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Dear Bankless Nation,

Welcome back, we hope you aren't too salty after our April Fools' joke on Saturday, don't worry Ryan and David aren't splitting up anytime soon 😆

Today, it's back to serious business – the Bankless team is digging into a regulator suit filed against Binance which features internal messages that don't paint a particularly shining portrait of the exchange's leaders. How much damage could this suit cause to CZ and Co.? Let's take a look.

- Bankless team

P.S. Jim Bianco knows about Bankless Podcast NFTs -- do you? This is the best response to Balaji's $1M Bitcoin Bet that we've heard. Collect it now!

Binance's KYC Chaos

Bankless Writer : Jack Inabinet

Photo by Ben McShane/Web Summit via Sportsfile

Fresh off of Coinbase’s receipt of a Wells notice, Binance and its founder CZ have found their way into regulator crosshairs.

On March 27, the CFTC brought a complaint against CZ, Binance Chief Compliance Officer (CCO) Samuel Lim, and multiple Binance-associated entities for numerous alleged violations of the Commodity Exchange Act and CFTC Regulations. Soon thereafter, the contemplated Binance.US <> Voyager acquisition was suspended.

This case is looking ugly for Binance.

There is a bananas level of detail and gossip in this lawsuit and we’re hitting on all of the highpoints below:

💣 Binance Bomb

The CFTC is lobbing some hefty accusations in its suit.

Gretchen Lowe, of the CFTC, alleged that “Binance’s compliance efforts have been a sham and Binance deliberately chose – over and over – to place profits over following the law,” and further claims that Binance, “flout[ed] and actively attempt[ed] to circumvent CFTC regulatory requirements.”

While not a surprise to many on CT, a serious US regulatory threat is mounting against Binance and the evidence is damning. Very juicy company chats on the popular “end-to-end encrypted messaging app” Signal have been picked up in the CFTC’s filings, meaning one of two things.

🎯 Targeting Americans

As a US regulator, the CFTC has jurisdiction over companies violating American laws. Establishing that the non-US arm of Binance knowingly onboarded US persons and entities is key for the establishment of jurisdiction. Unfortunately for Binance & Co., there is overwhelming evidence to suggest that this is the case.

After an absence of prohibitions against US trading for the first two years of operations, Binance did eventually implement controls, updating terms-of-service in 2019 to ban US consumers while restricting US IPs from accessing the platform in September 2019. Despite this “ban,” Binance internal reporting continued to reflect US user concentrations and revenues.

In January 2020, 19.9% of Binance’s customers were US based, shrinking to 17.8% in June 2020, nearly a year after updating its terms-of-service to restrict Americans from platform use. Revenue reports from September 2020, a full year after Binance restricted US IP access, show 2.51M customers were located in the US. After the CFTC announced its 2021 investigation into Arthur Hayes and the BitMEX squad, CZ directed Binance personnel to replace “US” in certain fields of internal data with “UNKNWN."

Four trading firms are referenced in the CFTC’s complaint, all of which are incorporated in and have a significant presence within the United States. Legal entities for the two listed brokerages are domiciled in the British Virgin Islands and Malta, yet key persons and other personnel from both reside in America.

🕵️ Intentional Subversion

When Binance employees weren’t busy ignoring US activity on the exchange, they were actively sabotaging their shoddy compliance infrastructure, the CFTC alleges.

Sometime prior to October 2020, Binance formalized a process to help US VIP customers evade internal compliance controls with a policy called “VIP Handling." Binance is alleged to have provided these white-glove services for the four trading firms referenced in the complaint, engaging with these clients in the setup of entity structures to avoid compliance and going as far to advise one firm flagged as located in the US to trade on the personal account of a British-based employee.

The CFTC asserts Binance recognized the evasive nature of these policies, with CZ encouraging confidentiality of the document and instructing on an October 2020 daily call that any communications on the “US ban” should be done via Signal. Lim circulated CZ’s message to other senior compliance officials, explaining, “we do all U.S. coms via signal as mandated by cz.”

🎭 All for Show Compliance

Centralized exchanges are responsible for monitoring clientele identities and their transactions. Domestically and abroad, implementation of AML, KYC, and other compliance programs is the responsibility of any financial service provider.

Like any centralized crypto trading platform, Binance was supposed to prohibit terrorist groups from accessing its services. Intercepted intra-Binance communications showcase multiple potential compliance violations. Court docs cite one such violation, occurring in February 2019, in which compliance chief Lim received warnings “regarding HAMAS transactions.”

At most companies, this would set off some compliance red flags. 🚩 🚩 🚩

Lim, however, chose to make light of the situation, stating, “terrorists usually send ‘small sums’ as ‘large sums constitute money laundering,’” to which, “Lim’s colleague replied: ‘can barely buy an AK47 with 600 bucks.’”

Certain Russian customers’ transactions set off compliance alarms in February 2020, with Lim flat out acknowledging, “Like come on. They are here for crime.” Binance’s Money Laundering Reporting Officer concurred, responding, “we see the bad, but we close 2 eyes.” Some analytics firms have found that Binance was the hub for 94% of illicit crypto money laundering activity to fund the war against Ukraine.

🤑 Chasing the Bag

Filings from the CFTC allege that Binance’s lax compliance was no mere accident. Instead, it was a strategic decision. According to Lim, accepting prohibited users was just a “biz decision” for Binance’s CEO.

Lim explained to Binance compliance employees that they should avoid off-boarding customers, even if they present a regulatory risk -- “Offboarding = bad in cz’s eyes.”

While Binance.US was being advertised independent of the mothership, Lim was secretly using the US platform to incubate important customers to be onboarded to the platform. As Lim puts it to an employee in a July 2020 chat, if they’re doing “sick ass volumes… we always have a way for whales,” by pushing to “accept [the client] on an exceptional basis.”

👑 Open Throne

Last year was brutal for crypto; major lending desks are memories of a distant past fueled by the GBTC carry trade and FTX’s violent implosion left a massive hole in the crypto derivatives market. Participants have been scrambling to find their substitute in a post-apocalyptic leverage landscape.

American exchanges are making their plays. The Winklevi and their exchange are marking their first foray into derivatives markets and Coinbase is reported to be actively discussing the launch of an overseas derivatives platform with institutional clients. Market maker Wintermute and Crossover Markets, a recently launched high-frequency crypto exchange, are both mulling expansion into crypto derivatives trading, as well.

Binance remains the dominant crypto derivatives platform; in March, the exchange processed 58% of BTC and 51% ETH futures volumes. Binance’s share of the derivatives market has been up only post-FTX. Any threats against Binance's strength could offer competitors an in-road elsewhere.

According to Robot Ventures partner Tarun Chitra, “There is a clear vacuum left in the crypto derivatives market, especially for regulated entities.” Americans also desiring leverage have been pushed on-chain and to suspect CEXs, like the Seychelles registered KuCoin, to quench their thirst. Building out trusted derivatives platforms for offshores markets enables rapid onboarding of untapped US consumers when regulatory clarity is established.

☠️ Death Blow or Overblown?

At least Cramer is a pessimist, right?

Allegations of willful compliance avoidance and the pursuit-of-profit-at-any-cost mentality displayed by key Binance personnel appear, at best, sloppy and reckless.

While a Signal compromise isn't out of the question, it seems more likely that regulators have flipped a Binance insider, specifically the unnamed Money Laundering Reporting Officer who appears complicit in compliance subversion efforts but avoids any charges in the CFTC’s complaint.

Relief requested by the CFTC includes blackballing all Binance associates from US commodities and securities markets, placing immense pressures on employees, especially those located in the US, to fully cooperate with the investigation.

Whether additional regulatory bodies pile on Binance remains to be seen, but things aren't looking great for the CEX kingpin.


Scan this section and dig into anything interesting

*Data from 4/3 2:00 pm EST (DeFi Index = $DPI, NFT Index = $Blue-Chip-10)


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