Binance, the world’s largest cryptocurrency exchange, is facing heavy scrutiny over its business model and practices. On Monday, the US Commodity Futures Trading Commission (CFTC) sued Binance and its founder, Changpeng Zhao, for illegal operation and numerous violations of the Commodity Exchange Act and CFTC regulations. The lawsuit alleges that Binance operated its trading platform “through an intentionally opaque common enterprise” and engaged in a calculated strategy of regulatory arbitrage to their commercial benefit.
Concerns and Risks Surrounding Binance’s Business Model and Practices
Binance’s explosive growth has been partly fueled by an army of influencers who gain kickbacks with every newbie they sign up to Binance. However, Binance’s influencer network is largely invisible to those who aren’t power users. CZ, Binance’s founder, has become crypto’s most visible spokesman, often appearing on cable business networks and releasing statements to tout the health of his business.
Binance handles over half of all spot and futures trades in crypto and over 90% of spot Bitcoin transactions. However, Binance is a private company and isn’t obligated to disclose financial information. Additionally, Binance.com isn’t licensed in nations that require the toughest public financial disclosures.
Some experts believe that Binance’s native token, Binance Coin (BNB), on its balance sheet accounts for most of its net worth. This could be a potential risk to the company if it needs to turn BNB into fiat currencies for operating expenses.
Furthermore, Binance has been under investigation by regulators for allegations ranging from intermingling customer assets to money laundering.
Binance’s Revenue Streams and Business Model
More regulation by foreign jurisdictions could impact Binance’s revenue streams in the future. It is also said that Binance is a riskier enterprise than customers may realize.
CZ, the founder of Binance, believes in financial transparency and working with regulators to restore trust in the industry. However, Binance’s overall trading activity increased significantly in 2021, but it dropped in 2022.
Binance derives roughly 90% of its revenue from trading and the rest from sources such as deposit, withdrawal, and margin lending revenues. Binance charges low fees for spot and futures trading with additional discounts. The estimated revenue for Binance in 2022 is $12 billion, but this figure may be an overestimate.
Binance’s Affiliate Program and Its Reliance on Binance Coin (BNB)
Binance’s affiliate program, officially called the Affiliate Program, involves enlisting prominent names in social media, such as influencers, financial and opinion leaders, analysts, and crypto funds. Eligible hosts can pocket 41% kickbacks on recruits’ spot trades if they start with fewer than 500 referrals and 50% when they hit over 500.
To keep the 41% kickbacks, an inviter must attract at least 10 new customers every 90 days that together generate at least the equivalent of 50 Bitcoin or around $1 million in new trades. Binance provides strong incentives for affiliates to keep building their clubs as they get a share of their recruit’s spot commissions forever.
Binance’s aggressive referral program is a major part of its growth and expenses. However, the program’s legality is not in question, but hosts must avoid falsifying their qualifications or trading records. The use of influencers raises compliance risks, and the program’s generosity could pose problems by cutting into profits.
Binance’s reliance on BNB presents a shaky aspect of the business. BNB’s primary use is as a currency that secures discounts for Binance customers, and it is the exclusive coin for staking on Binance’s BNB Chain. As part of its initial coin offering, Binance pledged to gradually purchase and “burn” 100 million BNB, or half of the number originally minted, to get people excited about the coin’s future value.
The strategy appears to have worked as the price of BNB soared from $30 to $670 by November 2021, making it the fourth most valuable crypto coin with a market cap of $53 billion. Binance’s founders have erased 24 million of their original 80 million BNB coins since June 2019, which had a cumulative value of $4.5 billion.
CFTC Sues Binance for Illegal Operation
The CFTC lawsuit alleges that Binance and its CEO have instructed its employees and customers to circumvent compliance controls in order to maximize corporate profits, violating US trading laws. Binance is accused of secretly coaching American “VIP” customers to evade compliance controls in particular.
Binance denied the accusations and said that it has made “significant investments” to ensure that US-based investors are not active on the platform. The CFTC can seek heavy fines and potentially ban Binance from registering in the US in the future, but it cannot bring criminal charges.
The likely outcome is that Binance ends up paying “hundreds of millions of dollars” in fines and will be prevented from registering a derivatives exchange in the future. The crypto industry is facing regulatory scrutiny from the Internal Revenue Service and Securities and Exchange Commission, and Coinbase, the largest US-listed crypto exchange, is also under investigation.
In conclusion, the recent legal troubles faced by Binance suggest that investors should approach their services with caution. While they are undoubtedly a prevalent business within the cryptocurrency market, their aggressive growth strategy may come at a price for both themselves and their clients. As regulatory scrutiny across the cryptocurrency sector increases globally, businesses must ensure they can comply with regulatory requirements to avoid legal troubles.
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