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Late last year, as crypto markets were struggling to regain their footing, the world’s biggest cryptocurrency exchange quietly moved $1.8 billion of collateral meant to back its customers’ stablecoins, putting the assets to other undisclosed uses. They did this without informing their customers. According to blockchain data examined by Forbes, from August 17 to early December–about the same time FTX was imploding–holders of more than $1 billion of crypto known as B-peg USDC tokens were left with no collateral for instruments that Binance claimed would be 100% backed by whichever token they were pegged to. B-peg USDC tokens are digital replicas of USDC, a dollar-pegged stablecoin issued by Boston-based Circle Financial, that exist on blockchains not supported by the firm such as Binance’s proprietary Binance Smart Chain. Each stablecoin is worth one U.S. dollar.
Of the raided customer funds, which consisted of USD stablecoin (USDC) tokens, $1.1 billion was channeled to Cumberland/DRW, a Chicago-based high frequency trading firm, whose parent was founded in 1992 and began trading crypto in 2014. Cumberland may have assisted Binance in its efforts to transform the collateral into its own Binance USD (BUSD) stablecoin. Until a crackdown in mid February by the New York State Department of Financial Services on stablecoin issuance, Binance was aggressively seeking to gain market share for its dollar-backed token against rivals like Tether and Circle’s USDC.
Other crypto traders, including Amber Group, Sam Bankman-Fried’s Alameda Research and Justin Sun’s Tron, also received hundreds of millions of shifted collateral from Binance, a Forbes study of blockchain data for Binance digital wallets shows (see chart). For Binance, which was founded in 2017 by Chinese Canadian billionaire Changpeng Zhao, it is the latest in a long history of controversial practices, from its ongoing lack of physical headquarters and a corporate structure that appeared to be designed to evade regulators, to reported federal investigations for money laundering and tax evasion. Last week, the Securities and Exchange Commission opposed Binance.US’s plan to take over failed crypto lender Voyager’s customer accounts citing inadequate disclosure about the safety of customer assets.
Patrick Hillmann, Binance’s chief strategy officer, suggests that the movement of billions of assets among wallets is part of the exchange’s normal business conduct. In an interview with Forbes he downplayed concern about commingling different investors’ funds while avoiding a question about the external transfer of assets from a digital wallet that had been used to hold collateral for Binance coins pegged to other cryptocurrencies. “There was no commingling,” he says, because “there’s wallets and then there is a ledger,” the latter of which tracked all funds owed to users and funds or tokens going to wallets, which are simply “containers.”
The implication of Hillmann’s comments is that despite what balances may show in Binance’s publicly viewable exchange wallets, the firm has its own set of proprietary records to keep track of funds. This would seem to undermine Binance’s recent efforts to demonstrate solvency through proof-of-reserves exercises. Having two sets of books means that the company is asking customers and regulators to trust its accounting while making it very difficult to independently verify the solvency it claims.
This current case of behind-the-scenes asset shuffling is reminiscent of FTX’s maneuvering prior to bankruptcy when its trading affiliate Alameda Research was alleged to have benefitted from FTX’s disregard for pledges made to customers that their billions of their assets would remain discrete from those of other exchange customers. While the temporary transfers to Cumberland/DRW and others have not elicited any backlash, or apparent investor harm, alleged manipulations by FTX have created trouble for its business partners. Class action lawsuits have been filed against crypto-focused banks Silvergate and Signature, over claims they aided Sam Bankman-Fried’s efforts to misappropriate customer funds before his exchange blew up. Cumberland/DRW declined to comment on the specifics of its recent transactions with Binance.
Crypto forensics firm ChainArgos was the first to raise concerns about Binance not following its own rules for how the pegged-token backing should work and about a persistent lack of collateral to secure billions of dollars in tokens that the exchange issues. It said in a January 17 report, “Someone received a loan of something like $1 billion for about 100 days. It is not clearly [sic] exactly what happened,” but “this is very large, very obviously manual and very recent.”
Last week, Fortune broke the news that Binance had liquidated the USDC collateral–burning it, in crypto parlance–and using the proceeds to pay its U.S. minting partner Paxos to create new BUSD. Fortune speculated the goal might have been to increase the exchange’s share of the dollar-based stablecoin market. With U.S. interest rates rising, yields on the currency held to collateralize the coins are becoming increasingly attractive.
This chart shows an almost identical $1 billion drop in the market capitalization in USDC and corresponding in increase in BUSD’s respectively between the period of August 17 to August 20.
Binance tokens (B-tokens) are Binance-blockchain compatible versions of stablecoins such as tether (Binance-Peg USDT), with $3.2 billion in circulation, and popular cryptos including ether (Binance-Peg Ethereum), at $956 million. There are more than 90 other coins, many with much smaller circulations, where Binance versions have been created.
Why does Binance create B-tokens? The practice of sequestering, or wrapping, a token to mint a new one is not new nor exclusive to the exchange. Billions of dollars worth of tokens have been wrapped and placed on new blockchains. To illustrate, prior to the B-token launch, a Binance user owning a tron (TRX) token would only use it on the Tron network, but an investment on Paxos’ BUSD, which uses the Ethereum blockchain, would only trade on that chain. It is in Binance’s interest to replicate as many tokens as possible on its Binance Smart Chain so that it can increase the number of users transacting on its platform. Increased usage of Binance’s ecosystem drives up the value of Binance’s own native token, BNB coin, which doesn’t represent any equity but has a market capitalization of $47 billion. It also increases the value of applications on its network, many of which it counts as portfolio companies.
Binance pledged to support its B-tokens with 100% backing of the underlying cryptocurrencies. According to Binance, the process is supposed to work like this: When Binance mints a B-token, it is supposed to store a 1:1 token of the underlying asset in a dedicated wallet earmarked for such pegged assets. However, a response by Hillmann to a Forbes query about the Binance-Peg BUSD token illustrates the firm’s shortcoming with the B-token collateralization process. He said that “while we [Binance] didn’t populate the wallet quickly enough, all of the BUSD had been bought to cover all of the wrapped BUSD.” He also insisted that others such as Circle or “anyone” would have been able to see this, however its not clear how this would be possible because Binance doesn’t publish its ledger information.
CoinArgos said the collateral underpinning the Binance-Peg USDC was deficient by more than $1 billion on three separate occasions in the peg wallet, and the exchange’s version of its BUSD stablecoin was undercollateralized by more than $500 million for the majority of 2021. Today the wallet holds approximately $7.0 billion, but that’s after the exchange added approximately $3.2 billion since mid-December, when Binance experienced heavy deposit outflow in the market-wide decline following the FTX collapse.
On January 24, Bloomberg quoted an unnamed Binance spokesperson admitting that the exchange had commingled funds and underfunded certain B-tokens “in error.” However, the spokesperson claimed cause for the underfunding appears to be intentional given that they were manually exported out of Binance, were sent to Circle and Coinbase, and the fact that the USDC assets in the wallet were completely drained.
The Binance-Peg wallet shows a sudden $3.6 billion balance drop on August 17, 2022. This reduction came from the exchange’s decision to withdraw 1.78 billion USDC tokens and 1.85 billion BUSD.
The transfers showing commingling began as far as back as November 2020, which is the earliest available data; Binance launched the B-token program in June 2019. The most recent fund transfer involving an exchange wallet (primarily for client funds) sending funds into the peg account occurred as recently as February 13 when the exchange removed $100 million USDC. Moving assets in and out of the wallet is not necessarily an indication of anything nefarious, as Binance has claimed in the past that all pegged tokens were collateralized even if they were not located in the same wallet. The fact that these funds came from a wallet typically used for safe customer fund storage, however, is potentially problematic.
The $1.78 billion withdrawal on August 17 came without a corresponding reduction in supply of B-peg USDC (see chart below), taking the crypto’s balance in the Binance-Peg Token wallet all the way down to zero. This means that if all B-peg USDC holders tried to redeem their tokens on that date, Binance likely would have been unable to satisfy the requests without significant delay.
Forbes identified the destination for $1.2 billion USDC tokens–all of those taken out of the B-peg wallet plus $120 million USDC from other sources, such as fresh deposits. The single largest recipient was Cumberland DRW, which received $1.07 billion. It is possible that the transfers to Cumberland DRW were linked to normal over-the-counter trading services it provides for third parties. Binance sent the remaining $201 million to Tron founder Justin Sun, Amber Group and Alameda Research. Amber Group did not respond to requests for comment and a former employee at Alameda suggested that its transaction did not seem out of the ordinary for the firm, which was in business during the time in question but is now part of the FTX bankruptcy.
Here is how Cumberland and other key actors gained hold of the USDC tokens:
It is difficult to ignore similarities to the transactions that contributed to the crisis and collapse at FTX. While FTX allegedly ran into trouble by misappropriating customer deposits to the benefit of its sister hedge fund Alameda, in this circumstance Binance seems to have taken funds that customers had reason to believe were dedicated collateral and used them for its own purposes. These actions may not have been illegal, simply because Binance is not regulated like a regular financial firm and purchasers of the b-peg tokens do not sign investment contracts with the exchange.
These revelations could encourage governments to require financial exchanges to be separated from asset custodians. In traditional finance, customer assets often need to be held at institutions considered qualified custodians, which are highly regulated and have specific rules regarding accounting and segregation of customer funds. In the U.S. SEC Chairman Gary Gensler is trying to port those rules over to crypto, which would require registered advisors and other regulated investment firms to keep customer assets at custodians better equipped to manage and secure funds rather than crypto exchanges. Cryptocurrency exchanges, which behave similarly to brokerages in traditional finance, often assume the functions of trading, custody, clearing and settlement, mostly done out of sight of regulatory authorities. While crypto-exchange’s corner-cutting approach can make transactions faster and less costly, it reduces the oversight of each trade in a sector that is already lightly regulated in comparison to more mature markets.
Binance’s propensity for playing by its own rules and sometimes changing them with little notification to clients, is likely to bring increased regulatory scrutiny on crypto exchanges and the hedge funds they do business with. It is also a big reason why “trusted” traditional finance giants like State Street, Fidelity and BNY Mellon have targeted crypto custody as growth businesses for 2023 and beyond.
Editor’s note. In a previous version of this article, ChainArgos was incorrectly referred to as CoinArgos.
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