Binance faces heavy scrutiny from regulators, investors pull out $1.6 billion

CFTC lawsuit and increased federal scrutiny

Binance, the world’s largest cryptocurrency exchange, is facing a slew of allegations and lawsuits from regulators. The latest lawsuit comes from the Commodity Futures Trading Commission (CFTC) accusing Binance of intentionally evading US laws by letting Americans trade crypto derivatives, which are prohibited for retail investors. This lawsuit highlights wider concerns about Binance’s compliance and regulatory practices. If the CFTC suit is successful, it could result in “hundreds of millions” in fines and a possible ban on Binance’s ability to register as a derivatives trader in the US.

Binance CEO Changpeng Zhao has responded to the lawsuit by stating that it is an “incomplete recitation of facts.” However, this hasn’t prevented investors from pulling out $1.6 billion from the platform since the lawsuit was filed. This could have long-term impacts on Binance’s business as it relies heavily on trading volume for its revenue streams.

Recent chaos with companies like FTX has likely emboldened regulators to take action against cryptocurrency exchanges. However, such regulatory actions are unlikely to harm the overall crypto market, as investor interest in cryptocurrencies remains strong despite increased regulatory scrutiny.

Concerns about Binance’s business practices

Binance has grown explosively and dominates the crypto market, handling over 50% of all spot and futures trades in crypto, and over 90% of spot Bitcoin transactions. However, this success has raised concerns about its business practices.

Binance’s business model relies on low fees and an all-traders-welcome culture but lacks transparency in its financial disclosures. In addition, its influencer network, which entices young traders to try crypto, is expensive and potentially shaky.

Binance’s net worth may heavily rely on its native token, Binance Coin (BNB), which could pose a risk if Binance needs to sell BNB and its price collapses. This risk is compounded by investigations and allegations from regulators, including intermingling of customer assets, money laundering, violation of rules, and noncompliance with protocols.

Impact on Binance’s revenue streams

More regulatory actions against Binance could affect its revenue streams. Binance’s revenue streams are heavily reliant on trading volume, with the exchange deriving roughly 90% of its top line from trading.

Binance has an aggressive referral program to attract new customers and was estimated to have revenues of around $12 billion in 2022. Its profit margins were likely huge due to its growing volumes. However, increased scrutiny from regulators could lead to fines and a dip in trading volume, impacting the exchange’s profitability.

Binance is also a huge sponsor in soccer and engages in conventional marketing alongside its aggressive referral program. The impact of regulatory actions on Binance’s marketing strategy remains to be seen.

Binance’s affiliate program and reliance on its BNB coin

Binance’s Affiliate Program enlists influencers, financial and opinion leaders, analysts, and crypto funds to attract new customers. The program offers hosts up to 50% kickbacks on recruits’ spot trades, with a requirement to attract new customers regularly to maintain kickbacks. Binance’s program is more generous than its competitors, with hosts receiving a share of recruits’ spot commissions forever.

Legal experts say the program is legal but carries liability risks for hosts falsifying qualifications or trading records, and for crypto firms working with undisclosed influencers. Additionally, Binance’s reliance on its BNB coin could pose risks if the coin’s value were to collapse.

BNB’s primary use is as a currency that secures discounts for customers and is exclusive to Binance’s BNB Chain for staking. To increase rarity and boost the coin’s value, Binance pledged to gradually purchase and eliminate from circulation 100 million BNB, or half the number originally minted. The strategy appears to have been successful, with BNB’s price soaring from around $30 in mid-2019 to $670 in November 2021, making it the world’s fourth-most-valuable crypto coin with a market cap of $53 billion.

US regulators need to find a balance

US officials need to find a balance between regulations that are too strict and providing a clearer framework for crypto to operate under that protects customers. William Johnson, a finance professor at the University of Massachusetts Lowell, cautions that if regulators push too hard, companies could leave the US.

Binance argues that it isn’t subject to US laws because it doesn’t have a physical headquarters in America. However, as the CFTC lawsuit highlights, this does not mean Binance is immune from scrutiny by US regulators.

The Internal Revenue Service and Securities and Exchange Commission are reportedly investigating Binance, and Coinbase, the largest US-listed crypto exchange, received a Wells notice last week from the SEC for possible securities law violations.

The crypto industry earlier this month lost two of its biggest connections to the mainstream finance world — Silvergate and Signature Bank. As cryptocurrency continues to evolve and mature as an asset class, regulators will need to strike a balance between protecting consumers and fostering innovation in this rapidly growing industry.

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