Crypto giant Binance offers little transparency after FTX collapse

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Jeff Sica of Circle Squared Alternative Investments claims that Bitcoin is the “nine-life cat” as he discusses the future of cryptocurrencies after the collapse of FTX.

The collapse of crypto exchange FTX has sparked calls for transparency in the industry. For many investors, the biggest player in the industry, Binance, remains a black box.

Crypto exchange Binance processes more transactions than most of its rivals combined, accounting for around half of spot crypto exchanges and two-thirds of derivatives exchanges, according to research firm CryptoCompare.

Its outsized role has come under greater scrutiny since the November collapse of FTX. Last week, US authorities accused FTX founder Sam Bankman-Fried of secretly diverting funds from exchange clients to his affiliated trading company, Alameda Research.

FTX founder Sam Bankman-Fried, center, is escorted by a Corrections Department van as he arrives at the Magistrate’s Court building for a hearing, in Nassau, Bahamas, Wednesday, Dec. 21, 2022. ( AP Photo/Rebecca Blackwell/AP Newsroom)

Like FTX, Binance discloses limited financial information. It does not say where the company is based. And its founder, Changpeng Zhao, is affiliated with market makers providing liquidity on its own platform, an arrangement that some market watchers say leads to a potential conflict of interest.

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“Does the exchange give preferential treatment to an affiliate? Does the exchange support an affiliate with customer money? These questions are about customers and regulators trying to protect them,” said Larry Harris , professor of finance at the Marshall School at the University of Southern California. of Business and former Chief Economist of the Securities and Exchange Commission.

“When a company is not transparent and unregulated, we have no real understanding of what is going on inside,” Professor Harris said.

FILE PHOTO: Changpeng Zhao, founder and CEO of Binance, attends the Viva Technology conference dedicated to innovation and startups at the Porte de Versailles exhibition center in Paris, France June 16, 2022. REUTERS/Benoit Tessier/Fi ( REUTERS/Benoit Tessier /File Photo/Reuters Photos)

Adding to investor concerns, an external audit firm that Binance hired to report on its reserves recently said it was suspending work for crypto businesses.

Patrick Hillmann, Binance’s chief strategy officer, said Binance has implemented strict controls overseen by a global risk department. He said the exchange does not trade against users. Although private companies are not required to produce financial statements, Binance is embracing additional transparency by showing proof of its reserves, he added.

“We have already restarted the [process] and will make additional announcements in the coming weeks,” Hillmann added.

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Binance was shrouded in secrecy after its inception in 2017. In recent years, when cryptocurrencies were booming, investors paid little attention to the corporate structure and governance within Binance. industry.

But Binance’s lack of transparency and the structure of its operations have raised concerns among regulators.

Long before FTX’s collapse, the US Department of Justice was investigating whether Binance had encouraged money laundering, and the SEC requested a list of information from Binance’s US subsidiary, including its connection to the world organization.

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Binance has said in the past that it works with regulators around the world and takes compliance obligations seriously.

Zhao, who was born in China and raised in Canada, launched Binance from Shanghai in 2017. After the Chinese government banned crypto exchanges, the team moved to Japan. In 2018, the Japanese financial regulator warned the company against conducting transactions for residents without having a license to do so. After that, Binance stopped disclosing a specific location.

Binance CEO Changpeng Zhao speaks at the Delta Summit, Malta’s official blockchain and digital innovation event promoting cryptocurrency, in St Julian’s, Malta October 4, 2018. REUTERS/Darrin Zammit Lupi (REUTERS/Darrin Zammit Lupi/Reuters Photos)

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Binance denies continuing to do business outside of China after the ban, but the Shanghai-based developers had been maintaining key software functions in its US arm, Binance.US, since last summer, the Wall Street Journal previously reported. This raised concerns among Binance.US executives that the US government would challenge that customer data was potentially accessed by the Chinese government.

Binance.US told the Journal at the time that the exchange had strong data protection and US customer data was stored on servers in the United States.

“Binance does not operate in China and we have no technology, including servers or data, based in China,” Hillmann said.

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While the collapse of FTX has rippled through the crypto universe, creating losses for other companies and depressing the value of tokens, Binance is much bigger and more important to the industry. The exchange is an important partner for Western crypto traders and institutions, and it is a major platform for those in developing economies who want to store funds outside of local government currency.

“People all over the world have their savings on Binance,” said Noelle Acheson, crypto macro strategist.

At the heart of FTX’s downfall was a liquidity provider and trading firm owned by Mr. Bankman-Fried, Alameda Research. This relationship gave Alameda business privileges that ultimately allowed it to exploit FTX client funds for its own purposes, US authorities alleged.

The SEC was investigating the relationship between Binance.US and two trading companies with ties to Mr. Zhao, the Journal previously reported. The companies serve as liquidity providers for the platform, and while Binance states on its US website that affiliate market makers could trade on the exchange, it does not specify which companies could.

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Mr. Zhao admitted that he was an investor and shareholder in one of Binance’s market makers. But he said the sole purpose of this entity, which he did not name, is to provide liquidity and it does not make a profit. “We are not trying to make money by trading ourselves,” Zhao said.

After FTX filed for bankruptcy, Binance pledged to show customers worried about their funds that their tokens were stored safely. While crypto transactions are public through the blockchain, they become private once they enter an exchange. Binance released numbers for Bitcoin, but before he could release for others, Mazars, the auditing firm he used, suspended work for Binance and other exchanges.

Mr. Zhao said that unlike FTX, his exchange has no borrowings and no debt. He also says it’s profitable. But the company has not released any financial statements. Binance was hit by $6 billion in outflows last week as nervous customers moved their tokens elsewhere.

International regulators have issued a series of warnings about operating in unlicensed countries. The warnings prompted Zhao, who once dismissed the offices as obsolete, to set up and register them in some countries. The company also said it was going through a restructuring “to provide regulators with more clarity about our organization.”

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Meanwhile, users cannot know exactly who they are dealing with. While Binance at one point listed its parent company as Binance Holdings Ltd., incorporated in the Cayman Islands, Binance said it never operated an exchange from there. On Monday, Binance’s Australian and New Zealand websites noted that “Binance is a registered trademark of Binance Holdings Ltd.”

“Having a trademark registered under a particular company does not mean that it is a parent company or that it is an exchange,” Hillmann said, adding that Binance operates through a certain number of entities incorporated in various jurisdictions.

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