Molly White's Citation Needed - The charges against Binance

Episode Date: January 15, 2024

This is the audio-only version of my video entitled "The charges against Binance".The charges against Binance: what are the accusations, and what's next for Binance and its former CEO, Changpeng "CZ" Zhao? Attribution and sourcing for this video are available at https://mollywhite.net/attribution/binance. Disclosures for my work pertaining to cryptocurrencies are at https://www.mollywhite.net/crypto-disclosures.

On November 21st, the United States announced a landmark resolution to multiple years-long investigations into Binance, the world's largest cryptocurrency exchange. The company's founder and CEO, Chang Peng Xiao, agreed to plead guilty to a felony, pay a fine, and resign. Binance the company agreed to plead guilty to three charges and pay a total of $4.3 billion in fines and restitution, and they agreed to a mass. overhaul of their compliance program, with independent monitors to be installed to hold them accountable. Coming only weeks after the conviction of Sandbankman-Fried, the CEO of FTX, which was once the

second largest global cryptocurrency exchange, this seems like another huge moment in the crypto crackdown. But is it? Or is it just a slap on the wrist? And what happens to Binance now? Let's take a dive passed the headlines into the history of Binance, what they did, why the United States government even cares about a cryptocurrency exchange located offshore, and what this resolution is likely to mean for both finance and the cryptocurrency industry going forward. I'm Molly White, a cryptocurrency researcher, an industry critic who writes about crypto and the broader technology world in the citation-needed newsletter. I also created and write Web3 is going just great, a website. A website where I track only some of the many examples of how cryptocurrency and Web3 projects

are failing to live up to their promises. Finance was founded in 2017 by Chengpeng Xiao, who is better known online just by his initials, CZ. CZ was born in China, but he and his family fled the country when he was 12 years old after the massacre at Tiananmen Square. He grew up in Canada and ultimately earned a computer science degree from a Canadian university, before returning to China in 2005 to work in the traditional finance and technology sector. He claims that in 2013, after hearing about Bitcoin during a poker game,

he sold his apartment in Shanghai and went all in, buying a million dollars worth of Bitcoin. The same year, he joined what would later become the cryptocurrency company, blockchain.com. In 2014, he was hired by a woman named Heyei to serve as chief technology office. for another cryptocurrency exchange, OKCoyne, which is now rebranded to OKX. After that, he founded Binance, and that's when things started to get really murky, in ways that are somehow widely accepted within the cryptocurrency world. Binance is an enormously secretive company, and it has actively worked to obscure even the most basic facts, like where it's based, and who else forms its senior leadership.

So I'm going to do my best here. Sizi founded Binance in June 2017, but he didn't work alone. Although Sizi is the public face of Binance and often described as though he is its sole founder, he had at least one other co-founder. The known co-founder is Heye, that same woman who hired him to work at OKCoin, although she had left the company by the time he recruited her to work at Binance. The Department of Justice has also described a third co-founder, a man whose identity I have not been able to determine.

We do know a little bit more about Hei these days, but her role at the company and even her existence has not always been widely known. She keeps a low profile, which she says is because her English is not very good, and she fears that speaking Mandarin will lead people to believe that Binance is a Chinese exchange, something that CZ has gone to great lengths to dispute. Despite remaining out of the public eye, she has been enormously influential. at Binance. In addition to being a core decision maker at the company, she helped with the early marketing that rocketed Binance to its status as the largest global exchange. Since then,

she's worn a lot of hats. She was chief customer service officer. She ran Binance's multi-billion dollar venture capital fund, and she ran the group that decides which tokens Binance will list for trading on the exchange. Oh, and she also has kids with CZ. She's described him as something like a college roommate and a, quote, comrade in arms and has balked at comparisons between their relationship and that of Sam Bankman-Fried and his top lieutenant, Caroline Ellison. She said, Carolyn was an employee, whereas I am a partner. In 2017, only months after Binance opened up shop, China started to crack down on the crypto industry in a major way. Rather than shut down, Binance relocated to Japan.

But in 2018, Japanese regulators warned the company about operating without a license, and so it uprooted itself once again, this time to Malta. But even the crypto-friendly Malta intervened in 2020, announcing that the company was unlicensed there, too. Since then, Binance has claimed not to have any headquarters, which is convenient from a regulatory perspective. CZ is based in the United Arab Emirates, and since 2021, most of Binances seem to be able to your leadership has been located either there or somewhere else in Asia. Within only weeks of its

launch in mid-2017, Binance began to grow really quickly, amassing more than 120,000 users within only 45 days, and almost a quarter of them were based in the United States. By March 2018, Binance had already become the largest exchange globally, as measured by trading volume, a status it maintains today. And by this time, the company had begun to feel some heat around their operations in the United States, where they were not registered and where they were blatantly flouting U.S. financial laws. But the number of customers from the U.S. and the amount of money they were trading would prove to be too alluring for Binance to quit, even as CZ acknowledged internally that they really should be blocking U.S. users from the platform. According to internal documents,

In March 2018, the company had around 3 million users from the United States, more than one-third of their overall user base. Probably at least in part because of this heat around U.S. customers, in April 2018, Binance hired its first chief compliance officer, something they had yet to do despite having almost 10 million users by that point. That person was Samuel Lim, and although he at times spoke to other senior leaders about making sure Binance was compliant in the United States and in other jurisdictions, he didn't seem to try all that hard to actually get them to do anything. In fact, sometimes he was the one helping

Binance avoid becoming compliant. This will be a recurring theme throughout this video. Although CZ and other executives sometimes discussed making changes that would reduce illicit activity on the platform and bring it closer into compliance with regulations, they never actually did much. Later, legal documents would reveal that Binance has been extremely focused on appearing to be compliant, including in internal conversations and policies, without actually being compliant. In an internal chat in 2020, Lim wrote that Binance's compliance was just, quote, email sending and no action for media pickup. I guess you can say it's faux show. I'm not sure he knows what faux show means.

Bear with me for a minute before we dive into the details of what finance was doing, because I want to just explain what I mean when I talk about compliance. Financial companies that serve United States markets are required to abide by, among other things, a law called the Bank Secrecy Act. A more apt name for it might be the Bank not so much Secrecy Act, because it's a law that requires banks and other financial institutions to proactively share information with the U.S. government in order to try to prevent money laundering, tax evasion, and really any kind of illicit activity that involves money.

The Act was signed into law in 1970 during the Nixon administration, but it was strengthened in the wake of the 9-11 attacks under the Patriot Act in an attempt to curtail terrorist financing. The Bank Secrecy Act is the reason that you have to provide substantial proof of your identity to financial institutions, like bringing an official government identity document when you sign up for a bank account and not just giving them your name. And it's why financial institutions have to keep records and are required to file what are called suspicious activity reports, or SARS, on customers who move around large sums of money or

otherwise raise red flags. When I'm talking about the Bank Secrecy Act, I will repeatedly be using two related acronyms, KYC and AML. AML stands for anti-money laundering, and it's just what it sounds like. Programs by financial institutions to detect and prevent customers who are trying to launder money. A part of AML is KYC, which stands for know your customer or know your client. And this refers to the processes by which financial companies make sure the people using

the services are who they say they are. If you've ever signed up for an account on a cryptocurrency exchange or honestly open an account with like any financial company and they've required you to submit a scan of your passport or your driver's license, that's KYC. Companies that fail to do a good job at KYC and AML face the risk of winding up on the bad side of a Bureau of the Treasury Department called FinC, the Financial Crimes Enforcement Network. All right, that's enough history. We'll go back to finance now. despite serving U.S. customers since their inception and as such being required to register with FinCEN, Binance just never did. And the Bank Secrecy Act required them to file suspicious activity reports, but despite regularly discussing suspicious activity internally and sometimes shutting down accounts

connected to criminal operations, Binance never filed a single suspicious activity report. And Binance certainly never complied with the Bank Secrecy Act's requirements around anti-money laundering and K.Y.C. In part because the vast majority of customers provided no identifying information whatsoever. See, Binance had what they called Level 1 and Level 2 accounts. Level 1 accounts were anonymous, and all people had to give Binance was an email address, and a pinky swear that they weren't in the U.S. or on any economic sanctions list. Level 2 accounts required a more complete set of KYC information, including a government ID document or number, citizenship, and a residential address. But there was almost no incentive or requirement to sign up for a level 2 account, and so most people didn't.

The only real downside to not having a level 2 account was that you could only withdraw up to 2 bitcoins per day. But even this wasn't really a barrier. For one, two Bitcoins were worth more than $100,000 at various points while Binance supported the level 2 accounts. So it was a pretty high limit. And besides that, if people wanted to withdraw more than two Bitcoins a day, they could just create new accounts with new email addresses and cash out as much as they wanted. Binance users had the option to create a Level 1 account for four years until May 2022,

when the company finally decided they had to shut down the offering, likely as a result of the legal investigations into the company. And even after that, until at least October 2022, customers could still evade KYC by going through what Binance called exchange brokers or nested exchanges, which were companies that traded on customers' behalf, often without doing adequate KYC themselves. It was through that loophole that Binance ended up providing services to groups like the X-EX Exchange, which processed transactions for ransomware attacks like the one on the colonial pipeline, and for Garantex, which processed ransomware transactions such as those involved with the Conti ransomware.

But despite the lack of identity documentation from their customers, Binance would have still been able to make some inferences about where their customers were located, based on what's known as an IP address, an identifier assigned to any device accessing the internet. By examining the IP addresses used by their customers, Binance could have made a pretty good guess about where they were based. But instead, Binance chose willful ignorance, with CZ internally acknowledging that they would have had far fewer users and less revenue had they actually blocked U.S. users. Better to ask forgiveness than permission, he wrote. U.S. customers weren't the only people Binance was failing to identify. They also served many customers from jurisdictions that are subject to comprehensive sanctions by the United States, including countries like Iran, North Korea, and Syria.

This might have been less of an issue if they weren't also serving U.S. customers, but because they were, and because cryptocurrency exchanges work by matching customers who want to sell cryptocurrency with those who want to buy it, they were facilitating trades between American and and sanctioned individuals. A big no-no. As far back as 2018, Binance gave lip service in their policies to banning customers from sanctioned areas, but in fact they were well aware that they had many such customers. Internally, they acknowledged that they had processed at least a million transactions with Iranian customers alone, but they tried to conceal this fact when contacted by law enforcement, with Chief Compliance Officer Samuel Lim stating, We definitely don't want to acknowledge we have Iranian users on board, as our official stance is we've gotten rid of them all and blocked.

Also in 2018, Lim spoke of being nervous about lying about sanctions enforcement. There is no fucking way in hell I am signing off as the CCO for the OFAC shit, he wrote, using the abbreviation for the Office of Foreign Assets Control, which handles sanctions violations. This nervousness seemed to stem from an understanding of his own personal liability. He would later write in a message to a colleague, U.S. users equals CFTC equals civil case, can pay fine and settle. No KYC equals BSA Act equals criminal case, have to go to jail.

Besides all these customers they weren't supposed to be serving, Binance also knew that their lax policies were attracting serious criminals to their platform. In July 2017, the very same month, Binance began operating, U.S. authorities filed 21 charges against the operators of a Russian Bitcoin exchange called BTCE and explicitly called out how lack of KYC was enabling criminal money laundering. Binance executives were later briefed on this enforcement action and on how BTCE's operations resembled Binance's own business practices. In August 2018, a service provider came to Binance with concerns

about what they called one of the worst hacking groups we have ever seen, and about how they were using multiple Level 1 accounts to cash out just under two Bitcoins a day to avoid the KYC limit. And in February 2019, a member of Binance's compliance team even joked about how Binance's lax controls were inviting criminals to the the platform. We need a banner. Is washing drug money too hard these days? Come to Binance. We got cake for you. Binance also had an explicit internal policy created by Lim on direction from CZ to tip off VIP users when they had become the subject of a law enforcement inquiry. Contact the user through all available

means, text or phone to inform him or her that his account has been frozen or unfrozen. We cannot in any circumstances directly tell the user to run or withdraw. We can get sued or undertake personal liability. Giving a strong hint, such as your account is unlocked, your account has been investigated by XXXX is usually a good enough hint of severity. If the user is a big trader or a smart one, he or she will get the hint. When some accounts were flagged to Binance as being associated with ISIS and Hamas, Lim instructed employees to first check. check if they were VIP accounts. If so, he said, offboard the user, but let him take his funds and leave.

Tell him that a third-party compliance tool had flagged him. At a later point, discussing customers from Russia, Lim remarked, like, come on, they're here for crime. Binance's money laundering reporting officer, quite a job title for someone working at Binance, agreed. We see the bad, but we close two eyes. Binance also knew about customers who were sending or receiving money from marketplaces that sold child sexual abuse material. Although they did shut down some of those accounts, Binance never filed any suspicious activity reports, meaning they never alerted law enforcement to this activity.

In late 2018, feeling the heat, Binance decided to hire a consultant to advise them on the legal risk they were facing in the United States. The consultant went to great detail on the regulations that Binance needed to be following, but wasn't, and then offered three possible strategies, a low-risk option in which finance would become fully compliant with the U.S. regulations, a high-risk option in which finance would continue as it had been, and a medium-risk option. Binance made it seem as though they rejected the consultant's recommendations, but in reality, they would ultimately go on to follow the medium-risk strategy very closely. This medium-risk plan involved creating what the consultant called a Tai Chi entity,

a reference to the Chinese martial art that emphasizes not using force against force, but instead strategically redirecting an opponent's force away or back towards them. This entity, he said, would insulate finance from legacy and future liabilities by becoming the target of all built-up enforcement actions. He also recommended several actions Binance could take, which he said would be just for publicity, including beginning discussions with the U.S. Securities and Exchange Commission, with no expectation of success, and solely to pause potential enforcement actions. In keeping with that plan, Binance announced in mid-2019 that they would begin blocking users from the United States and would launch a separate exchange for the U.S. market.

Quick clarifying point. Going forward in this video, you will hear me refer to Binance, Binance.com, or Binance Global. Those are all the same thing. And when I say that, I'm referring to the global primary finance exchange run by a CZ as CEO. I'm not referring to Binance US, which is the US entity, which I will always just call Binance US. So the Tai Chi consultant was brought back and he helped with the development of this new exchange for a couple of months. Several months later, under an entity called BAM trading, Binance launched Binance US. Binance US would go on to become one of the top five crypto exchanges in the United States. They were very careful about messaging because they didn't want to publicly admit that

they had ever had U.S. customers on the global exchange. Internally, in a meeting where he also described Binance.com's substantial U.S. customer base, CZ talked about how to announce the U.S. exchanges launch. We need to finesse the message a little bit, he said. The message is never about Binance blocking U.S. users because our public stance is we never had any U.S. users. So we never targeted the U.S. We never had U.S. users. So just how the consultant had suggested, Binance U.S. indeed appeared to do everything by the book. At the time of its launch, the exchange listed only seven cryptocurrencies, compared to the more than 100 tokens listed on Binance.com.

This was an apparent attempt to placate the U.S. Securities and Exchange Commission, or SEC, which is watchful for exchanges listing tokens it believes to be securities, although Binance U.S. would ultimately list more than 150 tokens. Binance U.S. also didn't offer trading in crypto derivatives, a riskier type of financial instrument that the U.S. Commodity Futures Trading Commission, or CFTC, doesn't want exchanges offering to retail customers. And they even registered the new U.S. exchange as a money services business with FinCEN and obtained state money transmitting licenses.

In order to further distance themselves from the entity, Binance and its executives were extremely careful to describe Binance U.S. as a partner, not a subsidiary. However, despite having its own executive team on paper, it was controlled by CZ, who was also the beneficial owner of the company. The executives that were installed and other employees of Binance U.S. didn't even have full visibility into the trading data of the exchange they were supposedly running. They had no control over their own bank accounts and had to get approval from CZ for even the most routine expenses.

Binance would occasionally transfer tens of millions of dollars out of Binance U.S. without the CEO, Catherine Coley, even knowing about it. When CZ directed that finance U.S. should list the B&B token in September of 2019, Coley objected because it was likely to be deemed a security by the SEC. CZ brought Coley to the room to strongarm a B&B listing, and it was listed the same month. In late 2020, Coley ultimately launched, which she called Project 1776, to gain independence from the global exchange, which she called the mothership. While she was working on this, Forbes magazine published an article exposing the existence of the Tai Chi plan, and Coley said its publication destroyed trust among employees of the U.S. exchange, who felt, quote, like they've been duped into being a puppet. Binance quickly sued Forbes and the two authors of the article for defamation, seeking damages

and the deletion of the article, although they dropped the suit a few months later. As for Project 1776, CZ fired Coley only some months after she embarked on the campaign. CZ installed a new CEO who resigned, only three months after taking the position, when it, quote, became clear to him at a certain point that CZ was the CEO of BAM trading, not me. Despite the public statements about blocking U.S. customers and limiting them to the no-fund-allowed U.S. exchange, the reality was very different. Binance wanted U.S. customers, especially those who were doing high volumes of trading and were very profitable for Binance to keep using the global exchange, where they had access to a wider

variety of products. Binance accomplished this through a combination of willful ignorance and knowingly helping customers, especially VIPs, circumvent their own supposed restrictions. When talking about showing a pop-up to restrict users with US IP addresses away from the Binance Global Exchange and towards the Binance US Exchange, CZ said, we need to word the pop-up very carefully, so we let people know what they need to do, including using a VPN without explicitly stating it. VPN stands for virtual private network, and it's software that, in addition to its many legitimate use cases, is also widely used to circumvent geo-fencing, which is the blocking based on IP address of customers who were not supposed to be accessing Binance's global

exchange. Ultimately, that pop-up that CZ was talking about, it was just a pinky promise. It just asked people to self-certify that they were not U.S. persons. Samuel Lim later told another employee that if U.S. users get on dot com, we become subjected to the following U.S. regulators, FinC, OFAC, and SEC. We try to ask our U.S. users to use VPN or ask them to provide, if they are an entity, non-U.S. documents. On the surface, we cannot be seen to have U.S. users, but in reality we should get them through other creative means. Meanwhile, in calls during June 2019, as Binance was preparing to launch the U.S. Exchange, Hei told CZ and other executives that Binance had at least 3,500 VIP accounts based

in the U.S. and that those U.S.-based VIPs accounted for around 25% of Binance's trading revenue. CZ really didn't want to lose those users, or that revenue. So he spoke about achieving a reduction in our own losses while ensuring that U.S. supervision agencies don't cause us any troubles by making U.S. users slowly turn into other users. Binance cannot say this publicly, of course, he said. We do need to let users know that they can change their KYC on Binance.com and continue to use it. But the message, the message needs to be finessed very carefully because whatever we send will be public, we cannot be held accountable for it.

So, Binance employees began a campaign in which they contacted US VIP customers, on the phone, not in writing, to inform them that Binance had misidentified their accounts as belonging to U.S. customers and asking them to correct the previously inaccurate records. CZ explained on a call with other executives, we cannot say they are U.S. users and we want to help them. We say we miscategorize them as U.S. users, but actually they're not. Samuel Lim added, we cannot advise our users to change their KYC. That's, of course, against the law. But what we can tell them is through our internal monitoring, we realize that your account exhibits qualities, which makes us believe it is a U.S. account.

This, he acknowledged, was International Circumvention of K.YC. And in chat conversations, Lim also spoke about giving special treatment to US VIPs who were doing sick-ass volumes. Documents were drafted to coach employees on having these conversations with the US VIP customers. For those who were suspected to be based in the U.S., based on their IP addresses, employees were told to inform them that it was their IP address preventing them using the exchange. If the user doesn't get the hint, indicate that IP is the sole reason why he or she can't use.com. They were told that they couldn't explicitly instruct the user to use a different IP. We cannot teach users how to circumvent controls. If they figure it out

on their own, it's fine. Make sure to inform users to keep this confidential, the coaching document said. Some employees went even further, using fake names for these conversations, out of fear that the strategy might leak and the company could be pressured to fire them. These VIP customers were coached to create offshore entities if they didn't already have them, and then update their K-Y-C information to reflect a basis of operations there. In some cases, finance just changed how they defined US user, so it wouldn't apply, and adjusted their automated geofencing controls accordingly. By September 2020, an internal report showed that around 16% of Binance's user base was based

in the United States. Around this time, Binance became very cautious about keeping records that they had U.S.-based users on the global platform due to a fear of leak risk, a fear that seemed to have been amplified by U.S. regulatory action against Bitmex, a different cryptocurrency exchange. The next month, at CZ's direction, Binance simply changed the label on their reporting to unknown. Around that same time, CZ also rebuked an employee for posting U.S. data in an internal group chat, instructing him to delete the message. CZ also told an employee who told him about a U.S. trading firm that was accessing the global platform, give them a heads up to ensure they don't connect from a U.S. IP address.

Don't leave anything in writing. Binance employees started to only discuss U.S. matters on Signal, where some chats had auto-delete functionality enabled. Despite the stated concern about connecting from U.S.-based IP addresses, even the programs that were intended to detect that were incredibly flawed. I has no confidence in our geo-fencing, an employee told Lim in November 2020. In October 2020, Binance had to hire an auditor to demonstrate to a U.S.-based business partner, Paxos, that it had an effective compliance program. Lim stated internally that they found an auditor who would just do a half-assed individual sub-audit on geo-fencing to buy us more time.

Binance's same money laundering reporting officer complained to him that she needed to write a fake annual MLRO report to Binance Board of Directors, WTF. So by this point, I've talked a lot about customers trading on the Binance Exchange, but I haven't yet gotten into Binance's own trading. Although Binance didn't disclose to customers that they were trading on their own platform, they actually operated around 300 house accounts, ultimately owned by CZ. See, in addition to Binance and Binance U.S., C, C, CZ also owns two cryptocurrency trading firms, both incorporated in 2019, called Sigma Chain and Merit Peak.

Both firms were only nominally independent from Binance. It's becoming a pattern. CZ owned them, and Binance employees were in charge of their operations. Why does a cryptocurrency trading company operating an only nominally independent trading firm ring a bell? Huh. Deja Vu. Weird. Both Sigma Chain and Merit Peak operated as market makers for Binance on both the U.S. and the global exchanges. So if you're running a cryptocurrency exchange, the simplest description of your business is that you match people who want to buy or sell an asset with other people who want to do the opposite side of that trade. But what if there's no one around who wants to make the opposite trade?

exchanges solve this problem by engaging market makers, which are typically large trading firms who will step in on the other side of a trade to make sure there's adequate liquidity within the markets. There is a substantial conflict of interest risk when it comes to operating both an exchange and a market maker, which is why such activities are required by U.S. security laws to be carefully separated. But Zizi's firms simply flouted these laws, which, are designed to keep firms from trading against their own customers. That is, profiting at their customer's expense. And that is exactly what Binance did.

From the moment of Binance US's launch, Sigma Chain engaged in extensive wash trading, which is when an entity trades assets among accounts it secretly controls in order to artificially manipulate that asset's price. The wash trading by CZ and his firms was beneficial. to him and those firms, but at the expense of the other traders on the platform. In fact, the very day Binance U.S. opened for business, wash trading between accounts operated by CZ, senior finance executives, and Sigma Chain

constituted more than 99% of the initial hour of trading for one particular crypto asset, and 70% for the full day. And when Binance U.S. would list the new crypto token, Sigma Chain would walk wash-traded. In a six-month period in 2022, Sigma Chain wash-traded newly listed crypto tokens in 48 of 51 cases. And even tokens that had been listed on the platform for a while were heavily washed traded, including in a spike of wash trading leading up to Binance U.S. raising a funding round, which appears intended to juice trading numbers to make the platform look more appealing to those prospective investors. But even while,

While CZ was engaging in this blatant and widespread wash trading, he and other Binance employees were talking up just how important it was that exchanges control against market manipulation and claiming that Binance did so. In April 2019, upset that Binance was appearing lower on a list of crypto exchanges by volume than he believed was accurate, CZ tweeted, credibility is the most important asset for any exchange. If an exchange fakes their volumes, would you trust them with your funds? What he didn't mention was that his very own firms were doing that exact thing.

Meanwhile, Binance U.S. was claiming both to the public and to prospective investors that they were carefully monitoring trading for manipulative behavior and made claims about their trading volume without disclosing the massive wash trading. Every single user that goes through our process goes through in-depth K-Y-C and AML. So we know exactly who's trading on our platform. We also have on-chain analytics monitoring all the behaviors that are taking place on our, you know, wallet addresses and going back with seeing the behavior of our trading that's taking place. With that, it just comes a great awareness of kind of who's transacting on our platform. And on-chain analytics, like you've seen, you know, there's probably four vendors out there now that provide really clear sets and risk parameters that we're in. able to make sure we're not, you know, welcoming behavior that's going to be toxic.

But despite Coley making these claims publicly, an employee would tell her, over a year later, apparently we have nothing in place to prevent wash trading, just tested myself, sold a market order into my own bid. Another employee replied, yikes. The wash trading was not the only problem with these entities. Massive amounts of Binances' money was reportedly flowing to and from Sigma Chain and Merit Peak, including between the global and U.S. entities. Customer money, investor money, and company money was all commingled in these accounts to the tune of billions of dollars. The wash trading of crypto assets, commingling of funds, and lack of disclosures would later raise alarms at the U.S. SEC, but it was hardly the only issue on that

agency's radar. Neither Binance Global nor Binance U.S. registered with the SEC as an exchange, a broker-dealer, or a clearing agency, despite apparently filling all of those roles, roles that would normally have to be separated. Furthermore, they listed tokens, including their own B&B token that looked a whole lot like unregistered securities. And they offered staking services, programs that the SEC cracked down on hard in the U.S. in 20203. And Binance employees knew they were risking enforcement actions from the SEC. All the way back in 2018, Lim bluntly stated to another member of the compliance team, we are operating as a fucking unlicensed securities exchange in the U.S. bro.

Bro. For years, rumors were swirling of a Department of Justice investigation into Binance and into CZ. And CZ seemed increasingly reticent to leave the United Arab Emirates, which notably does not have a formal extradition treaty with the United States. In fact, in 2021, when his father passed away, CZ didn't travel to Canada to go to the funeral, although Binance would later claim that he had. Sam Binkman-Fried joked on Twitter very shortly before the collapse of his own exchange that CZ might not be allowed in the United States. However, it would ultimately be the U.S. CFTC who came down on Binance first. In March 23, they charged Binance entities CZ and our pal Samuel Lim with seven

violations of the Commodity Exchange Act. Although the CFTC is only able to file civil complaints, which can result in injunctions from operating and potential fines, but no jail time, A lot of the behavior described in the complaint sounded really criminal. Lim would later go on to settle his portion of the CFTC complaint by paying a $1.5 million fine. Following the complaint, Binance was defiant and published a long statement by CZ describing his disappointments in the lawsuit, despite working cooperatively with the CFTC for over two years, he claimed. In this journey towards freedom of money, we do not expect everything to be easy.

We do not shy away from challenges. Only two months after the CFTC complaint, the SEC followed up with their own complaint, which included 13 charges against finance entities and CZ personally. The charges encompass the wash trading, commingling of assets, cryptocurrency staking, and operating without registration. Notably, the SEC also used the last. lawsuit, as they had in other lawsuits against firms like Coinbase and others, to describe a whole lot of popular cryptocurrency tokens as securities, something that could have a massive impact on the

cryptocurrency industry in the United States if that is upheld in court. Other cryptocurrency exchanges serving U.S. customers like Robin Hood and E. Toro all acted quickly to delist those tokens for their U.S. customers, cautious of also being accused of offering unregistered tokens. Along with the complaint, the SEC also applied for an emergency temporary restraining order, which was aimed at preventing CZ and Binance from transferring assets belonging to U.S. customers out of the United States. According to former SEC enforcement attorney John Reed-Stark, a TRO is, quote, the most powerful tool the SEC has, used sparing.

and reserved only for really bad situations. Binance, again, was defiant, accusing the SEC of regulating with the blunt weapons of enforcement and litigation, rather than the thoughtful, nuanced approach demanded by this dynamic and complex technology. In the months after the CFTC and SEC lawsuits were filed, Binance suffered misfortune after misfortune. Regulatory action from various jurisdictions caused them to exit or dramatically cut back their operations in those places, including Australia, Belgium, Canada, Cyprus, the Netherlands, and the United Kingdom, just to name a few. A seemingly never-ending train of executives and other

high-level employees quit, including the U.S. head of legal and the U.S. chief risk officer. A bad sign. Both Binance and Binance U.S. added to the list of employees that left the company by performing substantial layoffs. But throughout it all, CZ remained defiant, lashing out on Twitter at the media and dismissing reports as FUD. That is, until November 21st. That was the day the Justice Department announced that Binance had agreed to plead guilty to three charges, pay $4.3 billion in penalties, and submit to comprehensive monitoring to ensure that their compliance programs were finally properly implemented. Simultaneously, CZ pleaded guilty to one felony charge, resigned as CEO of Binance and agreed to a $50 million fine. Sentencing is scheduled for late February, and it's entirely possible that CZ will have to do some prison time.

This announcement surprised me. For one, despite the record-breaking fine, it seemed somewhat light-handed by the DOJ, who could have pushed to take the case to trial, although I will note that I have come to change my opinion a little bit on just how light-handed this agreement is. It was also surprising to me that CZ voluntarily showed up in Seattle to enter a guilty plea, after years of appearing to avoid the grasp of U.S. law enforcement. And finally, it was a surprise that he stepped down. from the company that had become an extension of himself, and seemingly without much of a fight.

It may be that CZ decided that the likely consequences were an acceptable price for, eventually, being allowed to move freely again. It also seems that the net was beginning to tighten somewhat around CZ, particularly after an investigation into Binance began this past summer in France, a country that does have an extradition agreement with the UAE. Furthermore, the UAE has been looking to clean up its reputation a little bit and be removed from the Financial Action Task Force's gray list. And CZ and Binance reportedly kept coming up in conversations between UAE officials and

financial authorities in both France and the U.S. As for the DOJ, the choice of action may have been out of concern that a more aggressive approach could topple the exchange, therefore endangering the finances of many of its direct customers and the far more people who would be impacted by the enormous impact a finance collapse would have on the cryptocurrency industry and crypto markets. Now, the DOJ did throw the book at Sandbank and freed, sure, but the damage to FTX had already been done at that point. And more generally speaking, the DOJ usually tries to avoid putting companies out of business, or at least that's what a former U.S. prosecutor told Wired Magazine. It also could have been because Binance had a bargaining chip,

information. With such a substantial global user base and a known history of serving criminals, Binance is sitting on troves of data that must be irresistible to the Justice Department. Perhaps they weren't willing to bet that they could force Binance to fork it over through the legal system and chose instead to find creative ways to get access to that valuable data through a friendlier settlement. All right, you've stuck with me this far. So now that we've touched on why the deal may have happened, let's dig into the charges and what they mean for Binance and for CZ. The DOJ complaint named Binance and CZ personally, and CZ pleaded guilty to one charge, failure to maintain an effective anti-money laundering program, I'd say.

Binance the company pleaded guilty to three charges, conspiracy to conduct an unlicensed money transmitting business, and to fail to maintain an effective anti-money laundering program, all one charge, conducting an unlicensed money transmitting business, to violations of the International Emergency Economic Powers Act, which prohibits causing transactions between U.S. people and Iran. Binance was also required as a part of their plea deal to prohibit CZ from present or future involvement in operating or managing the Binance business for a period of three years, although he is still, critically, the owner of the company. In addition to their own charges, though, the DOJ invited some friends to the party. The resolution with the DOJ also

involves settling the complaint from the CFTC that I described earlier, and they'll receive $2.7 billion in penalties and disgorgement from Binance, as well as $150 million from CZ. I will note that some of the money that Binance and CZ owe to the DOJ will be credited towards some of these other enforcement actions. Finally, this settlement also resolved an ongoing action by the Office of Foreign Assets Control, or OFAC, who is in charge of enforcing sanctions violations, and by the Financial Crimes Enforcement Network, FinCEN, who, as I mentioned earlier, is responsible for enforcing the Bank Secrecy Act. Both agencies impose their own fines and penalties, although, again, some of the fines collected by the DOJ will go towards the FinCEN or

O-FAC settlements. So the question now becomes, does Binance have the cash they'll need to pay these fines? It seems likely that CZ does, as he's been reported to be a multi-billionaire. But for Binance, it's hard to say if they can afford a $4.3 billion payout. There is a schedule that requires portions of the fine to be paid at different points, but ultimately, finance will have to cough up the whole amount within 15 months of their money. sentencing. Now, Binance says they're good for it, obviously, but are they? Binance discloses very little and has no audited financials, so no one outside of the company, and honestly, inside the company, can really say with certainty how much money they have. Binance claims to show proof of reserves

on their website, which they say is real-time proof that they have sufficient assets backing their user's holdings. But even if we put aside that proof of reserves are deeply flawed in terms of presenting a complete picture of a firm's assets and liabilities, Binances only claims to refer to customer assets and not corporate holdings. So it's really not terribly useful here. Would Binance resort to dipping into customer funds to pay the fines? An exodus of Binance customers has suggested that there are a good number of people who really don't intend to stick around to find out. Easily more onerous than the fines, though, are these monitorships that are being imposed, and Binance is footing the bill. Former enforcement attorney at the SEC,

John Reed Stark, has described the monitorships as a 24-7, 365 days a year financial colonoscopy. That's evocative. A U.S. prosecutor told WIRE that the monitorship was kind of crazy. I don't know what kind of business would want to operate while allowing that much government oversight. The DOJ has ordered Binance to become compliant with all the applicable laws they should have been following this whole time, and they're imposing a three-year-long monitorship to make sure that happens. Independently, FinCEN has also ordered a monitor to ensure Binance's compliance with the Bank Secrecy Act, and that monitorship has a term of five years. Their monitorship will also involve ensuring that all U.S. users are gone from the global exchange, and we'll be digging

into details around Binance's Russian cryptocurrency exchange partner that looks like the kind of partnership Binance reportedly had with Binance U.S. It is important to note that these charges don't involve Binance U.S., which will be allowed to continue serving U.S. customers, but without the overlap between them and the global exchange that's been going on this whole time. These monitors and the consultants they will hire to conduct additional reviews will be watching Binance like a hawk as they continue to operate, and going back through their past operations, news that I'm sure has struck terror into more than a few criminal operators. Remember all those suspicious activity reports that Binance wasn't filing?

Well, FinCEN doesn't intend to just shrug those off. Instead, the monitor will hire a consultant, and likely a team of analysts to do a formal suspicious activity report look back, identifying where reports should have been filed, and then filing reports pertaining to categories including ransomware, terrorist financing, high-risk jurisdictions, dark net markets and scams, and child sexual abuse material. According to that same U.S. prosecutor I mentioned earlier,

quote, it would be a game changer in taking down transnational syndicates doing evil deeds worldwide and trying to shield those crimes by using cryptocurrency to move money. FinCEN says they think there are at least 100,000 suspicious activity reports that should have been filed, but weren't. It's likely there's probably more than that, given that FinCEN doesn't have a complete look into Binance's records. And I will point out, there is precedent for this type of retroactive inspection after a criminal action to lead to other criminal charges after new crimes are exposed. For example, when U.S. authorities took down BTCE in 2017, criminals involved in child sexual abuse materials distribution and in the hacking of the Silk Road

Darknet marketplace were identified, thanks to data seized by the authorities. Now, this may be a hot take here, but the degree of data access by the U.S. government as a result of this action is actually arguably overbroad. Because in addition to the suspicious activity where there is actual cause to believe that a crime may have occurred, they will now have access to user data with no requirement that the transactions raise suspicion and no requirement that law enforcement demonstrate that they have probable cause that that user was involved in illicit activity. So regardless of your opinions on the prevalence of crime in the crypto world or of the likelihood a given crypto user is engaging in criminal activity, warrantless access to private data

should be cause for concern. So the question now is, what's next for Binance? Again, it remains to be seen whether they can pay the fine, although some knowledgeable commentators suspect the DOJ wouldn't have impose a fine that the company couldn't pay. It also remains to be seen whether Binance will or even can follow through with its compliance promises under the monitorship. I really can't overstate just how onerous this kind of a program is. In fact, a former Wells Fargo executive who was in charge of their financial crimes risk management program, told Ben Penn at Bloomberg Law, there has been nothing remotely close to this when it comes to complexity, length, scope, and to monitor what was a criminal enterprise, essentially.

Penn drew comparisons to the HSBC monitorship, which was imposed after they were found to have laundered drug money for Mexican cartels. HSBC's monitorship was also supposed to last for five years, but ultimately it was extended to almost 10 after the independent monitors discovered multiple failings. In Binance's case, somehow this monitor has to assemble a team that can probe the inner workings of a company that has been designed to be deliberately opaque and resistant to law enforcement inquiry, while also satisfying the expectations of financial regulators and others in the U.S. government who do not want to be seen to be giving Binance a pass. And even in a best case scenario,

where Binance is able to become fully compliant with the laws it was supposed to have been following all along, can Binance survive that? Part of the reason cryptocurrency companies can be profitable is because they're able to skirt expensive financial regulations. A profitable business case for a fully regulated, fully compliant cryptocurrency exchange is just not clear to me, despite the claims of companies like Coinbase who say they want strong. regulation. CZ explicitly stated internally that he was so hesitant to register and comply with U.S. regulations because it would likely touch off a dramatic reduction in customers and thus profits. And history does not offer a promising outlook for crypto exchanges that operated outside of the

law and then tried to shape up. Polonex was a cryptocurrency exchange known as an anything goes operation, and its lack of KYC was a big selling point. It was Shikcoin Casino No. Uno, according to a former employee, who described it as completely Wild West. Then in 2018, the U.S.-based cryptocurrency company's circle purchased the exchange with the idea of cleaning things up and making it into an above-board U.S. regulated exchange. They discovered, however, that when they introduced KYC, both customers and trading volumes, vanished. They gave up on the idea very quickly after that and sold the exchange in 2019 to Justin Sun, who moved it to the Seychelles and returned it to its Yolopolo-Polo roots.

Now, if finance fails to truly comply with U.S. regulations and its new monitorship requirements, or if finance otherwise fails to comply with the conditions of its plea agreement, all bets are off. The DOJ could come after the company and its executives criminally, far more harshly than they already have, and the DOJ and other financial agencies could seek to end the company's presence within the United States completely. And Binance has already raised some eyebrows as far as its attitude towards this supposed new above-board era in its history. During his very first public interview as the replacement CEO of Binance, the former online, Abu Dhabi regulator Richard Teng was evasive. His interviewer seemed frustrated when he said, I've asked you where Binance's global headquarters is. I've asked you whether Binance is going to

undergo an audit, how many employees the company currently has on its books, and whether you're applying for a license in the UK, which is what Binance told us during our last crypto conference. You haven't answered those questions. And Tang ultimately snapped at him. Why do you you feel so entitled to those answers? As for CZ, his future is also a little unclear. After pleading guilty to his felony charge, he was going to return to his home in Dubai until the sentencing hearing, which is scheduled for February. However, prosecutors appealed the judge's decision not to include a travel restriction in his bond conditions, and ultimately the judge decided that CZ was a flight risk who would need to remain within the United States.

dates until sentencing. His charge comes with a maximum 10-year sentence, although sentencing guidelines would put him at a much lower 15 to 21-month term of imprisonment. However, these guidelines are truly only guidelines. There's nothing to stop the government from trying to seek a maximum sentence or the judge from imposing one. And his plea agreement allows prosecutors to include evidence of additional crimes that were not ultimately charged against him, thanks to his cooperation, when providing materials for a pre-sentencing report, which is used to determine an ultimate sentence. On the flip side, CZ could also face lighter treatment than the sentencing guideline, and could even end up with probation or house arrest, although this would

likely be politically unpopular, given the sentiment towards cryptocurrency crimes and the apparent scale of wrongdoing at finance under CZ's leadership. As for CZ's willingness, to abide by his terms of his plea agreement? Well, he seems to be testing the waters as well, particularly when it comes to the part that prohibits him from publicly denying the wrongdoing he just admitted to. In a long message on Twitter, where he wrote, I made mistakes and I must take responsibility, he proceeded to do nothing of the sort, finishing the post with, on that note, I am proud to point out that in our resolutions with the U.S. agencies, they do not allege that Binance misappropriated any user funds and do not allege that Binance engaged in any market manipulation.

Fortunately for CZ and the future of his plea agreement, he was careful to ensure that that statement was technically correct, if also somewhat misleading. It relies on the fact that the allegations of misappropriation of user funds and of market manipulation come from the SEC. the one agency that did not join the group settlement. As for the SEC complaint, that is plowing ahead with full force. In fact, the SEC has already filed notice of supplemental authority in that case, attaching Binances and CZ's plea agreements with the DOJ and the consent order from FinCEN. The admissions made in those agreements could dramatically bolster the SEC's case against the company,

which could result in more hefty fines and in injunctions, although the SEC like the CFTC does not have criminal authority. I wish I could end this video with a confident prediction of what the future holds for Binance and for CZ and the cryptocurrency industry, where Binance has been a dominant force for more than five years. But it's pretty early to be doing that kind of thing, and I learned long ago that what happens in the cryptocurrency industry will almost always be more absurd and unbelievable than anything I predict.

Instead, I hope I've left you with a full understanding of what has happened up to this point, with which you are certainly free to make your own predictions. In fact, leave a comment if you want with what you think might happen. With that knowledge, we can watch what the future will bring together. Don't forget to buy some popcorn. Thanks so much for watching. This is my first long-form video, and I hope you've really really... enjoyed it. I'm super new to writing, recording, and editing video, so please leave me any feedback you have.

And if there are any topics you want to see me cover, either in video form or in my usual writing, please feel free to suggest those as well. If you like this video, you should check out my writing over at the citation needed newsletter, where I publish regular articles about the cryptocurrency industry and about tech more broadly. I also do a roughly weekly recap of what's been happening in the cryptocurrency world. So if you're looking to stay informed on what happens with Binance going forward, consider signing up for a subscription. All the content there is free and nothing is paywalled, but I do rely on the paid subscriptions to be able to do this kind of work full-time, including making this video. If you want to support my work without a subscription,

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