Front Burner - Binance and its Canadian CEO sued in major crypto case

Episode Date: June 8, 2023

The biggest crypto exchange in the world is being sued by an American regulator accusing Binance and its Canadian billionaire founder of breaking a string of laws and misusing investor funds. Changpeng Zhao and his company say they will fight back “vigorously.” Today on Front Burner, Jacob Silverman, who you may know from our podcast The Naked Emperor, joins us to talk about what all this means for crypto’s future. For transcripts of this series, please visit: https://www.cbc.ca/radio/frontburner/transcripts

In the Dragon's Den, a simple pitch can lead to a life-changing connection. Watch new episodes of Dragon's Den free on CBC Gem. Brought to you in part by National Angel Capital Organization, empowering Canada's entrepreneurs through angel investment and industry connections. This is a CBC Podcast. Hi, I'm Saroja Coelho. On Monday, the world's biggest cryptocurrency exchange took a major blow. Binance and its Canadian founder are being sued by the U.S. Securities and Exchange Commission. The company's CEO, Chengpeng Zhao, or CZ as he's known, is the richest man in Canada and one of the richest people in the world. He and his company

are accused of enriching themselves by billions while placing investors' assets at significant risk. Binance says it will fight back, quote, vigorously. The SEC is also suing Coinbase, America's largest crypto trading platform, and all this comes against the collapse of FTX. That's a story that we've covered at length on this program. Jacob Silverman is here with me today, and you might know him from the spinoff program we made called The Naked Emperor. Hi, Jacob.

Hi, thanks for having me. So let's start with the Securities and Exchange Commission, or SEC. What are they alleging Binance and its CEO, CZ, have done? Well, it's really a wide-r ranging series of offenses. This is a civil complaint we should make clear. These aren't crimes that are being alleged. But the main accusations surround Binance essentially concealing some of its operations, both in the US and around the world, that it violates securities laws, that a lot of the money coming into the Binance US platform, which was supposed to be separate from what they call Binance Global, was actually then controlled by CZ and would pass between various entities

controlled by CZ and another Binance executive who was in China for most of that time. They're claiming that Binance is unlawfully functioning as a securities market. The second charge, according to them, is offering unregistered crypto assets. And then the third point is misleading investors, making investors believe that it is a adequately protected database. Keep in mind that this is the largest crypto exchange out there around the globe right now. And so the SEC is seeing that Binance mishandled funds, did not protect consumers. And so that's having a negative effect. So it's really a wide ranging complaint. I think there are more than 13 civil charges. And it's not the first also because the CFTC, another American regulator, filed a complaint. And it seems like there may be more on the way. So it's a huge

sort of shot across the bow for Binance. And even though the company has maintained only a small business in the U.S. and has already pulled out of Canada, it's a major challenge for the company. I understand that part of this is actually taking the funds that clients had trusted Binance with and using them in what appears to be a pretty cavalier way. Yeah, they've been accused of commingling funds, which is something that FTX is also accused of and Sam Bankman Freed, which essentially involves taking the funds

that are supposed to be securely in a bank account that belong to people who went on your platform and bought crypto using real money, and then taking those funds and using them for basically any other purpose or for trading or operations of the company. I think the problem we see with Binance, or at least the larger picture that's being painted here, is that we don't always know where the money is coming from or going, and that includes user funds.

And CZ in particular seems to be in control of a number of shell companies and bank accounts that seem to handle the money. And once again, Binance US was supposed to be sort of hived off from Binance Global and was supposed to be operating separately. One thing that's become apparent through this latest SEC lawsuit is that actually Catherine Coley, the former American CEO of Binance US, seems to be testifying or cooperating with the SEC. And it's likely that other former employees are as well. What's really become visible to us in this complaint is some of the internal culture and that dismissal of authority around regulation.

I want to read you an exchange between two employees of Binance, and this is included in the SEC complaint against the company. So what we've got is the company's chief compliance officer writing to another employee here, and he writes, we are operating as an effing unlicensed securities exchange in the USA, bro. If that statement is true, what is the significance of it? Very simply, it means they violate securities laws knowingly. So that's pretty serious. That's certainly enough for a fine or being banned from doing business in the U.S. in some form. And there may be criminal charges to follow. I mean, one thing that I think is notable is that there's been reporting in the Wall Street Journal and elsewhere that CZ himself is being investigated. As we know,

he's named in the civil complaint personally. So I think it's important to realize that it seems that they knew what they were doing. I mean, there's been reporting in Forbes in the past on something called the Tai Chi strategy, which is sort of like finance set up these Potemkin operations in the U.S. and other places where they would establish local affiliates. They would promise to be in compliance. Really, a lot of the control was coming from Binance Global and from CZ and other senior Binance executives. And that seems to be the pattern that's been repeated and what happened here. Something that is very unclear to me at this point is why you

have government officials using a civil complaint. Why aren't charges being laid here? Why are they suing instead? I think it's a legitimate question of why hasn't something happened on the criminal end. And people are asking that question not only about Binance, but about other companies like Celsius, which collapsed very infamously last year, and which American regulators have already called a Ponzi scheme, there could be a sealed indictment against CZ. And we know that there was an ongoing criminal investigation of the Department of Justice, and there's been some reporting indicating that there's debate about what to do. I mean, this is a geopolitical and potential national security story as well. CZ does not come to North America, it seems. His father died a year or two ago in Canada. CZ did not come for the funeral, and he claimed that it was because of

COVID restrictions. But I think it is rather notable that he has not come to the U.S. or Canada, at least publicly, in some time. So what you're implying there is that he's trying to avoid being vulnerable to arrest. Absolutely. And I think that's pretty clear from his travels. He does travel a lot, but he's based in Dubai. The company is famously kind of opaque about its operations. This is something mentioned in the CFTC complaint. They actually use the word opaque, I believe.

And for a long time, no one really knew where Binance was based. It had no official headquarters. More recently, it set up sort of hubs, as they call them, in Dubai, where CZ lives, and in Paris. There are photos of CZ having dinner with Emmanuel Macron. So it's very much tied into politics, frankly. And it is possible if CZ ends up coming to the U.S. that there could be charges brought against him. But I think for now, the civil angle is the one being pursued by a number of regulatory agencies, not just in the U.S., but also overseas. What has Binance said in its defense? Binance will tell this story, and this is from my own reporting and from what you see in press, that they'll say, hey, we were a little messy in our early years and that we grew so fast. Like a lot of crypto companies, they did grow enormously fast and that they had to move

around a bit. They were forced out of China when a lot of crypto companies were. And so it was a messy growth process. And they weren't always doing things by the book, but there was no malevolence involved and that U.S. authorities and regulators aren't willing to work with the company. That's the general narrative and response you'll see in CZ's own tweets and blog posts and elsewhere. I think what people respond with and what the government has responded with is, look, we have actual evidence that your banking practices

are suspicious, that there are a lot of strangely named shell companies that seem to be on your bank accounts, that there's a mysterious official at your company who's in charge of all the finances, and that you weren't separate from your U.S. operations, among many other things, just like that message you read out earlier from a Binance official. I mean, it's clear that people are talking to the U.S. government, perhaps because they've been subpoenaed or perhaps because they want to cooperate. And it's clear that they have access to internal communications from some Binance executives. So it's really hard to say, even if you're a defender of Binance, that there's nothing here.

Binance's offshore operations seem to be at the core of a lot of this. Maybe you could flesh that out for me a little bit. Yeah, I think it's important to note, once again, that Binance is the largest crypto exchange in the world. How you quantify that can really vary. But some days they have 70% of all spot trading volume, basically of crypto trading volume. But Binance has always been this kind of opaque, amorphous entity. Where are they based? Who really owns Binance? Why are there all these companies that seem to be associated with it? Those have often been questions asked about it, just as they were eventually asked about FTX, frankly. And those questions have always existed. And Binance, frankly,

hasn't always done a good job at settling them. Sometimes they'll even admit that and say, you know, just like we were a little messy in our early operations, we haven't always been the best communicator. That's another one of their replies, I would say, or sort of justifications for how things have developed the way they have. But, you know, Binance has entities in the Cayman Islands, in Malta, in the British Virgin Islands, in sort of the usual tax shelters. And while we know that a lot of their employees seem to be in Southeast Asia and now in France, too, there still is a lack of clarity of really how they operate and who might be in charge besides CZ. A lot of those questions are going to continue to be asked over the next little while. What's interesting here is there's a lot of conversation around this dismissal of authority,

kind of shrugging off regulation. But isn't the whole point of having companies offshore to free them from national laws and regulations? Absolutely. I don't think you can really deny that. I mean, even companies that go offshore will sometimes say, Absolutely. I don't think you can really deny that. I mean, even companies that go offshore will sometimes say, hey, we have more flexibility, we found a more favorable jurisdiction or regulatory environment. And sometimes those things can mean different things. Like a favorable regulatory environment might mean there are no regulations, or it might mean that a city state like the UAE, in this case, has established some favorable crypto regulations that Binance has found it can work

with. So I think it's well known and no mystery why some companies go overseas. And it doesn't necessarily mean that they're operating illegally. But it does also mean that sometimes if they take those overseas business practices and bring them to a more regulated environment like the US or Canada, they might end up being in violation of the law. A simple pitch can lead to a life-changing connection. Watch new episodes of Dragon's Den free on CBC Gem. Brought to you in part by National Angel Capital Organization, empowering Canada's entrepreneurs through angel investment and industry connections. Hi, it's Ramit Sethi here. You may have seen my money show on Netflix.

I've been talking about money for 20 years. I've talked to millions of people and I have some startling numbers to share with you. years, I've talked to millions of people and I have some startling numbers to share with you. Did you know that of the people I speak to, 50% of them do not know their own household income? That's not a typo. 50%. That's because money is confusing. In my new book and podcast, Money for Couples, I help you and your partner create a financial vision together. To listen to this podcast, just search for Money for Cops. I want to get a little bit better understanding of the man at the core of all of this. I read an old quote from CZ.

It was published in McLean's magazine and said, quote, My worldview in most places I've lived has been, if there's no law against it, it's legal. And I can see that there's a simple logic to that. But is this technically the case, given what we've seen unfold over the last couple of days? It's a very sort of tech or crypto guy statement, I must say. I mean, you can sort of hear the libertarian underpinnings there. And CZ has shown himself to be kind of an old school crypto guy.

I got into crypto in 2013 when a friend of mine says, CZ, you should consider moving 10% of your net worth into Bitcoin. I looked into it. I didn't do 10%. I went all in. Wow. It turned out very well for you, obviously. Turned out okay. Not a big fan of regulators or governments or intermediaries.

He speaks to the values of decentralization and financial independence. And frankly, he has shown himself to be sympathetic to some of the more conservative or libertarian values that often come with crypto. I think companies also find that they have to follow the law, at least if it's enforced in places like the United States. So if you hope to do business here, you're probably going to end up running into the immovable object of the regulatory state and the Department of Justice. And that's what Binance is really finding now. This almost harkens back to one of your earlier questions, which is that companies, especially in crypto now, are talking about going offshore almost as a threat, saying we can't deal

with the US legal and regulatory environment. Binance last month pulled out of Canada saying with sort of some regrets since its founder is Canadian, but they didn't find it to be a place where they could do business. And they're not the only one, but other crypto companies have bragged about how, hey, we can do business here and we're glad to stay. So it becomes a sort of political fight and a rhetorical cudgel that's used at times, like don't make us go overseas, we'll do it. And frankly, I think that there are some people in the U.S. government who wouldn't mind because while crypto is a popular political issue at times, it has caused a lot of trouble for American consumers and regulators. How significant is it that the regulatory commission is going after not only Binance, but also its CEO, CZ? I think it's very important. I wouldn't be surprised to see

some kind of shakeup at Binance, but I'm not forecasting that for sure. But there was some reporting recently about Binance elevating some junior executive and sort of forecasting a possible eventual CZ replacement. I mean, this is not necessarily existential, but it could be. It's major for the future of the company. And one thing we found is that even when crypto companies are acting within the law, I mean, this is such a boom and bust industry that as quickly as a company rises to be the number one exchange in the world, as Binance did, it can fall rather quickly. And I think that's some of the concern here is that even though Binance is mostly based

overseas, and we're talking about these two different parts of it, Binance US and Binance Global, you know, the US can have a long reach and it may very well influence the future of Binance and its ability to survive. That ever-changing landscape there is a really important piece for understanding this story, because not that long ago, FTX was the big, big, big player. That has completely changed over these last six to eight months. So can you give me a sense of just how much of the crypto industry is controlled by Binance? It's a huge player, the most significant crypto exchange in the world. CZ, I think, is the most powerful person in crypto, even if you don't buy into any of the conspiracy theories surrounding him, which frankly, I don't.

But he's a very influential figure. And I would argue that there are three core pillars right now of crypto, of consumer cryptos that currently exist. There's Binance, there's Tether, and there's Coinbase. You could point to other important companies, but those are really the three big ones. They all face certain challenges, some of them regulatory. And if one of them collapses or runs into major obstacles to doing business and getting people their money back when there's an inevitable bank run on one of these companies, then I think you will see basically some kind of major collapse of consumer crypto beyond what we've already seen.

It's interesting that you should mention Coinbase. And I don't want to spend too much time on this, but it's a fascinating development that there's another lawsuit against Coinbase. Briefly, what's happening there? What's alleged? They were also sued this week by the SEC. So this is a big week for regulatory agencies and lawsuits against major crypto companies. Coinbase is important because it's the largest U.S. crypto exchange. It's publicly traded. So it's supposed to be kind of the regulated exchange that anyone can invest in or trade crypto on and that is available to US consumers and it's supposed to be a little more user friendly.

There isn't really a gesture towards criminal activity here or major violations beyond the fact that they are supposedly an unlicensed securities exchange, actually very much like that very spicy quote from the Binance executive, and that they were listing unlicensed securities in the form of certain crypto tokens. Beyond that, it's not really as, I would say, scandalous, perhaps, as what is suggested in the various complaints against Binance. And I don't think that you're likely to see criminal indictments against Coinbase employees, though there was an employee who went to jail for crimes related to insider trading. But it's really saying that the model you're pursuing is essentially that of an unlicensed securities exchange, and we can't tolerate that as a regulatory agency with

a mandate of consumer protection. Now, what the industry will say back is, hey, you approved the Coinbase's application to go public. But the SEC has already said just because we approved it doesn't mean we approved of the underlying business, which sounds perhaps a little evasive, but that's what they're going with right now. Taken collectively, how significant are these lawsuits? They're significant. I think both are potentially existential or critical for these companies. Already a number of state regulators are kind of banding together and telling Coinbase,

you have to cease and desist either your entire operations or the certain staking product, which is basically you give them your crypto and they give you a very high interest rate. There are all these financial and bank-like and securities-type products that have been rolled out

that basically regulators are now saying these put consumers in potential risk and they're not really licensed securities or registered securities. And that's the fundamental problem here. So whether you're talking about the more salacious end of what finance is being accused of, or kind of the more bureaucratic and almost prosaic accusations against Coinbase, they're still very major for both companies and really put their future operations here at risk. Coinbase has also talked about going overseas sort of as a threat. So it seems like we're really thinking about regulation here. What does it mean then when

you have the SEC going after Binance? I think it means that the SEC, one, isn't afraid to go after some of the biggest operators in crypto, which frankly was a problem for a while. The SEC has operated more as an enforcer and sort of a cleanup artist since the great collapse of the spring of 2022 and then FTX in the fall. But now they do have a bit of a mandate to do something about some of these operators in the industry who people think are in violation of securities laws. It also shows that even though Binance is largely an overseas

concern, its operations do touch the U.S. a lot. And U.S. regulators could potentially have a lot of influence over how the company runs and whether it can continue to operate. So here we have Binance, this behemoth company in the crypto world, getting sued by the Securities and Exchange Commission. The same regulator is going after another major player, as you described, Coinbase. This. The same regulator is going after another major player, as you described, Coinbase. This year, the regulator has gone after other companies, Kraken, Genesis, and this all comes after that collapse of FTX and its founder, Sam Bankman-Fried,

in the center of all of that. So given all of this that is erupting right now, what do you think the U.S. authorities are trying to do? I think regulators aren't perfect, and there's certainly a lot of political corruption in the U.S., as we've seen by the same Bankman-Fried story. I mean, Sam was on the verge of kind of achieving the regulatory capture he sought, I would argue, with various laws and regulations and how he was trying to steer crypto regulation towards the CFTC, which is a smaller US regulator. So in some ways, I think they're making up for lost time and for

some embarrassment that they were allowed to get to that point and a bit asleep at the wheel. I think people in the industry are saying, where were you before? Or where was the regulatory clarity that we sought? But from the government perspective, it is a little bit of an easier political environment to now go in and do some enforcement and try to act like the responsible authority that's frankly cleaning up a bit of the mess that crypto may have created on its own. The people at the center of all of this, the center of these crackdowns are giants in their industry. They are kind of the Bezos, the Zuckerberg's, the jobs of crypto. So what does crypto look like if they are actually brought down?

It's very interesting because when I talk to people, I hear some really different perspectives from inside the industry versus people outside, especially everyday consumers. And we tried to reflect this in the podcast I did about FTX, which is that a lot of people say in the industry, hey, Sam Bankman-Fried was sort of a bad apple, or there are some unscrupulous operators, but the technology, the business, the ideas here are valid, and there's a future for consumer crypto. You look at the numbers of declining retail interests

and then talk to everyday people who have lost their money or frankly consider it a scam or have their money stuck on a platform like FTX. And there's a lot more disillusionment and cynicism. And you can see it in the volumes and in the value of some of these tokens, which is that a lot of the regular consumer interest has left, and people aren't necessarily coming back to the casino. There's still money here. And you see things like WorldCoin, which is this very hyped crypto project, raised $110 million just a couple weeks ago. But just because there's still some money behind crypto and at some of these exchanges doesn't mean the consumers are going to be there when the industry really needs them and really needs them to grow and achieve mass adoption. So that's the disconnect I see. And they need these people to come back and start buying crypto again. And I'm not sure

if that's going to happen anytime soon. I think it's hard to deny that crypto is really at an inflection point and perhaps a low point for consumer interests. And whatever next life it has, I think will have to be something different. It's an absolutely riveting story and so important when we think about global economy. Thank you so much for opening up this part of the story. Glad to. Thank you. That's all for today. I'm Saroja Coelho.

Thanks so much for listening to FrontBurner. For more CBC Podcasts, go to cbc.ca slash podcasts.