2021-03-16 17:46:27

CFTC Opens Inquiry into Binance, One of the World’s Largest Cryptocurrency Exchanges | Michael Volkov

Matt Stankiewicz, Managing Counsel at The Volkov Law Group, joins us for a post looking into the CFTC’s recent inquiry into Binance. 

On Friday March 12, Bloomberg News reported that the Commodity Futures Trading Commission (“CFTC”) has opened an inquiry into Binance Holdings Ltd. (“Binance”) to investigate allegations that the exchange allowed US citizens to trade in cryptocurrency derivatives, without properly registering with the CFTC.  It is important to note that this is merely an inquiry at this point, and that Binance has not been formally accused of any wrongdoing and may not face an enforcement action.  However, where there is smoke, there may be fire.

This inquiry appears to have some parallels with the CFTC’s investigation of BitMEX, though it does not yet appear to rise to the same level.  For example, Binance has taken steps to wall off US citizens from its derivatives trading platform.  When the exchange first launched, Binance pooled all of its customers onto a single exchange headquartered outside of the US.  Roughly two years ago, the exchange took measures to segregate US customers and force them to a US-based platform, headquartered in San Francisco, which restricted certain coin offerings and financial instruments, such as derivatives and options trading. 

To enforce this, the first line of defense in their compliance is to restrict access based on a user’s IP address.  If a user attempts to log into the main Binance.com exchange with an IP address from a US location, the site prevents access and directs users to create an account on the Binance.us platform instead.  However, as many compliance professionals are dealing with now across the internet, simply restricting IP addresses is not enough.  There are a variety of tools, such as VPNs or the TOR browser, that can very easily circumvent these controls. This inquiry, depending on the outcome, could begin to provide guidance on this compliance challenge associated with operating a virtual-based exchange.

Further, Binance does indeed maintain a KYC program, in stark contrast to BitMEX.  Users to either exchange, whether the US-based platform or the foreign one, must undergo a KYC review before they are able to withdraw a certain level of funds. At this point, unverified users who have not undergone a KYC review are restricted to withdrawing no more than two Bitcoin per day. As I write this post, the price of a single Bitcoin is hovering just over $57,000.  That means, restricting accounts to withdrawals of two Bitcoin per day allows unverified users to transfer over $110,000 per day off the exchange.  These restrictions were very likely created at a time when Bitcoin’s price was much lower.  At this point, a $110,000 daily withdrawal limit may not be quite as strong a barrier as it needs to be. 

Many exchanges take a similar approach, that they can provide “limited” services prior to conducting a KYC review, though do so at their own risk.  US-based exchanges, in particular, can be extremely susceptible to money laundering and sanctions risks with such a high threshold.  The CFTC will now review Binance’s overall KYC program to determine whether the program is effective and that the platform is doing all it can to ensure US citizens are not trading on the unlicensed platform. 

Binance has always held a mixed reputation in the industry, especially with regards to its compliance efforts.  Further, an article from Forbes late last year cited a leaked document and an internal whistleblower to suggest that Binance may have been taking measures to aid US customers in circumventing its own internal controls, to help funnel these customers – and their associated revenues – to the main Binance exchange.  This information may form the basis of the CFTC’s inquiry and could certainly be damning for Binance.

While the Securities and Exchange Commission (“SEC”) receives a lot of attention in the crypto industry, and has pursued several high-profile enforcement actions, in reality it is the CFTC that oversees much of the space.  Many cryptocurrencies, if not most, are considered commodities for regulatory purposes within the US, which falls under the ambit of the CFTC.  The CFTC has consistently stated that Bitcoin and Ether specifically, the two largest and most popular cryptocurrencies by far, are indeed considered commodities and regulated as such.  

A derivative is a type of financial product that has a value based on an underlying asset.  At a high level, entities can use these products as a risk hedge or to speculate on future price changes of that underlying asset.  These types of financial instruments are not problematic per se, and the CFTC has actually expressed a willingness to foster development in the virtual assets industry, though with an eye towards mitigating risks.  However, derivatives are highly regulated by the CFTC and require registration with the Commission and implementation of compliance safeguards.  Binance itself has processed nearly $59 billion in derivatives, nearly double the amount of its nearest competitor.  The CFTC has yet to make any public statements regarding the inquiry into Binance. 

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