Matt Stankiewicz, Managing Counsel at The Volkov Law Group, joins us in an article on the CFTC’s latest investigation into Binance.
On Friday March 12th, Bloomberg News reported that the Commodity Futures Trading Commission (“CFTC”) was investigating Binance Holdings Ltd. (“Binance”) to investigate allegations that the exchange allowed US citizens to trade cryptocurrency derivatives without properly registering with the CFTC. It is important to note that this is merely an investigation at this point and that Binance has not been formally accused of wrongdoing and may not face any enforcement action. However, if there is smoke, a fire can result.
This investigation seems to have some parallels with the CFTC’s investigation of BitMEX, although it does not appear to be rising to the same level just yet. For example, Binance has taken steps to discourage US citizens from using its derivatives trading platform. When the exchange first launched, Binance consolidated all customers into a single exchange headquartered outside of the United States. About two years ago, the exchange took action to segregate US customers and force them to a US-based platform headquartered in San Francisco that restricted certain coin offerings and financial instruments such as derivatives and options trading.
To enforce this, the first line of defense in compliance is to restrict access based on a user’s IP address. If a user tries to log into the main Binance.com exchange with an IP address from a US location, the site will prevent access and instruct users to create an account on the Binance.us platform instead. Since many compliance experts are currently dealing with this on the Internet, it is not enough just to restrict the IP addresses. There are a variety of tools such as VPNs or the TOR browser that can be used to bypass these controls very easily. Depending on the results, this investigation could provide information on this compliance challenge associated with the operation of a virtual exchange.
In addition, unlike BitMEX, Binance actually maintains a KYC program. Users who wish to swap either the US or overseas platform must undergo a KYC verification before they can withdraw a certain balance. At this point, unverified users who have not undergone a KYC verification are not allowed to withdraw more than two bitcoins per day. As of this writing, the price of a single bitcoin is just over $ 57,000. This means that by limiting accounts to withdrawals of two bitcoin per day, unverified users can withdraw more than $ 110,000 per day from the exchange. These restrictions were very likely created at a time when the price of Bitcoin was much lower. At this point, a daily withdrawal limit of $ 110,000 may not be quite as strong as it needs to be.
Many exchanges take a similar approach: you may provide “limited” services prior to performing a KYC review, but at your own risk. Stock exchanges based in the US, in particular, can be extremely vulnerable to money laundering and sanction risks at such a high threshold. The CFTC will now review Binance’s overall KYC program to determine if the program is effective and whether the platform is doing everything in its power to ensure US citizens are not trading on the unlicensed platform.
Binance has always had a mixed reputation in the industry, especially when it comes to its compliance efforts. A Forbes article late last year cited a leaked document and internal whistleblower to suggest that Binance may have taken steps to help U.S. customers bypass their own internal controls, and those customers – and those associated with them Revenue – Forward to the US Main Binance Exchange. This information could form the basis of the CFTC’s investigation and it could certainly harm Binance.
While the Securities and Exchange Commission (“SEC”) in the crypto industry has received a lot of attention and has taken several high-profile enforcement actions, in reality it is the CFTC that oversees much of the space. Many, if not most, of the cryptocurrencies are considered commodities for regulatory purposes in the US, which is within the scope of the CFTC. The CFTC has consistently established that Bitcoin and Ether, by far the largest and most popular cryptocurrencies, are actually viewed as commodities and regulated as such.
A derivative is a type of financial product whose value is based on an underlying asset. At a high level, companies can use these products as a risk hedge or to speculate about future price changes for this underlying. These types of financial instruments are not problematic per se and the CFTC has indeed expressed its willingness to encourage development in the virtual asset industry, albeit with a view to reducing risk. However, derivatives are heavily regulated by the CFTC and require registration with the commission and implementation of compliance safeguards. Binance itself has processed nearly $ 59 billion worth of derivatives, almost twice as much as its closest competitor. The CFTC has not yet issued any public statements regarding its investigation into Binance.