. exchange, Binance U.S. Despite this announcement, Binance Holdings Limited took steps to retain a significant number of U.S. customers. In particular, Binance focused on retaining valuable “VIP” customers who were responsible for the majority of Binance’s trading volume and revenue.
- Failure to comply with customer verification (KYC), transaction verification and monitoring, and reporting of suspicious transactions
According to the investigation, for years Binance allowed customers to open accounts and trade without providing any identifying information other than an email address. Binance began requiring all users to provide KYC information in August 2021 but allowed users who did not provide KYC to continue trading on the exchange until May 2022.
By doing so, Binance facilitated billions of dollars worth of cryptocurrency transactions for its customers, including in the United States, without implementing KYC.
Binance laundered proceeds from transactions on the darknet market, hacks, ransomware, and fraud. For example, between August 2017 and April 2022, $106 million worth of bitcoins were sent between Binance.com wallets and Hydra, a popular Russian darknet trading platform often used by criminals to sell illegal goods and services.
Binance has not reported suspicious transactions linked to the Palestinian group Hamas and others.
The correlation of the FTX situation
Even before it was finally clear that the DOJ would bring charges against Binance, news leaked out that the federal prosecutors looking into the case were concerned that an indictment could cause customers to panic and cause mass withdrawals, as happened with FTX last year.
Customers rushing to withdraw their funds from FTX ruined that exchange as FTX management stole customer funds for themselves and the exchange was unable to meet its obligations to customers (lack of liquidity). Many people started to compare the situation with Binance and FTX, but our opinion is that they are diametrically opposite cases.
In the case of Binance, federal agencies failed to prove that the exchange a) misappropriated any user funds, and b) engaged in market manipulation. At the moment, Binance appears to be stable. Its latest Proof of Reserves report – shows that the exchange holds $65 billion in crypto assets alone. The outflow of funds since 21 November was (according to the DefiLlama website) $1.3 billion, which is not a record for Binance and is unlikely to seriously affect the exchange’s operations.
As Binance representatives repeatedly state, “We have never hesitated to stand up for our core values of user safety. We take our responsibility as a custodian of funds very seriously and provide 1:1 support for every user asset. This means users can withdraw 100 percent of their assets from the platform at any time.”
What will happen to Binance next?
On social media X, Changpeng Zhao wrote: “I know it’s the right thing to do, I’ve made mistakes and I have to take responsibility for them. It’s best for our whole community, for Binance, and for me personally.”
Unfortunately for Zhao and Binance, it doesn’t end there. Despite resolving most of the court cases on 21 November, Binance is still under attack by the Securities and Exchange Commission (“SEC“), with court proceedings continuing.
The press release also announces that Binance is committing to withdraw from the US market, an independent compliance monitor will be appointed for Binance during the transition period, and Binance is committing to fix and improve its anti-money laundering and sanctions compliance programmes.
Binance may never get the favor of regulators, but paying the fine, complying with the requirements, and ending a multi-year criminal investigation may allow it to start a new life.
Regardless, the settlement between Binance and US federal agencies is a positive step forward for the entire industry toward transparency and compliance.
It is expected that the fine, tighter regulation and withdrawal from the U.S. will reduce Binance’s global share of the crypto market, but so far there are no signs of that happening. Binance was, is, and will be the largest cryptocurrency exchange in the near future.
I would like to finish this article with a comment from Binance’s new CEO Richard Teng: “We operate the world’s largest cryptocurrency exchange by volume. The trust placed in us by our 150 million users and thousands of employees is a responsibility that we must take seriously”.
The content of this article is intended to provide a general guide to the subject matter, not to be considered as a legal consultation.