On Monday, securities regulators in the U.S. sent a message to the digital currency industry: When it comes to crypto, nothing is too big to fail. Or kill. Binance, the world’s largest crypto exchange, and its founder, Changpeng Zhao, are accused of running an anything-goes crypto casino that committed some of the same cardinal misdeeds that contributed to the downfall of Sam Bankman-Fried’s FTX — including stealing customer money and using secret trading firms to prop up the business, according to a suit filed by the Securities and Exchange Commission in federal court. Because this is a crypto fraud accusation, there’s even a mysterious $11 million yacht.
The 13-count, 136-page lawsuit offers a detailed picture of how the Cayman Islands-based exchange, which has no fixed address, has obtained money from the U.S. financial system while evading rules and safety measures. The scope of the suit is not only damning for Binance but signals that the crypto industry as it has operated for the past five years could be coming to an end. The undercurrent here is that fraud, or at least deceit, was crucial to its business model. “Through thirteen charges, we allege that Zhao and Binance entities engaged in an extensive web of deception, conflicts of interest, lack of disclosure, and calculated evasion of the law,” SEC chair Gary Gensler said in a press release.
The suit is also a rebuke to the invulnerable image created by Zhao, who goes by the initials CZ to his fans. Last year, Zhao effectively destroyed FTX in a series of tweets highlighting the financial rot at the core of Bankman-Fried’s crypto empire. Binance has stood alone as the only truly global giant crypto exchange, a go-to place for the buying and selling of just about every digital currency in the world. Zhao also positioned himself as something of an anti–Bankman-Fried, a calm and steady truth-teller rather than a fidgety liar. What the suit alleges, though, stands in stark contrast to that image.
Binance and Zhao aren’t accused of any crimes, but the allegations are the most serious made by the federal government against a standing crypto giant. In a statement, the company said it intends to defend itself and that the SEC doesn’t have the jurisdiction to file this suit anyway, given that Binance — at least in theory — doesn’t operate in the United States.
The bigger picture, though, is that the SEC complaint marks another major negative moment for crypto after more than a year rife with such brutal milestones. Many of the industry’s once-brightest stars are in jail or being sued. Investors and speculators are seeing fewer and fewer reasons to believe that becoming crypto-rich is a realistic possibility, as depressed valuations and an expected onslaught of rules will probably continue to weigh on what once was functionally an anything-goes global casino accessible on any smartphone.
The suit is long and complex, detailing the many alleged ways that Binance sought to evade accountability, but there are five essential things to know about how it all operated:
There were two secret trading firms
It sounds obvious, but you can’t have a functional exchange if people don’t use it. It’s supposed to stand in the middle of buyers and sellers and find a balance between them that keeps people coming back. But one thing that’s definitely not good for an exchange is to have secret trading firms at the middle of it that secretly control the buying and selling of all the assets on the exchange — which, in this case, is exactly what Binance is accused of.
At the center of the lawsuit are allegations that Binance is, like FTX, a sham propped up by trading firms that Zhao secretly controls — and that money diverted to these firms were used, in one instance, to buy an $11 million yacht. One of them, called Sigma Chain, was primarily used to prop up Binance’s U.S. arm. The other, Merit Peak, was used internationally. Both of them were run by Binance employees at the direction of Zhao to keep prices and trading volume high.
Unlike Bankman-Fried, whose hedge fund, Alameda Research, was a known entity, neither Sigma Chain or Merit Peak were generally familiar to the public. Both were allegedly used to create an illusion around Binance’s size and power. In some instances, Sigma Chain was the only trading partner, or counterparty, available on the platform. In others, it engaged in wash trading, or fake trading that makes it look like there’s more demand for something than there really is. In some cases, the fakes accounted for 99 percent of the trading of some coins. Merit Peak allegedly used customer funds to buy Binance USD, its house currency.
Customer money was handled poorly
In the U.S., financial services companies can’t just take all their customers’ money, throw it into a big pile, and call it a day. The money has to be separated into separate accounts, which are tracked and protected by the force of the law. At Binance, though, this was apparently not the case. According to the SEC, “billions of U.S. dollars of customer funds from both Binance Platforms were commingled in an account held by a Zhao-controlled entity.” That entity was one of the trading funds, Merit Peak, which then used customer money to buy crypto assets.
The allegations in the suit bolster reporting by Reuters into this very issue at Binance, though the newswire had said that there was “no evidence that Binance client monies were lost or taken.” Instead, the issue appears to be the expectation of how the money would have been used, according to the report. Still, it’s not clear if the trading firms ended up profiting off this allegedly looser treatment of customer money by buying and selling in its own accounts.
Binance executives said incriminating things
If you’re a chief compliance officer, your job is to make sure that your company follows the rules. There’s nothing wrong with having a desire that there be fewer rules or that the rules be easier to follow. If you were the CCO of Binance, however, it would not look great if you said the following:
- “We are operating as a fking unlicensed securities exchange in the USA bro.”
- “We do not want [Binance].com to be regulated ever.”
- “[o]n the surface we cannot be seen to have US users[,] but in reality, we should get them through other creative means.”
But this is actually, literally, truly what former CCO Samuel Lim said, according to the suit. (Lim is not a defendant in the suit, but he is being sued by another U.S. financial regulator, the Commodities Futures Trading Commission.) The crux of this here is that Binance wanted U.S. users with a lot of money but didn’t want to have to deal with the pesky rules imposed by the U.S. government for obtaining that money. After one July 2019 meeting, “the Binance CCO noted that Binance would engage in ‘the international circumvention of [know your customer’ anti-money laundering rules]’ and Zhao affirmed that his ‘goal’ was ‘to reduce the losses to ourselves, and at the same time to make the U.S. regulatory authorities not trouble us.’”
“We always have a way for whales”
I can’t help myself, so here is another quote from Lim detailing how he’s going to try to get around U.S. trading rules: “We let them trade on .com through a special arrangement.” He further explained, “We ask them to onboard with US, and then if their volume is really very big … we will push hard on .com side to accept it on an exceptional basis … we always have a way for whales … either we do it, or [a competitor crypto trading platform] does it.” In another instance, he said that U.S. customers should trade through VPNs. This is one of the big pieces of this suit. Binance had a plan to make it look like they weren’t soliciting U.S. customers when in fact their business depended on them.
Crypto had a very bad day
After the SEC filed its suit, the value of most major cryptocurrencies fell. Among the worst was Binance’s BNB coin, used to finance the exchange, which lost 10 percent. BUSD, its in-house stablecoin, wobbled from its $1 peg price, though it did not have the kind of imminent crash that came along with FTX’s own currency.
But it wasn’t just the coins created by Binance. The SEC goes hard on ten other cryptocurrencies for being unregistered securities offerings — essentially, they’re investments that haven’t been registered or okayed by regulators. Solana is one, and it also fell about 10 percent. This is essentially an extension of the SEC’s war on crypto exchanges for allowing trading in things that they shouldn’t be. Last year, the SEC went after Coinbase for essentially the same thing in a suit that’s still ongoing. In a since-deleted tweet, Zhao called this facet of the suit “a preview of what’s next … We need to unite.”