When the time comes to write crypto history, 2023 may go down as the year regulatory pressure hits its peak. Between the restrictions on staking, the difficulties of access of crypto platforms to banking services, unreliable reports or repeated thrusts from the SEC, the authorities want to bring the crypto industry to heel at all costs. The SEC hit hard this week by formally suing the two world leaders in crypto-asset exchanges, Binance and Coinbase.
If the two giants are targeted by the same financial policeman, the issues and the consequences are different. We detail the three most serious charges in the Binance vs. SEC case, then draw a parallel with the equally important Coinbase vs. SEC case.
What links between Binance, Binance.US and these entities named BAM Trading and BAM Management?
As you know, Binance (binance.com) is the #1 platform for buying, selling and trading cryptocurrencies. Launched in 2017, Binance has no specific headquarters. It is based everywhere and nowhere simultaneously, in France, Switzerland, the Cayman Islands, etc.
Binance.
US is another platform owned by an American company named BAM Trading. Binance.US is supposed to abide by US cryptocurrency laws, which are stricter than anywhere else. Binance.US was created in 2019 with the help of Binance, which provides it with the technology and brand.
BAM Trading is a business that Harry Zhou, a former employee of Binance, founded in 2019. It has been given a license by the US government's FinCEN, which deals with the battle against money laundering and the financing of terrorism.
Within the framework of a partnership with Binance, BAM Trading was then able to launch Binance.US (binance.us), specifically intended to welcome American traders.
What does the SEC accuse Binance and Changpeng Zhao, it's boss?
"A web of deception". In phrasing, the SEC complaint against Binance, filed on June 5, echoes the essence of the CFTC complaint, filed on March 27. The thirteen grievances of the financial policeman against the heavyweight of crypto assets take up the same reasons, this time with more substantial evidence.
The offering of unregistered securities and investment programs. Deliberately failing to properly report to the SEC as platform, broker, and clearing intermediary. Dissemination of knowingly disguised information to investors.
The list goes on, but interestingly, two of the SEC's grievances are aimed specifically at Changpeng Zhao. What do we blame him for? To have secretly piloted Binance.US as he does for Binance Global while claiming to give carte blanche to his then acolytes Catherine Foley and Brian Brooks. To have had control over the funds of its subsidiary, directing them as it pleases to two hedge funds belonging to it.
1 – Binance.US, a useful fiction to deceive the American authorities
From its inception (September 2019), Binance.US claimed managerial independence from Binance Global. To comply with the administrative requirements of the United States, of course, but above all, to be authorized to offer specific services to American clients (trading, staking and other investment products).
In reality, both entities would have been entirely under the control of Binance's CEO. The machination, subtly dramatized by SEC lawyers, refers to the famous "Tai Chi" plan, a code name first revealed by Forbes in October 2020.
What is it about? As early as 2018, Binance masterminds realized that serving US customers on Binance.com made the platform an unregistered stock exchange. Binance then calls on several advisers to give it legal advice. One offers several solutions under a document labeled The Tai Chi Plan.
The strategy aims to circumvent collaboration with US regulators while operating in the United States with "moderate" risk. We ended up creating a Tai Chi entity – Binance.US – which was to serve as a "scapegoat" in the face of "accumulated regulatory tensions", "reveal, delay and resolve" them and "isolate Binance from past and future responsibilities".
Under this scheme, Binance Global waives trading fees generated by US client trading activities. But it receives "license fees" and "service fees" paid regularly by its American subsidiary.
2 – CEO of Binance.US, straw man profession?
A very close collaboration would remain between the two. Since its creation, CZ would hold at least 81% of the various entities present in the capital of Binance. The US.
In the lawsuit, ex-CEO Brian Brooks ("CEO B") explained his concerns about Binance.US' reliance on funds from the parent company. He told the SEC under oath that he "thought it was a real problem". Translation: the heavy dependence on CZ, as the main de facto shareholder and financial counterparty, must be revised.
All of this would have lasted until at least December 2022. Binance Global, through service agreements with its subsidiary, would have served as the designated custodian "for crypto assets deposited, held, traded and/or accumulated on the Binance platform. .US".
Enough to give Binance and CZ "sufficient control to manage and authorize the transfer of cryptographic assets, including between various omnibus wallets" without needing the green light from the local boss of Binance. The US.
Worryingly, the SEC says that at the time its attorneys filed its lawsuit, all crypto assets stored on Binance.US were not "in [its] exclusive custody and control."
💡 Binance and Binance US: Two puppets controlled by the same puppeteer
The SEC complaint details the shareholder chaos of the Binance.US platform, whose capital is in the hands of two entities called BAM Trading and BAM Management. Employees up to the CEO had very little real control over the company.
Some of this information comes directly from the sworn testimony of two former CEOs of Binance.US, who apparently spoke candidly with the SEC. It's a new revelation. The CEOs are not named in the lawsuit but can be easily identified as Catherine Coley ("BAM CEO A") and Brian Brooks ("BAM CEO B").
Coley told the SEC that she was "armed" by CZ when she wanted Binance's token, BNB, listed on Binance.US against her advice. She also said she was unaware of any asset transfers within her own company, amounts totaling millions or even billions of dollars.
"haha [I] am in a race against time to make sure we know where $17m is moving," she wrote in an internal message, where she said she was "frustrated with the inability to function independently of the parent company".
3 – Wash trading to inflate volumes and attract customers
Particularly virulent in this part of the complaint, the SEC ironically quotes CZ's words: "Credibility is the most important asset in any exchange! If an exchange is rigging its volumes, would you trust them with your funds? ".
The SEC's complaint reveals specific wash trading mechanisms at work on Binance.US and the laxity of the controls supposed to prevent them. What is wash trading? A trader creates false volume by concurrently selling and buying the same tokens (all without assuming market risk or changing their actual position). This is a sort of market manipulation.
It is here that CZ is specifically accused. Sigma Chain, a Swiss company owned and managed by CZ, is believed to have been behind a significant share of fake volume on Binance. The US.
Sigma Chain was run by several Binance employees who reported to CZ, and the Swiss company presents itself as "the primary market maker for Binance.com" and a market maker for Binance. The US.
On Binance.US' first day of operation, the SEC says Sigma accounted for more than 70% of the platform's volumes. This wash trading occurred between Sigma Chain accounts and accounts managed by Zhao Hai and other senior Binance executives.
"Between January 1, 2022, and June 23, 2022, alone, Sigma Chain accounts engaged in wash trading on 48 of the 51 tokens newly opened for trading," the SEC argues. In the three months leading up to fundraising from Binance.US, "Sigma Chain accounts reportedly actively traded 51 of the 58 tokens available at that time on Binance.US."
4 – Mixing of funds for the benefit of its managers
The SEC brings an even more serious accusation against Binance. Here the SEC explicitly accuses CZ of having embezzled nothing less than client funds!
Remember how FTX shuffled customer funds and loaned them to Alameda, causing the exchange to go bankrupt? The SEC claims Binance.US funds were frequently misappropriated, with some even going to finance personal expenses.
To sum up, Binance, Sigma Chain, and another trading and market-making company called Merit Peak based in the Czech Republic frequently transferred tens of billions of dollars of assets between them.
Between October 2022 and January 2023, CZ allegedly personally received $62.5 million from one of Binance.US' bank accounts 👇
Worse, a CZ entity shuffled "billions of dollars of client funds" from US and international entities into a single account controlled by them. According to the complaint, third-party entities would have received the funds from this account under the guise of purchasing and selling cryptocurrencies.
For example, the SEC highlights the transfer of $190 million in 2021 from Binance.US to Sigma Chain. Shortly after, the offending bank account allegedly spent $11 million acquiring a yacht. Here in yellow 👇
5 – Unregistered Securities and Illegal Profits
Throughout the complaint, the SEC identifies several "crypto asset securities," i.e., tokens that it says meet the definition of a security in the same way as a stock or an obligation.
On what criteria? Well based on the famous "Howey test", which says that an asset is a security if it (1) is an investment involving money (2) in a joint venture with (3) a reasonable expectation of profit (4) generated by the efforts of others. A test that dates back to … 1933 😅
Binance Coin (BNB)
The SEC recalls that Binance had issued its BNB via an "initial token offering" (ICO) to "raise funds for the development of the platform". According to the regulator, the company has regularly touted the token as an investment in the future success of the Binance platform.
Again, the SEC is on the transcript of a CZ Q&A session with his followers on Reddit in 2017. the platform (…) Basically, if the platform is successful, the more users use the platform to trade, the more users buy the coin, so the price will increase".
The SEC also quotes a 2021 Forbes interview with former Binance.US CEO Brian Brooks: "[BNB] makes our clients act a bit more like shareholders – people who want the successful business; their interests are aligned with those of the company."
Binance USD (BUSD)
The case of the stablecoin BUSD refers to a prominent position of the SEC. Last February, we reported to you in our columns the formal notice sent to Paxos, the issuer of this stablecoin.
In this "Wells notice", the regulator already pointed out several investment mechanisms around the BUSD.
The SEC blamed Binance for creating its "BUSD reward program". A program whereby clients placed BUSD against a fixed return. According to the complaint, a mechanism is a sign that investors have indeed received profits from the stablecoin placed by Binance.
Simple Earning and BNB Vault
The SEC is also attacking these two well-known investments by Binance customers. These pool user tokens to generate returns through various means.
Indeed, Binance uses them to carry out operations such as staking, lending or supplying liquidity to its platform.
The SEC again considers that these programs imply an expectation of profit on the part of investors based on the efforts of others (which corresponds to the definition of an investment contract according to the Howey criterion).
Other Top 100 Cap Cryptos
In its complaint, the SEC also names other top 100 cryptos as unregistered securities offered by Binance.
These include the S OL (Solana), ADA (Cardano), MATIC (Polygon), FIL (Filecoin), ATOM (Cosmos), SAND (The Sandbox), MANA (Decentraland), ALGO (Algorand), AXS ( Axie Infinity).
Why these specific tokens and not Bitcoin or Ether? The complaint does not specify, but most of these tokens were launched as part of an ICO. Centralized organizations that build a blockchain ecosystem or project link all of them.
Many also use the "burn" mechanism, which consists of regularly withdrawing tokens from circulation and sending them to a dead address. However, it is a mechanism that the SEC considers as a means by which these organizations promise profits to investors (which says a reduction in the overall supply of tokens, says the increase in the price of tokens remaining in circulation).
What does the SEC blame Coinbase for?
On June 6, the day after the complaint against Binance, the SEC filed a lawsuit against Coinbase. The grounds for the complaint are quite similar. The SEC accuses Coinbase of operating its crypto-asset exchange platform without registering as a stock exchange, broker and clearing house.
The SEC also criticizes Coinbase for failing to register the offer and sale of its staking-as-a-service program, which allows its customers to earn profits by participating in the validation of transactions on certain blockchains.
But unlike Binance, Coinbase has a case to trump the SEC. Starting with the regulator's own past inconsistencies.
1 – An Illegal Crypto Exchange … used by the US Government
The complaint is absurd in at least one respect. As recently as March, the feds used Coinbase to resell crypto seized in FBI-led operations.
US authorities transferred 50,000 bitcoins – worth a billion dollars – to crypto wallets, including 9,825 bitcoins, to a wallet controlled by Coinbase.
Authorities seized Bitcoin in November 2021 after hackers attacked the defunct dark web trading platform Silk Road.
2 – An illegal broker … floated on the Stock Exchange
The SEC combed through Coinbase's business in 2021 before giving it the green light to go public.
Coinbase became the first cryptocurrency company to go public on April 14, 2021, on Nasdaq, the second largest American stock exchange after the New York Stock Exchange (NYSE). What has changed since?
Conclusion: what are the risks of Binance and Coinbase?
The two cases are not of the same ilk.
There are no suspicions of accounting fraud and manipulation against Coinbase. Furthermore, the SEC does not personally target Coinbase CEO Brian Armstrong, unlike Chengpeng Zhao. At worst, Coinbase faces a significant fine and delisting of tokens targeted by the SEC.
Binance, on the other hand, is at (very) big risk in a potentially disastrous civil case. The SEC seeks a huge fine, civil penalties, and injunctions to bring Binance, CZ, or related entities to heel. Additionally, it aims to prevent CZ from serving as an officer or director of any American company that issues securities.
The SEC repeatedly cites "ill-gotten gains, with prejudgment interest." Earnings for which it demands repayment in the billions. The CFO and COO's conversation reveals a conservative estimate of "only $10 million" for legal fees and settlements concerning BNB listing on Binance.US.
The SEC has understood that the US market is crucial for Binance's finances. Although Binance has recently packed up in other countries (like Canada), it must maintain substantial income from US traders and businesses.
Binance employees themselves admit this several times in their internal messaging, already revealed in the CFTC complaint. One of the phrases of Samuel Lim, head of compliance in 2018, has already become a meme: "Bro, we operate like a f***** Stock Exchange without a license in the United States".