Q1 2023 wrap-up and legal troubles in cryptoland

by Vested Team
April 3, 2023
9 min read
Q1 2023 wrap-up and legal troubles in cryptoland


As we close Q1 2023, we want to:

  • Reflect on the state of the market at the end of the quarter 
  • Discuss the legal troubles enveloping all major actors in cryptoland, specifically: (i) Operation Choke Point 2.0 and (ii) Details from CFTC’s lawsuit against Binance

Bear market? What bear market?

At the end of Q1 2023, risky assets rallied. As of this writing, Bitcoin is up 72%, while the S&P 500 and Nasdaq-100 were up more than 7% and 16%, respectively. This is despite the relentless bad news about persistent inflation, volatility in the banking sector, and troubles in the crypto sector. 

Figure 1: Performance of major US indices (Q1 2023). Chart is from AlphaScreener

What’s driving the rally?

The rally in equity does not seem to be driven by institutional investors, as they withdrew $5.2 billion from global equity funds – funneling most of their investments to money market funds. Bloomberg also reported that many firms are reducing their equity exposure in March 2023. Currently sentiment among institutional investors is quite bearish (Figure 2). 

Figure 2: Sentiment level of institutional investors over the years. Source 

So what’s driving the rally? If you look at the breakdown of the S&P 500 by its constituents, you can easily see that the rally is driven by the mega cap tech stocks. In Q1 2023, Apple, Microsoft, and Amazon notched more than 20% return, while Nvidia, Tesla, and Salesforce rallied by more than 90%, 68%, and 50% respectively. 

Figure 3: Q1 2023 heat map of S&P 500. Chart is made with AlphaScreener

Legal trouble enveloping crypto

The Bitcoin rally is interesting because it is a bit unexpected. For those who have not been following the news, there is an unconfirmed rumor that the US government is conducting Operation Choke Point 2.0 against the crypto industry. 

PS: Operation Choke Point was an initiative by the US, beginning in 2013, to systematically reduce cash and credit access to specific industries by pressuring certain banks that work with said industries. The operation investigated banks in the US that do business with firearm dealers, payday lenders, and other companies deemed high risk for fraud and money laundering. It ended in 2017, after which the FDIC promised to stop issuing “informal” and “unwritten suggestions” to banks. Critics of the operation argue that while the initiative’s intent might be well-meaning, it bypasses due process. 

Here’s a high-level timeline of what recent events that may indicate Choke Point 2.0 is happening:

  • On January 28th, 2021, seven days after the Biden administration took office, a rule designed to ensure that large national banks cannot deny access to financial services based on a “subjective” basis was killed 
  • On April 7th, 2022, FDIC issued a letter requesting institutions to report their current and planned crypto-related activities to the FDIC and to state regulators. The letter also warned that crypto activities might pose compliance risks
  • On January 3rd, 2023, more agencies issued warnings about crypto. This time, in addition to the FDIC, the Federal Reserve Board and the Comptroller of the Currency joined in. That same month, the Fed issued a new rule that further discouraged banks from holding crypto assets
  • As a result, banks were pressured to terminate banking relationships with the crypto industry. Recently, Circle announced that it has stopped processing ACH and wire payments
  • On February 12th, 2023, the SEC issued a Wells notice to Paxos Trust, announcing that it plans to sue the company for violating investor protection laws for issuing stablecoins (Paxos is the issuer of Binance branded stablecoin, BUSD) deemed to be securities. Soon after, on March 22nd, 2023, Coinbase received a Wells notice from the SEC as well
  • In recent weeks, two US banks with significant roles in processing USD deposits to crypto platforms were closed. Silvergate is in liquidation after facing a liquidity crisis due to deposit outflow. Two weeks ago, Signature Bank was also closed by regulators despite not being insolvent. Rumors abound that the closure of Signature was to send a message to other banks not to be involved in the crypto sector, something that regulators have vehemently denied   

Whether there’s indeed an ongoing effort to shadow-ban crypto in the US by making it impossible to do crypto-fiat conversion, legal actions will continue, making it increasingly difficult to conduct fiat/crypto conversions.

You can’t buy an AK-47 for $600

In addition to the pressure banks in the US face, legal actions against offshore crypto exchanges are just beginning. On March 27th, Commodities Futures Trading Commission (CFTC), which regulates derivative markets, filed a civil lawsuit against Binance, its CEO, Chanpeng Zhao (CZ), and its former CCO, Samuel Lim (who was the CCO from 2018 – 2022), and a few other entities for failing to register as a “futures commission merchant” while offering unregistered crypto derivatives options to US customers.

The lawsuit (read it here) alleges that Binance, since its launch in 2017, has sought out US customers and has actively skirted US regulations and sanction enforcements. The whole document is well worth a read. Here are some highlights.

Binance maintains multiple offices worldwide without clear headquarters to obfuscate itself from regulatory oversight. From a 2019 internal document, CZ stated that this is a deliberate strategy to “keep countries clean [of violations of law]” by “not landing .com anywhere. This is the main reason .com does not land anywhere.”

Despite touting that it bans US customers, Binance actively seeks and services US customers. These efforts go as far as:

  • Teaching users how to use VPNs to obfuscate their location and circumvent IP blocking 
  • Hiring affiliate marketers (called Binance Angels) in the US to answer questions from customers and test new features
  • Assisting VIP clients to move their accounts to offshore accounts so that on paper, they do not look like US customers
  • Updating its internal database so that US users locations are replaced with “UNKWN”, obfuscating users’ whereabouts

Binance likely trades against its users. The lawsuit stated that CZ are indirect owners of two prop trading firms and that about 300 Binance accounts conduct proprietary trading on the platform without anti-fraud or anti-manipulation surveillance.

Binance has policies that offer its VIP clients a heads up if said clients are being investigated by regulators. Here’s a snippet from Binance’s policy, written by its Samuel Lim, the former CCO (emphasis ours):

“[A]t point of [account] freeze [based on a request from a law enforcement agency]  and immediately after the unfreeze [which would occur 24 hours after the account freeze]. VIP team is to contact the user through all available means (text, phone) to inform him/her that his account has been frozen or unfrozen. Do not directly tell the user to run, just tell them their account has been unfrozen and it was investigated by XXX. If the user is a big trader, or a smart one, he/she will get the hint.”

Binance has a gamified trading scheme called the “Battle function”, which allows users to compete head-to-head with one another in “a one-minute battle period,” to see who makes the most money trading derivative contracts for crypto (which basically is just a bet on some future price, without ownership of the underlying asset). This function is a crypto version of Pokemon battle but where people can lose a lot of money (Binance allows up to 125x leverage). This setup makes Robinhood’s confetti animation (shown after a successful trade), something that the company faced scrutiny over due to gamifying trades, appear so quaint in comparison. 

Another way Binance skirted the US ban is by not doing KYC at all. It created a “tier 1” customer level that does not require any KYC or identity verification. These accounts only require email IDs. Tier 1 customers can deposit and trade, but are only limited to 2 BTC withdrawals per day. This is a meaningless limit, because 2 BTC can range between $57,000 to $92,000 – per data from this past year alone. This loophole allows US citizens (and other unsavory actors) to continue using Binance and for Binance to feign ignorance. As of February 2022, only 30-40% of Binance’s customers had been KYC-verified.

The no-KYC stance is something that Binance is quite adamant about. In February 2020, Lim wrote that if Binance becomes “too stringent” then “[n]o users will come.”

When business partners ask for Binance’s compliance audit, the firm would try to hide its lack of compliance program:

But according to Lim, Binance purposely engaged a compliance auditor that would “just do a half assed individual sub audit on geo[fencing]” to “buy us more time.” As part of this audit, the Binance employee who held the title of Money Laundering Reporting Officer (“MLRO”) lamented that she “need[ed] to write a fake annual MLRO report to Binance board of directors wtf.” Lim, who was aware that Binance did not have a board of directors, nevertheless assured her, “yea its fine I can get mgmt. to sign” off on the fake report. Around the same time as the referenced “half assed” compliance audit, in November 2020 the MLRO exclaimed to Lim in a chat, “I HAZ NO CONFIDENCE IN OUR GEOFENCING.”

Binance’s CCO (Chief Compliance Officer) does not think that $600 is enough to buy an AK47.

“… in February 2019, after receiving information “regarding HAMAS transactions” on Binance, Lim explained to a colleague that terrorists usually send “small sums” as “large sums constitute money laundering.” Lim’s colleague replied: “can barely buy an AK47 with 600 bucks.” And with regard to certain Binance customers, including customers from Russia, Lim acknowledged in a February 2020 chat: “Like come on. They are here for crime.” Binance’s MLRO [Money Laundering Reporting Officer] agreed that “we see the bad, but we close 2 eyes.”

PS: Hamas is a Palestinian militant organization sanctioned by the US government.

And another choice quote to illustrate the level of familiarity Binance has with facilitating illicit activities.

Lim’s internal discussions with compliance colleagues illustrate that Binance has tolerated Binance customers’ use of the platform to facilitate “illicit activity.” For example, in July 2020, a Binance employee wrote to Lim and another colleague asking if a customer whose recent transactions “were very closely associated with illicit activity” and “over 5m USD worth of his transactions were indirectly sourced from questionable services” should be off-boarded or if it was in the class of cases “where we would want to advise the user that they can make a new  account.” Lim chatted in response: “Can let him know to be careful with his flow of funds, especially from darknet like hydra. He can come back with a new account. But this current one has to go, it’s tainted.”

Binance knowingly serves sanctioned countries while also serving US customers.

“[T]here are a bunch of laws in the US that prevent Americans from having any kind of transaction with any terrorist, and then in order to achieve that, if you serve US or US sanctioned countries there are about 28 sanctioned countries in the US you would need to submit all relevant documents for review [but that is not] very suitable for our company structure to do so. So, we don’t want to do that and it is very simple if you don’t want to do that: you can’t have American users. Honestly it is not reasonable for the US to do this . . . . [U.S. regulators] can’t make a special case for us. We are already doing a lot of things that are obviously not in line with the United States.” 

The above were some highlights to illustrate the alleged disregard towards regulations that Binance has in its eternal pursuit for profits. The CFTC’s document is very detailed: there were quotes taken from chats (even though CZ and the Binance team uses Signal, a disappearing messaging service), private communications, and internal Binance documentation. Did CFTC get hold of CZ’s phone? I wonder how they acquired all this information. Is there a mole within Binance? Or a former rival well-versed in the industry cooperating with the US government? 

This reminds me of one of SBF’s final tweets before FTX’s collapse.

Six months ago, Binance and FTX seemed unbeatable. Binance with the largest crypto exchange in the world (still is), and FTX the US media and regulators’ darling. Even as the crypto world collapsed around them, the two firms seemed to be the paragon of excellence.

Fast forward to now, FTX has collapsed and has been shown to be a fraud, and Binance, if the evidence cited by the CFTC proven to be true, is engaged in circumventing the Bank Secrecy Act and OFAC sanction controls.  

You can’t make this stuff up…

PS: CFTC cannot bring about criminal charges, but it can seek heavy fines and a permanent ban. Likely, a parallel criminal investigation by the Department of Justice is underway, as violations of US sanctions are not a trivial matter.

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