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Ever since the demise of FTX, the crypto industry has been questioning who might be next on the chopping block.
Binance, whose founder Changpeng Zhao arguably hammered the final nail in FTX’s coffin by announcing he was selling the firm’s FTT holdings, is now under the microscope. More specifically, the crypto industry is questioning whether there are any parallels between Binance’s relationship with its BNB token and the FTX-FTT connection.
According to a private financial document reviewed by CoinDesk, Alameda Research (also owned by FTX founder Sam Bankman-Fried) had a balance sheet “full of FTX’s FTT token.” This effectively meant that the hedge fund rested “on a foundation largely made up of a coin that a sister company invented, not an independent asset like a fiat currency or another crypto.” CoinDesk further criticised the relationship between FTX and Alameda as “unusually close.”
Of Alameda’s US$14.6 billion assets, US$3.66 billion is accounted for by “unlocked FTT” and US$2.16 billion is comprised of “FTT collateral”. US$292 million of “locked FTT” are also present among its US$8 billion liabilities.
Ultimately, this structure led to FTX’s collapse. More specifically, the obfuscation and susbsequent revelation of this structure led to the collapse.
Citing the findings made by CoinDesk and lessons learned from the LUNA crash, Zhao announced Binance would be selling its FTX position, which triggered a rapid bank run. He then toyed with the idea of buying FTX out, but eventually pulled out from the deal, conclusively sealing FTX’s fate.
Binance Proof of Reserves reservations
With its biggest competitor FTX now out of the equation, Binance has the opportunity to dominate the space and become the Google of crypto. In an effort to reassure customers and the industry that there is still some legitimacy in the space, crypto companies have been releasing their proof of reserves.
According to a report by the Wall Street Journal (WSJ), Binance’s proof of reserves contain a number of discrepancies.
John Reed Stark, senior lecturing fellow at Duke University School of Law and former chief of the Securities Exchange Commission’s Office of Internet Enforcement criticised the report for failing to address the effectiveness of internal financial controls” and not “express an opinion or assurance conclusion and doesn’t vouch for the numbers”.
“I worked at SEC Enforcement for 18+ yrs. This is how I define red flag,” Stark said.
Furthermore, Binance only showed its amount of bitcoin assets and bitcoin liabilities, not its total assets and liabilities in its five-page report from a partner at the South African affiliate of the global accounting firm Mazers.
WSJ also highlighted that there were differences between the total bitcoin liabilities, with the proof of reserves showing that Binance was 97% collateralized, excluding assets lended to users through loans or margin accounts.
Douglas Carmichael, an accounting professor at Baruch College in New York and former chief auditor of the U.S. Public Company Accounting Oversight Board said that investors should be not be satisfied with Binance’s repeort.
“I can’t imagine it answers all the questions an investor would have about the sufficiency of collateralization,” Mr. Carmichael said. “That’s the main thing it seems to speak to.”
Kraken CEO Jesse Powell also tweeted, “the whole point of this is to understand whether an exchange has more crypto in its custody than it owes to clients.”
The entire report and feedback from said report are hardly winning Binance in reassurance and credibility points but a lack of information doesn’t necessarily equate to bad information. Zhao has also resopnded to the criticism, stating “I said multiple times publicly, the bottleneck was the auditors has a few weeks wait. We move forward in incremental steps.”
BNB be cray
If Binance’s proof of reserves raises some red flags, wait until we tell you about BNB. The first parallel between BNB and FTT is obviously that both coins were created from thin air by the respective exchanges, which is equally as impressive as it is unnerving that BNB is the fourth largest cryptocurrency after BTC, ETH and USDT.
Fortunately, Binance is not propped up by BNB unlike Alameda was with FTT. However, its Secure Asset Fund for Users (SAFU), an emergency insurance fund that was established by Binance in July 2018 to protect users’ funds, has a significant amount of BNB on its accounts.
BNB accounts for 44% of the SAFU fund at US$367 million, 32% is BUSD at US$300 million and 24% is bitcoin at US$270 million. As Twitter user Willy Woo states, “While I commend Binance for having such a fund, there’s no sense putting incidence-correlated BNB in there. How would we feel about FTX having an insurance fund filled with FTT?”
Whist its a pessimistic view on the value of BNB, Woo’s FTX-FTT concern is valid. Can the industry really trust any exchange which uses its own token to fund anything they own?
Cryptocurrency market analyst Dylan LeClair expresses even more concern. “Label me a pessimist, but all I see is a whole lot of hot air… Must be a ‘new paradigm’,” he tweeted about BNB’s success.
Sharing an overlay of BNB/USDT on FTT/USDT, LeClair shows that both BNB and FTT traded in similar patterns. “I’m sure it was retail that sent BNB 10x in two months. Same with FTT, right?” He rhetorically questioned. “It definitely wasn’t the exchange operator with an incentive to drive up the price of their own token to create a feedback loop of attention, hype, and more users… Definitely not.”
CZ himself advises exchanges to steer clear of using their own tokens as collatoral. “Two big lessons: 1: Never use a token you created as collateral,” he tweeted. “2: Don’t borrow if you run a crypto business. Don’t use capital “efficiently”. Have a large reserve. Binance has never used BNB for collateral, and we have never taken on debt.”
LeClair still remains skeptical. “This entire space is just an attempt at modern alchemy,” he tweeted. “Create tokens out of thin air & use capital + marketing in an illiquid market to create a narrative. Binance got 40% of BNB in ICO, which was worth ~$50b at the top. CZ my man, I really hope you’re telling the truth.”
As Cryptosaurus writes, BNB is an “air-based token” which has a recipe of “create a token, use capital and marketing in an illiquid market, and dress it all up with a witty narrative.”
Furthermore, if LeClair is to be believed, BNB could be over-leveraged. “Think of some alts that outperformed this bull run? SOL (Alameda leverage and fraud), AVAX (3AC), LUNA (perpetual motion machine), etc. It wasn’t a new paradigm. It was just leverage & people believing the story. BNB is different I presume?” He questions.
LeClair explained that whilst Binacne itself does not leverage against BNB, its users themselves do, with Binance “subsidizing the finanance cost.”
He goes on to show that BNB borrows have been suspended on Binance and that “BNB is currently the only asset on Binance (that isn’t being delisted imminently) that users can post as collateral but cannot borrow in cross margined accounts.”
“What’s the probability that Binance pumped $BNB in 2021 with a couple hundred million in funds, creating 10s of billions of “value” for themselves (owns 40% from ICO), and they are now stuck defending $BNB?” He adds.
BNB not bad
Whilst DeClair’s concerns are certainly valid, there are some stark difference to Binance’s coin and FTX’s. For starters, about 80% of BNB’s supply has already been released into the markets, whilst only 38% of FTT’s was circulating in the market. Alameda and FTX controlled the majority of the remaining supply.
BNB’s low FDV (fully diluted market cap) means it trades closer to the market price and makes it harder to inflate its price.
Furthermore, according to Chain Debrief, FTT was “printed out of thin air for SBF and Alameda to borrow against, and to bolster its balance sheets,” whereas “BNB is simply being used to reap rewards on the Binance exchange and participate in the BSC ecosystem.”
FUD surrounding Binance seems to be intensifying since the collapse of FTX. As reported by CoinDesk on 13 December, net outflows from Binance reached US$902 million in the prior 24 hours, surpassing that of its rivals. The figure is almost nine times higher than Bitfinex, which had the second highest net outflow during the period.
Blockchain data suggests that Jump Trading and Wintermute are among the biggest withdrawers from Binance. Jump Trading, the largest withdrawer, pulled out US$146 million over the past seven days including US$102 million in BUSD. Wintermiute took out US$8.5 million of wBTC.
On 12 December, Reuters reported that splits between U.S. Department of Justice prosecutors are delaying the outcome of a criminal investigation against Binance. The report claimed that the DOJ discussed possible plea deals with Binance’s lawyers too.
However, Binance has since refuted the claims, stating, “Reuters has it wrong again. Now they’re attacking our incredible law enforcement team. A team that we’re incredibly proud of – they’ve made crypto more secure for all of us.”
In a tweet, Binance shared the their response to Reuters, stating “Binance responded to over 47,000 law enforcement requests with an average response time of three days, which is faster than any traditional financial institution — some of which can take months, by which point the money has gone.”
“As has been reported widely, regulators are doing a sweeping review of every crypto company against many of the same issues. This nascent industry has grown quickly and Binance has shown its commitment to security and compliance through large investments in our team as well as the tools and technology we use to detect and deter illicit activity,” a Binance spokesperson said.
To be or BNB?
Since the collapse of FTX, the crypto industry quite rightly has been on edge. Among the many lessons FTX taught us is that no exchange or crypto firm is too big to fail. Understandably, the crypto space is second-guessing FTX’s main competitor and sole survivor Binance.
Many of the concerns are certainly worth consideration, and Binance needs to do better to reassure the industry with further transparency. Not all FUD is warranted, but Binance needs to make an extra special effort to reassure customers and restore credibility to the industry, as an industry leader itself.
BNB is by no means perfect, and its success thus far can be perceived as a red flag, especially during the current climate. That said, the Binance-BNB relationship isn’t as intimate as the FTX-FTT-Alameda incestual romance. Nonetheless, a bet on BNB is still a bet on Binance, which is far from risk-free.