How stable is Binance, really?

The crypto market jitters about Binance this week were likely overblown—but there are still reasons to be concerned about the health of the world's biggest crypto exchange.

Portrait of Binance CEO Changpeng Zhao.

How stable is Binance? Raphael Lafargue—ABACAPRESS.COM/Reuters

Just last month, Changpeng Zhao looked like the undisputed king of crypto. The upstart exchange FTX had spectacularly imploded in early November, and Zhao, the CEO of the exchange giant Binance, had carried out the kill shot by dumping FTX’s native crypto token and triggering a liquidity crisis that sank FTX and its founder and CEO, Sam Bankman-Fried. For a few days, it even looked like Binance would acquire FTX.

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Just last month, Changpeng Zhao looked like the undisputed king of crypto. The upstart exchange FTX had spectacularly imploded in early November, and Zhao, the CEO of the exchange giant Binance, had carried out the kill shot by dumping FTX’s native crypto token and triggering a liquidity crisis that sank FTX and its founder and CEO, Sam Bankman-Fried. For a few days, it even looked like Binance would acquire FTX.

In the weeks since, FTX’s disordered collapse has risked pushing an already-stressed crypto industry over the brink. Prosecutors and regulators have alleged that FTX was not just a company in distress, but a massive fraud, and Bankman-Fried was arrested Monday in the Bahamas. The FTX debacle has also triggered widespread mistrust among crypto survivors, who are watching for what dominoes might fall next—and whether one of them might be Binance.

Binance is the world’s largest crypto exchange by volume. But it has been plagued by trouble with regulators and is facing potential criminal charges related to money laundering and sanctions violations. Misgivings about the company accelerated this week after customers pulled billions worth of assets from its platform and Binance temporarily halted withdrawals of a key asset. Other crypto companies held crisis meetings to plan how they’ll respond if Binance’s situation worsened.

So, how much trouble is Binance in? It’s not as bad as FTX, insiders say, but it’s still not good.

Senior executives at several other well-known crypto firms, including Binance’s biggest rivals, told Fortune they do not believe Binance is on the cusp of insolvency—a conclusion bolstered by blockchain data that shows the company holds ample stores of Bitcoin and liquid assets. While some casual observers have drawn parallels between Binance and FTX, those within the industry aren’t going there.

Zhao acknowledged this week that the company and crypto more broadly are enduring a tough stretch. In a memo to staff, he wrote that the industry is undergoing an “historic moment” and that the next few months would be “bumpy,” but assured them that Binance “will survive any crypto winter.”

Nonetheless, the company and its CEO are under scrutiny like never before—and the next few months will determine whether Binance has a long-term future.

Binance’s very bad week

While this week’s news cycle has been consumed by Bankman-Fried, and crypto-related testimony in Washington, D.C., a fresh drama about Binance played out quietly in the background. It began when the analytics firm Nansen published data to show customers cashed out around $3.6 billion worth of assets over seven days from Binance, including almost $2 billion in a single day.

The spur for the withdrawals was likely a report published Monday that claimed factions in the Justice Department are pushing aggressively to file criminal charges related to sanctions violations and money laundering against Binance and its CEO. The full extent of the outflows may have been higher than reported, since the Nansen data includes withdrawals of Ethereum and stablecoins but not Bitcoin. An executive at a Binance rival, who requested anonymity because he was not authorized to speak publicly, told Fortune that his company’s internal estimates suggest that total outflows may have been as high as $6 billion to $8 billion, including cash-outs of Bitcoin and other currencies like Tron.

The alarm over Binance increased amid reports that the company was failing to process withdrawals of USDC, one of the more widely used stablecoins pegged to the U.S. dollar. This is part of what made it feel urgent to map out the worst-case scenarios involving Binance, the executive at the rival company said.

That worst-case scenario might sound familiar: It speculates that Binance could be using a token called BNB, which is native to Binance’s own blockchain, as collateral for loans. Binance denies this practice, but if it were true, it could leave the company vulnerable the same way FTX’s FTT token did. The value of BNB could crater if the market were to grow uneasy about Binance’s health, which would leave Binance unable to pay back loans, leading it to sell its holdings of the wildcat stablecoin Tether. That in turn could lead to Tether—whose reserve structure has always been murky—failing to maintain its $1 peg, which would set off a wide conflagration across the crypto markets.

A spokesperson for Binance told Fortune that the exchange has never used BNB as collateral. But speculation about such a disastrous scenario is making some in the industry uneasy about Binance’s large holdings of assets like BNB and Tether, which offer little transparency. Another executive, who likewise insisted on anonymity, said their own firm convened a special meeting in the wake of this week’s Binance headlines to explore how it would react if the giant exchange collapses over the holidays.

Binance itself has responded forcefully to all of this dire prognosticating (which might be more reassuring had we not all seen similar behavior from other troubled crypto leaders).

Late on Tuesday, amid widespread murmurings about the situation at Binance, CEO Zhao took to Twitter to downplay the recent outflows, noting that the company has experienced bigger ones in the past and suggesting such events amount to healthy “stress tests.”

By the end of the week, outflows from the platform had begun tapering and fears about its financial health quieted down some.

Just a ‘stress test’?

Other crypto industry figures agreed with Zhao’s assertion that concern about the outflows were overblown. These included the venture capitalist Nic Carter, who rejected claims of a “bank run” at Binance as hyperbolic, and noted that total assets on its platforms dipped 15% at most and that much of the money had already flowed back.

As for Binance temporarily halting withdrawals of USDC, the company says that occurred for technical reasons rather than due to any existential threat to Binance’s financial health. The backstory is complicated but it involves a recent decision by Binance to convert its holdings of USDC—which is controlled by rivals Circle and Coinbase—to its own stablecoin, known as BUSD. Binance likely made this decision to favor its own coin, as other exchanges have recently done, because stablecoins have become an increasingly important source of revenue for their issuers as interest rates climb. (Issuers typically invest the dollars backing the stablecoins into T-bills and pocket the interest.)

Binance does, however, let customers convert any USDCs that were forcibly converted to BUSD back to USDC for the purpose of withdrawals. The upshot is that, when nervous investors sought to redeem their USDC from Binance this week, the company did not have enough on hand to immediately honor the withdrawals. This meant Binance had to wait for its American banking partner—a New York company called Paxos that tokenizes assets and issues white-labeled stablecoins for Binance and others—to obtain more USDC on its behalf. In an interview with Fortune, Paxos confirmed this, saying many of the withdrawal requests occurred outside of banking hours, which slowed its ability to deliver USDC to Binance.

Even so, a significant number of Binance’s customers appeared to have dropped Binance’s stablecoin in favor of the one issued by Circle and Coinbase. “We saw record-making history yesterday with more than $2.5B USDC issuance in a 24-hour period,” Circle’s CEO, Jeremy Allaire, told Fortune.

While Binance appears to have survived the events of the last week relatively unscathed, its biggest battles lie ahead.

Binance’s fight for legitimacy

Binance burst on the scene during the crypto boom of 2017, and soared to popularity by offering a cornucopia of digital assets and innovations, including its own blockchain. It soon became the biggest crypto exchange in the world by trading volume, thanks in part to Zhao’s ruthless growth-at-all-cost strategies that included hopscotching the world in search of favorable regulatory environments and—in its early days—lax application of know-your-customer laws.

But even as Binance became the dominant player in the crypto world, Zhao has maintained the status of an outsider. This may be because he is not part of the clique of entrepreneurs who brought Bitcoin into the mainstream during crypto’s early years, and who still wield outsize influence at conferences and on social media. Or it may be because the crypto establishment is uneasy with Binance’s initial cowboy approach to regulation—even though nearly every popular crypto company also played it fast-and-loose in their early days. Whatever the reason, Binance has few friends in Washington, D.C., which has become the de facto center of global crypto regulation—a situation that could spell trouble for the company as U.S. lawmakers move to impose new laws on the controversial industry.

In recent months, Binance has sought to portray concerns about the company as a xenophobic response to Zhao’s Chinese heritage. In a September blog post, Zhao—whose parents moved the family to Vancouver when he was 12—suggested that competitors were trying to undermine him by playing up his ethnicity. “I am Canadian citizen,” he wrote. “Period.” He has echoed those sentiments on Twitter in recent weeks.

But despite Binance’s disavowal of ties to China, rumors persist. One credible report, for instance, suggests the company maintained an office in Shanghai that was shut down in late 2019, though Binance has denied its existence. The company has shifted headquarters between various jurisdictions known for light regulation, including Malta, and does not provide clear information about where its headquarters is located today. A spokesperson said Binance has “regional hubs” in Dubai and Paris.

And then there is the matter of Binance’s finances. Zhao has repeatedly asserted on Twitter that every asset a customer places on Binance’s platform is backed 1:1 by assets held by Binance. Earlier this week, the company published an audit, an apparent attempt to reassure customers that their funds were safe. But it did little to quiet fears. The audit was prepared by the South African branch of global firm Mazars, rather than by one of the Big Four accounting firms, and critics noted that the document was woefully incomplete. One accounting professor went so far as to call it “worthless.”

In response to an inquiry from Fortune about the audit report, a well-known crypto founder—whose company competes with Binance—likewise blasted the report as insufficient. “It really comes off as if they’re covering up something. … [They’re] trying to show collateral value rather than 1:1 assets vs liabilities. The collateral trick is exactly the game FTX was playing, borrowing good money from users with bad money for collateral. It’s very suspicious,” wrote the founder, who asked not to be identified.

In response to an inquiry about why Binance did not use a Big Four firm, a spokesperson said the company asked the firms to do conduct a so-called proof-of-reserve audit but that “they are currently unwilling to conduct a PoR for a private crypto company.” They added that Binance in the meantime intends to use technological solutions known as Merkle Trees and zk-SNARKs to provide evidence to customers that their funds are safe.

As for BNB, the Binance-created token was released in 2020 and is today the fifth-most-valuable cryptocurrency, with a market cap of around $43 billion. In response to an inquiry from Fortune, a Binance spokesperson strongly argued that BNB is not analogous to FTT—the illiquid token that FTX’s disgraced founder Sam Bankman-Fried created and then used to as collateral.

“Binance has never used BNB for collateral, and we have never taken on debt as an organization. BNB is a blockchain token, which means it is the official currency of BNB Chain, the largest chain by active users on the globe—even larger than ethereum,” the spokesperson wrote. “This is the utility that BNB provides to millions of users across the globe each day and why it is highly liquid and has organic demand. Furthermore, BNB is a finite asset that is algorithmically burned periodically and is managed by a voting protocol within the BNB Chain community. FTT on the other hand, was an ‘exchange token’ which provided little to no utility to the marketplace and was entirely illiquid.”

Binance has sought to portray BNB and its associated blockchain as largely decentralized, and akin to Bitcoin or Ethereum. These claims have been greeted with skepticism, however, within the broader crypto community, particularly after a revealing incident: The Binance chain got hacked for $570 million in early October. In response to the hack, Binance quickly “paused” the chain’s activities—a feat that could not be easily undertaken on a decentralized blockchain. The incident provoked mocking responses like the one below about who actually controlled the chain:

‘No choice but to go legal’

For now, the opinions of the crypto world are likely to have less of a say in shaping Binance’s future than the opinions of another influential body: the U.S. government.

While Binance has been under scrutiny for years by various governments—as have numerous other crypto firms—the company today appears to be facing an unprecedented level of legal peril. Recent Reuters reports, based in part on leaks from the U.S. Justice Department, have highlighted a series of actions by Binance that have put the company and Zhao in the crosshairs of federal prosecutors.

Those actions include Binance permitting actors in heavily-sanctioned Iran to conduct millions of dollars of transactions on its platform, and a 2018 plan—first reported by Forbes—to use a U.S. subsidiary as a Potemkin Village to distract regulators while the company continued to allow American customers onto its unregulated international exchange. (Binance says it never put the plan into place, and suggests that it’s unfair to impugn the company for an aborted plan hatched over four years ago).

In its most recent report published on Monday, Reuters cites Justice Department sources who say prosecutors within the agency aim to file criminal charges against Binance and Zhao in the near future—though the agency is reportedly divided over whether to do so. Reuters also cites discussions between the Justice Department and Binance lawyers about a potential plea deal.

All of this coincides with a strong push by Binance over the last 18 months to repair its earlier outlaw reputation. This push has included hiring figures who occupied senior positions at enforcement agencies such as Interpol and the IRS, and setting up a U.S. entity run by experienced American executives.

Finding a way to walk the straight and narrow has become necessary, one individual who has reported closely on Binance told Fortune, because the company’s offshore operations and large volumes of cash floating across its platform have become too big for regulators to ignore. “They got so big they had no choice but to go legal,” said the individual.

Whether Binance succeeds in this gambit is another matter. For all of this to work out, the company must not only avoid the full wrath of the Justice Department, but also reassure investors and the rest of the crypto industry that it will be transparent about the true nature of everything on its books—including its hoards of BNB, Tether, and other coins. To date it remains unclear what, exactly, is on Binance’s balance sheet.

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