Will Binance, which has a profit of $1 billion, attract US government regulation? The problem comes from derivatives and security tokens

Abstract: Binance is undoubtedly the world's largest cryptocurrency exchange, but it will face severe challenges from the US government in terms of derivatives and security tokens. Unlike BitMEX, Binance has always wanted to be a "good kid" in the United States and has invested heavily in embracing regulation.

On December 4, Binance founder Zhao Changpeng was selected as one of the world's top 50 people by Bloomberg. In an interview with Bloomberg, he said that Binance's profit in 2020 was between 800 million and 1 billion US dollars, and its profit in 2019 was 570 million US dollars, which may be the most profitable company in the global cryptocurrency industry. Recently, two Chinese competitors, Huobi and OKEx, have been troubled by investigations since October, and data shows that Binance's business has benefited from this.

The founder of Binance left China after September 4, which became its competitive advantage. But Binance's competitors also emphasized that the US government's crackdown on leading cryptocurrency companies will be a hidden worry for Binance. The US government's strong regulation of BitMEX and TELEGRAM, the former targets derivatives, and the latter targets security tokens, and Binance Global Station and BNB are also more or less involved, so does Binance have any risks from across the Pacific?

On October 29, Forbes reported that Binance intends to evade US cryptocurrency regulation through a carefully designed corporate structure. The article disclosed a 2018 business plan, Tai Chi, whose primary goal is to reduce the pressure from US regulation and anti-money laundering regulations, and ultimately use Tai Chi as a shield to deal with US regulatory measures to help Binance carry out high-leverage cryptocurrency derivatives trading services in the United States.

The article believes that Jared Gross, Binance's transaction and merger manager and legal advisor, and former employee Harry Zhou participated in the formulation of the "Tai Chi" plan, and even hinted that the FBI was involved in the investigation. The founder of Binance responded on Twitter that the "Tai Chi" plan was not written by Binance's current or former employees, and emphasized that Binance always operates in accordance with the law, and then announced a lawsuit against the Forbes reporter.

The incident has not completely stopped. Binance seems to have been warned and began to conduct a large-scale investigation of US users on Binance Global Station, requiring them to withdraw funds within 14 days and transfer them to Binance US Trading, which holds a compliant license. However, Binance said that it announced in 2019 that it would not provide services to US users, and regular investigations were normal, not targeting any incidents.

Derivatives trading mentioned in Tai Chi is a business that the US regulators are currently paying more attention to. BitMEX, the world's largest professional derivatives exchange, has just been severely cracked down. High-leverage cryptocurrency derivatives trading services need to be registered with the US Commodity Futures Trading Commission (CFTC) and obtain relevant licenses. Since September 2015, the CFTC has regarded cryptocurrencies as commodities under the US Commodity Exchange Act and included them in the scope of supervision, including cryptocurrency derivatives contracts.

According to the CFTC official website, based on the registration licenses obtained by the Chicago Mercantile Exchange and LedgerX Cryptocurrency Options Exchange, which already have Bitcoin derivatives listed, the cryptocurrency derivatives trading licenses issued by the CFTC are mainly the following: Swap Execution Facilities, Derivative Clearing Organization, and Designated Contract Market. It took a total of 5-6 years from LedgerX submitting its application to the official approval of each license, which shows how complicated and strict the application process is.

What are the consequences of circumventing CFTC regulation? In October this year, the CFTC sued BitMEX for providing trading platform services without registration, providing illegal options services, failing to register as a designated contract market, and violating relevant anti-money laundering regulations. BitMEX executives were subsequently arrested, and the turmoil is still ongoing. This also indirectly aggravated the Forbes article's accusation that Binance evaded regulation.

It can be seen that Binance’s US subsidiary cannot legally share in the field of cryptocurrency derivatives for the time being. But on the other hand, Binance’s global derivatives services have been booming after being pessimistic. Multiple data show that Binance’s derivatives trading volume has ranked first in the world, with a 24-hour trading volume of more than 10 billion US dollars. With such a large trading volume, it is inevitable that non-compliant users will slip through the net.

Unlike BitMex, which has always avoided regulation, Binance has always embraced regulation, including obtaining a New York State license for the BUSD stablecoin and assisting the U.S. Department of Justice in arresting Russian hackers. Binance US holds money transmission licenses in multiple states in the United States (companies providing payment services in the United States are required to obtain money transmission licenses in each state, but the licenses are not issued for the cryptocurrency industry). However, the New York State BitLicense (a cryptocurrency trading license held by Grayscale affiliate Genesis) and the registration license issued by the CFTC are not listed on the Binance US site.

The US government's crackdown on BitMEX has traced back a large number of past violations, including providing services to hackers and Iranian customers, providing services to users without KYC, and having a bad attitude towards US regulation. In comparison, Binance is more like a "good kid" of regulation, but as an emerging industry with a huge size, Binance will also face risks if the US government attacks the industry's leading companies.

In fact, the leading US exchange Coinbase is caught in a war with the US government. A few weeks ago, Coinbase, together with several cryptocurrency companies and investors, wrote to the Treasury Department to protest the upcoming regulations. The proposed regulations may require financial institutions like Coinbase to verify the recipient or owner and collect relevant identity information before the owner of a non-custodial wallet receives the assets.

In addition to derivatives, another business of Binance that may be regulated by the US government is its platform currency BNB. In April 2020, the US District Court for the Southern District of New York received a series of class action lawsuits, alleging that Binance did not register its token (BNB) as a security, and that Binance did not register with the US Securities and Exchange Commission as an exchange and brokerage trading service provider, and that investors did not receive sufficient information as required by federal and state securities laws to understand that their investments were subject to significant inherent risks.

Although the above Forbes's suggestion that the FBI is investigating is likely to be groundless, many people have not paid attention to the fact that in July this year, the U.S. Securities and Exchange Commission (SEC) announced that it would authorize blockchain analysis company CipherTrace to track Binance Chain transactions and BNB. The initial term of the authorization is one year, and it can be extended for up to 4 years. Binance responded that the authorization is aimed at reducing illegal activities such as hacking and fraud. Why the SEC launched this investigation and the current progress of the investigation have not been disclosed.

Refer to the US government's judgment on TELEGRAM tokens and the Howey test standard, including that investors need to invest funds or other resources; investors' funds, services or items are centralized and invested in common projects under the control of investment sponsors; investors expect investment projects to bring profitable returns, and investors also need to bear the risk of capital loss; investors' returns are only earned by investment sponsors or third parties unrelated to investors; generally speaking, investors do not participate in the actual operation of the project, and the success of the project has nothing to do with investors. The most critical thing is that investors expect investment projects to bring profitable returns. BNB is likely to fail the Howey test and be defined as a security. "Legal Regulatory Path for Non-Sovereign Digital Currency in the United States"

Binance is also very sensitive to this. Its response strategy is to downplay BNB's investment attributes and strengthen its functional attributes. At the end of 2019, Binance published a blog post about the exploration of multiple applications of BNB, saying that the total number of these applications has exceeded 120, in order to prove that BNB is not a security token. In addition, it is worth noting that Binance has invested heavily in charity, which is suspected to be related to responding to US regulation.

in conclusion:

First, Binance's business is expanding very quickly. Since U.S. regulators have a tradition of cracking down on industry financial giants and the rules of the cryptocurrency industry itself are vague, there are considerable risks from this perspective.

Second, Binance is very sensitive to U.S. regulation, responds quickly, invests heavily, and takes many measures to embrace regulation.

Third, unlike China, US regulation is more “on track”, with less uncertainty and room for negotiation. Unless the US adopts a completely confrontational attitude, there will be no tragedy like TELEGRAM or BitMEX. Binance may also face the problems of OKEx and Huobi, but the leaders are overseas, so the most they can do is affect the Chinese business.

Fourth, for ordinary investors, there is no need to worry about the regulatory risks from the United States for the time being, but for Binance, the regulation from the United States will still be a matter of extreme importance to both internal and external parties. (Special author: Cici Cici Editor: Wu said blockchain)