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SEC Sues Binance & Coinbase For Breaking US Securities Law, Shocking Absolutely Nobody
A slew of charges against the world's two largest "crypto" exchanges have come down from the SEC, we're just surprised it took this long.
After several years of investigation, the SEC has thrown the kitchen sink at Binance and Coinbase with a litany of charges spanning all walks of US financial crime.
The two largest cryptocurrency exchanges in the world are now under fire, not only for operating as unlicensed exchanges, broker-dealers, and clearing agencies, but for listing securities unregistered with the SEC as well.
Given that the crypto ecosystem is a hodgepodge of unlicensed financial instruments and opaque protocols masquerading as the future of finance that exist solely because of 14+ years of zero-interest rate policy, we’re just surprised it took this long for formal legal action. Nevertheless, here we are now. Now that money is no longer free, Gary Gensler is striking while the iron is hot—seeking to correct a years-long error in allowing rampant financial crime to take place. It’s hunting season.
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No holds barred from the SEC
SEC Commish Gary Gensler is going scorched Earth, with the cherry on top being two comprehensive lawsuits filed over the last 24 hours by the SEC—thirteen charges have been brought against Binance, while only five against Coinbase. Let’s break down all the charges levied against the two cryptocurrency behemoths.
1) Operating an unregistered exchange, broker, and clearing agency
Both firms are being charged with operating as an exchange, broker, and clearing agency without so much as filing for the licenses required for these businesses. The SEC notes that both Binance and Coinbase have made billions of dollars from unlawfully facilitating the buying and selling of what it’s calling “crypto asset securities”.
Part of both companies’ ethos is a veneer of sought-after compliance and professionalism. Phrases like “we’ve tried to cooperate with the SEC and CFTC” and “there are no clear guidelines” have been used by CZ and Brian Armstrong ad nauseam. In Coinbase’s case, they have been meeting with policymakers in DC to build out a framework for operating these businesses legally—the same cannot be said of Binance, which merely projects this outward appearance of an honest company trying to follow the rules while doing the opposite. CZ was uncooperative with US financial regulators who sought records from Binance in 2020 to confirm they were abiding by anti-money laundering laws, despite his outspoken demeanor of wanting to abide by the law. Binance has been wantonly in violation of US securities law:
First, Binance and BAM Trading, under Zhao’s leadership and control, have unlawfully offered three essential securities market functions—exchange, broker-dealer, and clearing agency—on the Binance Platforms without registering with the SEC.
— SEC v Binance
This is something their former CCO candidly admitted in an unencrypted message:
While Coinbase is actively working to develop and abide by a legal framework for these assets, it’s an exercise in futility, given that a legal framework for them already exists—it’s called US exchange and securities law.
b) Unregistered offer and sale of crypto asset securities
The Securities Act of 1933 requires that investors have ample financial information about securities and their underlying companies prior to sale, and prohibits deceit, misrepresentations, and other fraud. Binance has allegedly broken both tenants.
Binance Coin, or BNB, is the native token for Binance’s BNB Smart Chain, a fork of the Ethereum blockchain. In actual practice, it is a network used almost exclusively for minting and selling other assets from a central issuer that are not registered with the SEC. Blockchains are often touted as decentralized, but when a central issuer controls the issuance of the asset and can start and stop the blockchain it runs on, it is decentralized in name only, thus making it subject to regulatory action.
Per the Howey Test, a security is an investment of money in a common enterprise with the expectation of profit to be derived from the efforts of others. Functionally, BNB is a security for the Binance common enterprise, but it has not been registered as a security with the SEC. The first and second claims in the SEC v Binance lawsuit are against BNB and BUSD, Biannce’s own version of a stablecoin that like BNB has not been registered.
Other crypto assets listed as unregistered securities that Binance and Coinbase unlawfully sold are: SOL, ADA, MATIC, FIL, SAND, AXS, CHZ, FLOW, ICP, NEAR, VGX, DASH, and NEXO.
The fourth and fifth charges levied against Binance are the same as the final charge brought forward for Coinbase, targeting both of their respective yield offerings. Referred to as ‘Earn’ programs or ‘Staking’, they are essentially lending programs where users can lend their unlicensed assets to high-yield borrowers. In the eyes of the SEC, staking is a security, and Ethereum is named amongst the securities that users were allowed to earn yield from on the Coinbase platform. Not the first time that ETH has been explicitly categorized as a security, meaning it is not decentralized, and that a central entity is responsible for the asset’s issuance and control of the protocol:
Just like FTX/Alameda, a great deal of Binance’s own holdings are comprised of a token that it spun up on its own. Seeing as Binance is a company, and companies borrow against the value of their assets, Binance has been using vaporware that it created as collateral just like FTX and Alameda. When the investing public catches on, the house of cards can tumble rather quickly—likely one of the reasons the SEC is seeking to take Binance into receivership before a cataclysmic unwind could occur. The assets may be fake, but the liabilities are real.
c) Failure to restrict US investors from accessing Binance.com
Binance routinely subverted basic KYC requirements and rules. The firm is not allowed to operate in the United States due to its exotic derivatives products precluding it from securing licenses from the CFTC. This has been known for quite some time, with Binance even publicly encouraging users to use a VPN to change their location to a jurisdiction off of US soil to a country where Binance was legally allowed to operate. Binance has projected that at least 1.47 million of its customers resided in the United States as of an August 2019 internal presentation.
From the Binance.com Platform’s launch until at least September 2019, Binance overtly marketed its services to all customers and imposed no restrictions whatsoever on the ability of U.S. persons to buy, sell, and trade crypto assets on the Binance.com Platform.
During this period, Binance opened tens of thousands of accounts for customers who submitted “Know Your Customer” (“KYC”) identity verification information that indicated they were based in the United States or who accessed the platform via Internet Protocol (“IP”) addresses indicating that they were physically located in the United States. Binance, and Zhao as its control person, knew that U.S. persons transacted on the Binance.com Platform.”
— SEC v Binance
Binance ignored all illegal US residency for the sake of keeping massive, high-net-worth customers on the platform. Referred to in-house as “VIPs”, there were over 3,500 of these customers by 2019.
CZ also operated Binance and its US affiliate under the same roof illegally.
Binance.US was created and marketed as an independent trading platform for US investors when in actuality CZ and Binance were secretly controlling its operations.
d) Misleading investors
In a world filled with imperfect information, it’s crucial that investors can find accurate information about the financial products and services they want to use before investing in them. It is the first aforementioned tenant of the Securities Act of 1933. Unfortunately, Binance illegally deceived customers.
The claim that all funds are backed 1:1 and even overcollateralized has been a major marketing point for Binance, regularly accusing skeptics of spreading FUD and creating the SAFU account where customers can see their funds held in cold storage, safe and sound. When your corporate mantra that gets trotted out at every turn is to ignore the skeptics, chances are you’re trying to hide something. It doesn’t matter that Binance shows its assets if we cannot see its liabilities.
Binance has even claimed that it has no debt, having taken on no liabilities over the years. For the world’s largest cryptocurrency exchange, servicing tens of billions in customer assets, this is an absurd claim. Growing a firm this large quickly involves plenty of funding, and we believe that debt was and is involved in Binance’s regular funding needs. Several wallets labeled as Binance have rehypothecated user funds, something that is not contained in the agreement signed by customers when they register. This improper moving and mixing of funds, combined with opaque liabilities, has misled investors into thinking that Binance is a fully-reserved financial institution, downplaying the associated risk with the platform.
Though Binance and Binance.US are touted as fully separate entities, that couldn’t be further from the truth. Sitting under the same ownership umbrella of several shell companies created and helmed by CZ, it’s hard to feign the notion of independent companies when looking at it from above:
Sigma Trading, a trading firm owned by CZ, was involved in wash trading from 2019 to 2022. Sigma bought and sold the same asset across thousands of accounts that it owned, artificially inflating the volume of trading to create the illusion of an actively traded and liquid market. The ability of another one of CZ’s wholly-owned companies to manipulate markets on Binance and gin up trading interest in assets confirms the fact that these are not separate, independent entities as CZ has gone on record numerous times to claim.
Between January 1, 2022 and June 23, 2022 alone, Sigma Chain accounts engaged in wash trading in 48 of 51 newly listed crypto assets (on Binance).
— SEC v Binance
Multiple firms have been circulating capital between themselves like an ouroboros, conjuring fake liquidity to dissemble regulators and the investing public into believing that Binance, and the assets it sells, are legitimate.
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Bad apples die when money is no longer free
Cryptocurrency is not bitcoin, but rather a byproduct of reaching for yield after 14+ years of near-zero interest rates in the United States. It is the result of opportunistic venture capitalists who observed a neutral, fully digital commodity money and have poured billions of dollars into either disingenuously or confusingly trying to capture that market share.
Now that rates have aggressively soared and positive real interest rates are emerging after a long hibernation, these crypto firms that can’t generate a positive return over their non-zero borrowing cost have perished in short order.
It began with Terra/Luna collapsing within six weeks of the Fed’s March 2022 rate hike, then the Celsius platform a few weeks later, and a steady trickle of failures until FTX, the world’s second-largest crypto exchange at the time, went bankrupt to round out the year.
They fall like dominoes in the order of fragility, because money is no longer free. The battles now facing Binance and Coinbase aren’t being waged on the balance sheet, but in the courts. The world’s leading regulatory authorities have seen the devastation wrought by fraud and scammers throughout 2022 and are looking to finish the job themselves in 2023 by finally bringing the last few stragglers into the regulatory window that has been ignored for years.
Bitcoin was not named as a security in both Binance and Coinbase lawsuits and for good reason: it is a commodity. Moreover, it’s a commodity that even producers can’t control the supply issuance schedule of, making it more neutral than traditional commodities like gold, silver, copper, and oil. Gery Gensler has even said as much.
Even so, the VC-funded mission to disingenuously associate bitcoin with crypto has worked in the eyes of the market. The strong correlation between the two sent bitcoin tumbling, introducing an uphill battle as these exchanges fight for their ability to operate in court and the market slowly de-risks. Prices recovered modestly and impressively Tuesday afternoon.
Major liquidity headwinds for bitcoin
While both exchanges may be able to continue operations as normal for the time being, and eventually even keep bitcoin listed as an asset on them, their entire business models are in jeopardy. With every asset apart from bitcoin at risk of being delisted for violating securities law, these two exchanges that service $14.5 billion in daily liquidity flows and roughly $80 billion in assets may one day be forced to severely downsize or shutter operations:
Bitcoin is now facing liquidity headwinds on the exchange front as well as the macro front.
Binance holds 3.63% of bitcoin’s circulating supply, the most out of any exchange. The forced temporary suspension of Binance from facilitating the buying, selling, and withdrawal of bitcoin could drain even more volume from an already inactive market. It would send shockwaves through the market as investors rush to pull their coins off exchanges or sell their bitcoin, exacerbating the risk-off impulse already commencing:
Coinbase is not far behind, holding 2.38% of bitcoin’s circulating supply. The total bitcoin balance held across all exchanges has fallen from nearly 18% of total BTC at its peak to 12% today, an encouraging sign that investors are taking ownership seriously as more exchanges are embroiled in illegal and fraudulent practices:
As of this writing, Binance’s hot wallet has already processed over 30,000 BTC in withdrawals since the SEC lawsuit was filed earlier yesterday—outflows going to some combination of other exchanges, cold storage, and sold for USD. Still, these outflows so far are barely observable compared to the post-FTX outflow of nearly 100,000 bitcoin but could pick up as the court case evolves in the months ahead:
Binance services more ~$500 billion of bitcoin futures volume every month—a halt to this activity due to the combined crackdown of the SEC and CFTC would mean that over half of the liquidity regularly provided to BTC via rolling futures contracts would be wiped out until it migrated to another derivatives platform:
As we’ve explained these last few weeks on Substack and Twitter, a liquidity drain is already underway across markets. The Treasury is refilling its coffers now that the debt ceiling has passed, projected to issue $600 billion in bills between now and the end of the month. That’s $600 billion of liquidity that will be sapped from the RRP, but more importantly for risk assets, from bank reserves, customer deposits, and other financial assets being sold like equities and bitcoin to buy higher-yielding, safe, duration risk-free T-bills.
Pair the reality of deteriorating liquidity with a collapsing M2 money supply and bank capital requirements rising, money and credit are at their tightest in years and only slated to get tighter.
As the investing public de-risks, liquidity is sapped from markets at large and major exchanges offering bitcoin find themselves in jeopardy, the young sub-$500 billion asset faces its toughest battle yet in the months to come.
The SEC’s jurisdiction over Coinbase is sensible given it’s a US-based and publicly listed company, but what about Binance?
CZ has refused to identify the company’s country of incorporation, but over the years and as stated in the SEC case, the Cayman Islands is where it’s headquartered.
Binance was founded in Shanghai in 2017, but later moved to Tokyo and then Malta. While its holding company is based in the Cayman Islands, Binance says it does not have a headquarters and has declined to state the location of its main Binance.com exchange. — Reuters
Given that it is a British territory, and the Cayman Islands itself may want to salvage its reputation away from being a financial safe-haven for fraud, it wouldn’t surprise us if the government cooperated wholly with the SEC as the Bahamian government did in the case of FTX and Sam Bankman-Fried.
The SEC also says that it has jurisdiction over this case given that Binance knowingly operated the offshore exchange, broker-dealer, and clearing agency for US investors despite it being illegal. Also, tens of billions of dollars have utilized US-based bank accounts in both Binance and CZ’s names, yet neither the firm nor CZ has ever registered with the SEC.
The SEC has now asked the courts to freeze Binance’s assets and appoint a receiver to liquidate US-based holdings—this move is likely based on the suspicion that Binance is hiding the state of its balance sheet or the real location of client funds. This isn’t an assumption that’s too far off the mark considering their aforementioned proclivity to cry FUD while rehypothecating user funds without consent behind closed doors.
Make as many Twitter polls as you want CZ, your followers certainly won’t be able to pay your legal fees. On the bright side, maybe your lawyers will accept BNB.
Until next time,
Joe & Nik
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