Six Steps to the Gallows: Binance Faces Potential Consequences

Securities and Exchange Commission (SEC) fines and restrictions have become commonplace for cryptocurrency companies. It is important to note, however, that Binance's situation differs from the general trend. A different regulatory body, the Commodity Futures Trading Commission (CFTC), is suing the company.

The lawsuit mentions the company's CEO and co-founder, Changpeng Zhao, and the former director of regulatory compliance, Samuel Lim. They are accused of violating US laws and engaging in unregistered trading in futures and options.

We've created a brief summary of the 74-page document received by the Illinois court on March 27, so you can quickly get up to speed. The lawsuit contains six accusations, and if any of them are proven, both Binance and its clients could face significant consequences.

First breach: Binance served US customers

In July 2019, American regulators prohibited citizens from utilizing Binance. In response, the exchange advised its users to use virtual private networks (VPNs) as a loophole. By using anonymizers, exchange clients can hide their geolocation and appear to be located in Europe.

Binance openly offers this trick to its Chinese clients as well, but Chinese regulators turn a blind eye to CZ's shenanigans.

Second breach: Binance notified its VIP clients when law enforcement authorities requested information related to their accounts.

The agreement made with an exclusive member of the community explicitly states that if the law requires Binance to freeze their account, the team will notify the user "by all means available." The account will be blocked for no more than 24 hours, after which the client will have the chance to withdraw their funds.

The regulator considers dozens of institutional investors who trade on the exchange and provide a large portion of its liquidity as VIP clients.

Third breach: the exchange's staff engaged in front-running with its clients

The lawsuit alleges that Binance engaged in proprietary trading through over 300 accounts belonging to CZ and two of his affiliated companies. Changpeng Zhao personally engaged in this unlawful behavior while trading on his own platform using two different accounts, and the CFTC is prepared to demonstrate this in court.
The CFTC claims that company executives' personal accounts were exempt from insider trading prohibition.
This is a serious accusation, especially considering that Zhao has repeatedly stated on Twitter that:

  • Binance does not trade for profit;
  • The company's revenue comes only from commission fees;
  • Zhao and his employees are not allowed to conduct more than one trade every 90 days.

If the accusations against Binance are confirmed, it could lead to a serious reputation scandal. This is because the exchange would have deceived not fiscal authorities (which users tend to understand), but its own customers. This would be an entirely different scenario and could have much worse consequences.

Fourth breach: Falsifications were found in Binance's AML compliance audi

According to the lawsuit, in fall 2020, the cryptocurrency exchange executives conducted a fake, "incomplete" audit to satisfy a request from Paxos. Samuel Lim himself admitted this when he told his followers that Binance had deliberately hired an auditor to conduct a superficial sub-audit for anti-money laundering reporting purposes. The company needed this to buy time while solving the KYC/AML issue. Around the same time, the money laundering control officer (MLRO) wrote on Twitter about the exchange's ability to control this process: "I'm not confident in our system." The CFTC also highlighted this in the lawsuit.

Fifth breach: Binance knew criminals used its platform, but ignored such issues.

The fact that this accusation was made is largely due to Samuel Lim's loose tongue and short-sightedness. In one of the discussions about money laundering for Hamas, he stated that terrorists usually send many small amounts to avoid drawing attention to transactions. His colleague at the company responded, "You can hardly buy an AK47 for $600."

As if that wasn't enough, in February 2022, during a conversation about Russian clients and sanctions, Lim stated, "We see bad things, but we both turn a blind eye to those."

The CFTC lawsuit against the cryptocurrency exchange reflects both incidents.
It's reasonable to question why they would share confidential information on social media knowing their accounts are likely monitored by regulators. Nevertheless, the answer to this question is already apparent.

Sixth breach: In order to maintain control, Changpeng Zhao set up an untransparent organization.

Binance has about 120 organizations within its corporate structure, all directly or indirectly controlled by CZ. The quote from the document is quite telling: «Zhao answers to no one but himself. Binance does not have a board of directors». Essentially, the regulator is accusing the exchange, which positions itself as decentralized, of creating a strict hierarchy of power and being overly centralized.
There is something incongruous about this situation, one could well conclude.

What are the implications of the CFTC lawsuit and accusations for Binance customers?

During the court hearings, it is likely that some unpleasant details about CZ's internal operations will come to light. The way the charges are structured, the exchange doesn't have a good way out of the situation. 

While Zhao may be able to defend himself against futures trading and option charges, trading against its own customers and hiding money flows with terrorist origins could still seriously damage the cryptocurrency giant's reputation.

Furthermore, all profits received from American clients may be subject to enormous fines.