The Breakdown - Commingling Customer Funds? Binance Under Scrutiny for B-Token Wallet

Episode Date: January 28, 2023

On today’s episode, NLW catches up on the continued fallout of Crypto 2022, including: Scrutiny around wallet balances that suggest Binance has had commingled user funds and company reserves around B-tokens  The latest from the FTX bankruptcy, including accidental revelations around BlockFi A Celsius Network proposal for an asset-recovery token  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW - Join the most important conversation in crypto and Web3 at Consensus 2023, happening April 26–28 in Austin, Texas. Come and immerse yourself in all that Web3, crypto, blockchain and the metaverse have to offer. Use code BREAKDOWN to get 15% off your pass. Visit consensus.coindesk.com. - “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell and research by Scott Hill. Jared Schwartz is our executive producer and our theme music is “Countdown” by Neon Beach. Music behind our sponsor today is “Swoon” by Falls. Image credit: Antonio Masiello/Getty Images, modified by CoinDesk. Join the discussion at discord.gg/VrKRrfKCz8.

Look, there is no universe in which I am rooting for Binance to fail. I want all of these things to be the sort of small errors their spokespeople want to make them seem like. But Binance have got to get their shit together when it comes to all of these processes. The level of scrutiny and the importance of the leading companies in the space doing it right has never been higher. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world.

The breakdown is produced and distributed by CoinDesk. What's going on, guys? It is Friday, January 27th, and today we are checking in on crypto companies behaving badly. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friendos, happy Friday. I hope you are doing well. And I am doing well because this week, I have to say, has been blissfully free of bad guy stories and crypto firms behaving badly.

At least mostly. That said, I do believe we've tipped over the point where the accumulation of news along those lines and follow up from the fallout of 2022 has amassed enough relevance that we needed to do an update show. So today we'll be catching up on the latest around the FTX bankruptcy, around Celsius, BlockFi, and a few other stories. Let's actually start, though, with Binance. All eyes in this industry have been on Binance since the collapse of FtX.

Now, part of that is that SBF has tried to make the fall of FTX seem like a targeted hit from rival CZ, rather than a byproduct of his own rampant, long, hidden, newly exposed fraud. But even those not buying Sam's message of CZ being an assassin, are still carefully watching any big institution, and especially exchanges like the lone superpower that is Binance, for any signs either of trouble on the one hand or malfeasance on the other. A couple weeks ago, we discussed Binance's admission that at times in the past, their stable coin hasn't been fully backed one-to-one as promised.

That revelation was uncovered by blockchain analytics company Chain Argos after they analyzed reserve cold wallets for Binance PeggUSD. Now, after the story got a ton of press thanks to Bloomberg, Binance fully admitted the issue. They said it was a known issue that they had already solved. A spokesperson said, From the data, it is clear that the rebalancing did not always keep pace with the demand for BinancePeg BUSD. Having identified this ourselves last year, we now rebalance more frequently to ensure the

Binance Peg BUSD is transparently fully backed. When the story was blowing up, CZ called it fud, but others like Travis Kling said, please explain to the market how it is fud when a finance spokesperson confirms to Bloomberg that BUSD had more than a $1 billion hole in its collateral value. Still, more or less, people decided to take Binance at their word that it was an issue of the past. However, another one of those issues of the past popped up this week. Earlier this week, Bloomberg reported that Binance mistakenly kept collateral for some of its pegged assets intermingled with customer funds.

Finance has issued 94 so-called Binance Pegg tokens or B tokens, which represent assets like Bitcoin and Ethereum but on the Binance smart chain. These tokens are supposed to be collateralized on a one-to-one basis, and the reserves for almost half of these assets are stored in a cold wallet known as Binance 8. Discovered this week, though, that wallet contains more tokens than required to back each of the B tokens, implying that the collateral is mixed with customer assets. A Binance spokesperson told Bloomberg, quote, collateral assets had previously been moved into this wallet in error and referenced

accordingly on the B token proof of collateral page. Binance is aware of this mistake and is in the process of transferring these assets to dedicated collateral wallets. assets held with the exchange have been and continue to be backed one to one. Emily Nicole from Bloomberg writes, Binance has acknowledged an error that means it currently keeps reserves for almost half of its 94 Binance Pegg tokens worth over $539 million mixed up with customer funds inside a $16.5 billion exchange wallet.

Laurent Kisses, a crypto trading advisor at CEC Capital, explain that while the collateral is pooled together with other funds, there is a risk that clients may not be able to withdraw. He said, in essence, this means that there is no segregation of assets between clients' funds and any collateral used. This could lead to the owners not being able to withdraw due to lack of funds or liquidity by the exchange. This could resonate like what FTX and Alameda did on a daily basis. An audit would generally highlight such shortcomings and ask to remedy it immediately.

If Binance was regulated, this would be an essential part of their internal controls. This is the latest in a string of questions around Binance's internal mechanisms. There was the aforementioned under collateralization of the Stablecoin BUSD in 2021, as well as the report late last year, which was held out as being a proof of reserves, but was not prepared to the same standards as other reports from other exchanges. That report, in fact, led to audit firm Mazzars removing the report from their website and refusing to do any further work for crypto firms. A finance spokesperson said, to be clear,

Binance holds all of its clients' assets and segregated accounts, which are identified separately from any accounts used to hold assets belonging to finance. Binance does not invest or otherwise deploy user assets without consent under the terms of specific products. Now, when this news broke, there was even more chagrin this time around for, I think, obvious reasons. Former SEC lawyer Alex Damsker said, sigh. Binance is mixing customer funds with collateral, and that's just what was found offhand.

Strike of the ban, the SBF salsa is about to start again. Brett Johnson, a security consultant says, Binance admits quote-unquote mistake of storing user assets inside collateral wallet. Translation? That proof of reserves audit was bullshit. Investor Adam Cochran says, so first it was a bug on their BUSD issuance and now an error on 94 different peg tokens. Why would you trust the value of any assets on the Binance chain at this point? Then again, there was another slant that I saw from a few parts of the community, that this sort of behavior is going to be relegated to the past because

of the properties of blockchains themselves. Andrew Thurman, who works at Nansen, says, this is what happens when you combine even incomplete token gestures to transparency like proof of reserves with a growing army of on-chain literate observers. Good stuff. And then there was one of my favorite comments from Jay Vegas who said, feels like there's a niche market for a crypto exchange where the company doesn't misuse customer funds. Look, there is no universe in which I am rooting for Binance to fail. I want all of these things to be the sort of small errors their spokespeople want to make them seem like. But Binance have got to get their shit together when it comes to all of these

processes. The level of scrutiny and the importance of the leading companies in the space doing it right has never been higher. On top of that, the on-chain sleuths clearly need to stay on them to make sure that whatever processes led to these sorts of errors are, in fact, relegated to the past. After FTCS, we simply can't risk hand-wavy, it's all good, don't worry, sort of thinking. Now, it does seem like after these stories, the market is pricing in some additional risk around Binance. Circulating supply of Binance's stablecoin BUSD dropped to 15.4 million on Wednesday, losing a billion dollars over the past week, and 2 billion or 11% over the last month. As a result of this contraction in BUSD, the overall stablecoin market cap has fallen for the

10th straight month in January, and now sits at $137 billion. Over the past month, Tether has gained 1.3% in market cap terms, while Circles USDC has contracted by 1.9%. It should be noted that part of this contraction can be explained by investors deploying their stablecoin holdings into crypto risk assets alongside the recent rally, although the size of the contraction in BUSD could imply some broader concerns with the soundest of the Binance Stablecoin as well. Next, let's turn our attention to FTX. One revelation around that situation this week came by accident. Bankrupt crypto lender BlockFi had $1.2 billion tied up in FTX companies, according to an accidental disclosure of unredacted financial statements. The documents which were uploaded in

error on Tuesday showed that BlockFi had $831.3 million in loans outstanding with Alameda research, together with $415.9 million worth of assets held with FTX. These amounts had been redacted in previous filings after BlockFi entered into bankruptcy protection in late November following the collapse of FTX. In first-day filings back in November, lawyers for BlockFi had previously disclosed around $1 billion in exposure to FDX in Alameda. The recent documents were part of ongoing discussions with creditors and disclosed significantly more details about BlockFi's financials. BlockFi had over 650,000 customers when they entered bankruptcy with almost three quarters holding account balances under 1,000. Between May and November last year, BlockFi made only $14 million

in revenue from trading fees. The company had a little over $300 million in cash alongside wallet assets of $366 million. In total, BlockFi had assets worth $2.7 billion, although almost half were associated with FTX and Alameda, so became impaired following the collapse of FTX. The extent of BlockFi's interdependence with FTCS and Alameda gives additional context to the $400 million line of credit offered by FTX as part of a rescue package in July of last year. According to the latest financials released by BlockFi, the value of FTCS-linked assets have been written off to zero, leaving $1.3 billion in assets with approximately 669 million of those assets described as liquid and available to be distributed to creditors.

Now, on the FTX bankruptcy, a few more direct updates. First, a long list of FTCS creditors, not inclusive of retail customers, was released. And when I say long list, I'm talking about 116 pages. There weren't really any big revelations here. It was more just another testament to how extensive the company's dealings were and how messy the bankruptcy is likely to be. Some of the companies and entities listed were even confused to find themselves on there. Yahoo Finance writes, Swiss markets watchdog Finma and Japan's FSA regulator were also listed in the 116-page document. A FINMA spokesperson said it could not explain why it had appeared on the list of creditors. The watchdog was not a client of FTCS and had not acted on its platforms, the spokesperson said.

Another bit of news on Wednesday the new FTX management objected to a U.S. Department of Justice request for an independent investigation. The company claims that the proposed review would just add cost and delays to its work. work. They said they're already engaged in an extensive investigation. The company also asked for the bankruptcy judge's help in securing some information and documents that it has had trouble accessing, particularly at seams around Sam's family. On Thursday, CoinDesk published a piece called Sam Bankmanfried's mother and brother not cooperating with financial probe, FTX lawyers say. Basically, the management says that outside of Sam's dad, his family just isn't really responding. They said that his mother has, quote, ignored the requests altogether, and that they've also not received any, quote,

meaningful engagement from his brother Gabriel. FTX alleges that Gabe's lobbying organization, guarding against pandemics, purchased a multi-million dollar property a few blocks from the United States capital, which the debtors believe was purchased using misappropriated customer funds. Note the New York Post and other outlets reported that this house was just put on the market in D.C for $3.2 million. The FtX bankruptcy estate is also trying to figure out more information about Sam's Mom's Political Action Committee, Mind the Gap, and around the 16.4 million dollar house that is titled in his parents' names. Join CoinDesk's Consensus 2023, the most important conversation in crypto and Web3,

happening April 26 through 28th in Austin, Texas. Consensus is the industry's only event bringing together all sides of crypto, Web3, and the Metaverse. Immerse yourself in all that blockchain technology has to offer creators, builders, founders, and more. Use code Breakdown to get 15% off your pass. visit consensus.coindesk.com or check the link in the show notes. All right, next up, Celsius. Lawyers for Celsius Network said on Tuesday that the bankruptcy company is planning on reinventing itself as a publicly traded, quote, recovery corporation

in order to exit the bankruptcy process and suggested that this process could be completed within months. The newly announced plan, which notably has not been approved by the U.S. trustee's office or other regulators, would grant tokens to customers with locked assets on the platform above a certain threshold, dubbed asset share tokens or AST. Users could hold their ASTs, which would entitle them to dividend payments over time, or sell them on the open market. The users who did not meet the threshold for token distribution, which lawyers estimated would be between 60 to 70% of customers, would instead receive a one-time distribution in liquid crypto tokens. Lawyers did not indicate where they think that threshold will

be placed. A lawyer for Kirkland and Ellis, who is representing Celsius, said, The distribution would be at a discount. We're not envisioning a full recovery, but it's a meaningful recovery. It would be a one-time distribution in liquid crypto, call it Bitcoin, Ethereum, stablecoins, something that has, you know, readily tradable, readily ascertainable market value to everyone who has claims below a certain threshold. Despite a recent ruling that the crypto deposited by Celsius' earned customers formed part of the bankruptcy estate rather than being owned by the customers, Celsius intends on treating all customers equally under this plan. Celsius said the fact that earn his property of the estate doesn't mean that we can go out and have a party with it. It goes

back to the customers. Kirkland and Ellis told the court that this plan of a recovery corporation was formulated after Celsius failed to receive any attractive bids for its assets. On the On the other hand, because Celsius assets are mostly in the form of crypto tokens, there are concerns that any attempt to sell these tokens to compensate creditors will exceed the liquidity available in crypto markets. Quote, the debtors can't just simply distribute their assets and move on, so to speak. This would require us to sell many illiquid assets at what we believe are fire-sale prices. So given that, the debtors are focused on placing their assets into a new company, which would hold those assets and manage them over time to maximize value as markets improve.

Now, the solution is an echo of the resolution of the 2016 Bitfinex hack, where the offshore were exchanged issued recovery tokens representing the dollar value of the Bitcoin loss by the exchange. BitFinex eventually redeemed all tokens at par, however, at times these recovery tokens were sold for as little as 10 cents on the dollar. While the BitFinx solution has been suggested by commentators as a way out for some of this cycle's crypto bankruptcies, including by SBF as a way to deal with the FTX catastrophe, this is the first time the plan has been seriously put forward in court. Now, editorializing for just a moment, it's hard for me to believe that a court is going to allow

this, even if it does seem like an interesting idea. to some of the creditors. But holding aside any personal feelings, I'm glad that it's going to be tested in court at least. Last up, with the Genesis bankruptcy underway, another segment of the DCG Empire is moving forward with its own legal battle. Grayscale's lawsuit against the SEC has been scheduled for oral arguments on March 7th, which is much earlier than had previously been expected,

with the court choosing to expedite the hearing. Grayscale is suing the SEC over its decision to reject an application to convert the Grayscale Bitcoin Trust into an ETF, which would enable the redemption of shares, closing the GBT discount, which currently sits around 40%. The case is getting significant attention from media and lawmakers. Grayscale's CEO, Michael Sonenschstein, appeared on CNBC's squawk box this week to make the case against the SEC's decision.

He said, quote, crypto is a new and emerging asset class, but it is here to stay. I think it's important to remember the role that regulators like the SEC play when it comes to investors. They're not here to tell investors what to or want not to invest in. They're here to ensure that all the proper disclosures are made so that when investors do go put capital to work, that they're being made aware of all the risks associated with any potential investment they're making. That's really the role of the SEC.

They're a disclosure regulator. They're not a merit-based regulator. Now, the SEC's stated reason, I'll remind you, for refusal of a Bitcoin spot ETF, is the lack of safeguards against market manipulation in Bitcoin spot markets. The problem with that is that they've approved a futures ETF that uses the exact same price indices that these spot ETF proposals would also use. So clearly there's an inconsistency there. Anyways, as with all of these situations, I'm very glad that these things are coming to court sooner rather than later. Hopefully, that will give some more resolution. Anyways, guys, that's the story from here.

I hope you have had a great week and are looking forward to an even better weekend. Until tomorrow, be safe and take care of each other. Peace.