Binance Lawyer: Don’t Tick Me! I am at the bottom of this human pyramid!

Here’s a tip from a small business owner: If you’re a financial firm and you’re going to disclose your liabilities and assets to ease the concerns of your clients, who have lately become concerned that said liabilities outweigh said assets, you should ensure that the supervisory authority does so not actually shows that your liabilities exceed your assets. I know this seems like basic belt-and-harness stuff, but it’s the kind of mistake we see in business all the time.

Here’s an example: if you’re a cryptocurrency exchange, you should not, for example, reveals that two-fifths of your cryptocurrency reserves are coins that you minted yourself, and that your reserves of legitimate crypto (oxymoronic as that clause is) are themselves over-pledged. You should not take out $2 billion in assets to prove you have the reserves you say you do when, like, 25 cents will do. Nor should you expect an increasingly skeptical public to be reassured when the accounting firm you contracted to check under the hood qualifies the report by saying they won’t even “express an opinion or an underwriting conclusion” on the numbers. This is the troubled position Binance, the largest cryptocurrency exchange in the world by an order of magnitude, is currently in. With a skeptical public shifting its attention from the smoldering wreckage of one crypto firm to one of the last major players not yet on fire, the timing could have been better.

The collapse of Bahamas-based cryptocurrency exchange FTXs was so spectacular, so filled with colorful details and funny gags, and so massive in its entirety that it’s easy to overlook the array of machinery from Binance that really got things going. FTX founder and godawful League of Legends Player Sam Bankman-Fried stunned the crypto world when he announced on the morning of November 8 that he would be selling FTX to Binance, which had spurred FTX’s collapse by liquidating the reserve of FTX’s internal token, FTT. This move led to a quasi-bank run that FTX was nowhere near prepared to cover, because it had badly overstretched its reserves by funneling people’s money over to Alameda Research, its money-losing affiliate hedge fund. Binance planned to take over FTX but chose to let it die a natural death after seeing how broken it really was.

If that kind of corporate warfare had played out between firms that provide what a normal person would identify as goods and services, one can rightly conclude that the firm still standing at the end of the day would be in a better position to have driven its biggest competitor to destroy. But that logic breaks down here, because the resource that FTX, Binance, and all the other bankrupt or soon-to-be-bankrupt crypto exchanges are competing for is not, say, wood that can be processed into lumber, but a steady supply of suckers who want to cash in on a zero-sum casino game. This is something of a renewable resource, it turns out, but it is not an inexhaustible resource.

When the dust settled after Bankman-Fried finally stopped ignoring his lawyers’ advice and incriminating himself to anyone willing to DM him on Twitter (though he sadly ignored me), Binance may have found itself in a position to eat up some of FTX’s market share of those looking to make money on a zero sum casino game. There was one crucial problem though, which was that the prospect of making money or even not losing all your money due to terrible scams suddenly looked far more dubious to normal people after FTX died. If the theoretical scaffolding of crypto seemed shakier after the collapse of FTX, which had bought enough publicity and good press to become something like a recognizable normal brand, why would even the least discerning sucker trust a similar concern? If a company big enough to have its name on MLB referee uniforms and an NBA arena engaged in fraud as something like its entire business model, the weight of any given company would naturally seem less important.

Those are the existential questions Binance sought to clarify with the disclosure, which the accounting firm that performed the analysis went to great lengths to clarify was not an audit. In fact, the scope of the reserves analyzed by Mazar’s, a South African accounting firm, was limited to Binance’s bitcoin holdings, which amounts to 13 percent of its portfolio. A Wharton accounting professor told Coin Desk that the report “is more worthless than even the Tether or USDC report.” Fittingly, the don’t-call-it-an-audit raised far more questions than it answered. First, neither Binance CEO Changpeng Zhao (known as CZ) nor anyone else will actually say where Binance is headquartered.

That’s a pretty serious deal! The company was founded in China, although it left the country when the Chinese government banned cryptocurrency. No one will say where it is based (it could be Malta) or what is at the center of the nested series of holding companies and shell companies designed to shield Binance from regulators. Binance has a US presence, although they also do a ton of business in France, the Middle East and Africa (especially Nigeria). Their explicit strategy, as revealed in a leaked 2018 plan dubbed the “Tai Chi document”, is to set up as many different companies and subsidiaries, including Potemkin affiliates designed to be brought down to throw off regulators, in a attempts to become essentially unregulated. Reuters reported in September that the Justice Department was investigating Binance for some money laundering — using Binance appears to be one of the main ways to avoid international sanctions — and on Monday they reported that federal prosecutors are considering whether to file criminal charges against CZ and Binance, if lawyers have reportedly already begun discussing plea agreements.

The most notable line in the Reuters investigation is a rebuttal from Binance’s legal team to the federal government.

Binance’s defense attorneys at U.S. law firm Gibson Dunn have held meetings in recent months with Justice Department officials, the four people said. Among Binance’s arguments: A criminal prosecution would wreak havoc on a crypto market already in a prolonged downturn.

Reuters

Again, because cryptocurrency is more akin to a financial system of belief than it is to a security attached to anything that exists in the real world, the specter of regulation can be as bad as the regulation itself. There are signs that people are starting to pull their money out of Binance, which is the kind of development that tends to portend much more serious wobbles. Nothing that Binance has released to the public about its holdings should make anyone confident in their ability to meet demand should a serious bank run occur. And as the FTX debacle showed everyone, nothing in crypto is too big to fail.