The crypto market, a realm of innovation and rapid growth, is currently embroiled in a high-stakes face-off between the behemoth exchange, Binance, and the formidable US regulator, the Securities and Exchange Commission (SEC). This confrontation has brought to the forefront a myriad of allegations, casting shadows over the operations of the world’s largest crypto exchange and its enigmatic CEO, Changpeng Zhao. So, what are crypto mirage trades?
Binance, a name that has become synonymous with cryptocurrency trading, has been accused by the SEC of operating a “web of deception.” This intricate web allegedly includes artificially inflating its trading volumes, a practice known as “wash trading,” and diverting customer assets. The gravity of these allegations is profound. The SEC’s complaint, lodged in the federal court of Washington, D.C., paints a picture of a company that not only misled investors about its market surveillance controls but also operated an unregistered securities exchange.
The charges delve deeper, suggesting that Binance and Zhao had clandestine control over customer assets, enabling them to mix and divert these funds. Furthermore, the creation of separate U.S. entities is seen as a calculated move by Binance to sidestep U.S. Federal securities laws.
Adding another layer to this intricate narrative, the SEC has pointed fingers at Sigma Chain, a trading firm under Zhao’s control. From September 2019 to June 2022, this firm is alleged to have engaged in wash trading, further inflating the trading volume of crypto asset securities on the Binance.US platform. SEC Chair Gary Gensler’s statement on the matter was unambiguous, accusing Zhao and Binance of deception, conflicts of interest, and a deliberate evasion of the law.
In the wake of these heavy allegations, Binance’s initial response was notably muted. While the exchange did not immediately comment, Zhao took to Twitter, assuring that a formal response would be forthcoming once they’ve thoroughly reviewed the SEC’s complaint. He emphasized the team’s commitment to ensuring the stability of their systems, including vital functions like withdrawals and deposits.
However, this is not Binance’s first brush with regulatory scrutiny. Earlier in March, the U.S. Commodity Futures Trading Commission (CFTC) had sued the exchange for what they described as operating an “illegal” exchange and a “sham” compliance program. Zhao’s response to these charges was one of disappointment, criticizing them as an incomplete portrayal of facts. Additionally, whispers of a Justice Department investigation into suspected money laundering and sanctions violations have been circulating.
As we dive deeper into this unfolding drama, we aim to unmask the illusion behind these allegations and decode the intricacies of wash trading on Binance, shedding light on its implications for the crypto industry.
Binance’s Inception And Controversy
Founded in Shanghai in 2017 by Zhao, Binance’s meteoric rise has been nothing short of spectacular. Despite its holding company being based in the Cayman Islands, the exchange has maintained an air of mystery regarding its primary operations, declining to pinpoint the exact location of its main Binance.com exchange. Dominating the crypto trading landscape, Binance.com processed an astounding $65 billion in trades daily last year, capturing up to 70% of the market.
Binance.US, a subsidiary of the global cryptocurrency trading giant Binance, operates as a cryptocurrency trading platform based in the United States. It began its trading operations on September 24, 2019, offering 13 fiat-to-crypto and crypto-to-crypto trading pairs, including BTC, ETH, XRP, BCH, LTC, BNB, and USDT.
On June 14, 2019, Binance announced that starting from September, it would cease to offer services to both business and retail customers in the U.S. Prior to this, Binance had disclosed in a blog post its collaboration with BAM Trading Services to introduce a U.S.-specific platform, Binance.US. This collaboration involved Binance licensing its trading and wallet technologies to BAM. According to Binance, BAM secured a FinCEN registration on June 11.
Yet, amidst its success, Binance has not been without controversy. Reports from Reuters have highlighted the firm’s processing of payments for entities aiming to dodge U.S. sanctions. Furthermore, allegations of Binance mixing customer funds with its corporate revenues in a Silvergate Bank account have raised eyebrows. While Binance has refuted these claims, stating that users were purchasing their bespoke dollar-linked crypto token, the air of suspicion remains.
What’s Wash Trading?
The global cryptocurrency arena has been rife with controversies, and central to this is the issue of wash trading. Binance.US, affiliated with the global giant Binance, found itself in the crosshairs of regulators and market watchers. In 2019, amidst a backdrop of regulatory concerns, Binance announced its decision to restrict services to U.S. customers. This move was followed by the launch of Binance.US, in partnership with BAM Trading Services, to cater specifically to the U.S. market.
Wash trading, a deceptive practice where the same entity buys and sells an asset to create a misleading impression of market activity has been a significant concern. While it’s illegal in traditional asset classes in the U.S., its status in the crypto sector remains ambiguous. Initial claims of exchanges inflating their volumes were speculative until comprehensive reports, like the Bitwise report to the SEC, highlighted the extent of the issue. These reports, however, faced challenges and denials from the implicated exchanges.
Detecting wash trades is complex due to the anonymity of traders. However, using statistical methods like Benford’s Law, which examines the distribution of leading digits in large datasets, and analyzing trade size distributions, researchers have been able to identify patterns consistent with wash trading. For instance, unregulated exchanges often deviate from expected statistical patterns, suggesting the presence of wash trades. On average, over 70% of the reported volume of these exchanges is estimated to be wash trades.
The rise of decentralized exchanges (DEX) post-2020, fueled by advancements in smart contract technology, also witnessed wash trading. However, the transparent nature of blockchain makes these activities more detectable on DEXs.
The primary incentive for exchanges to engage in wash trading appears to be to boost their rankings and attract customers. Newer exchanges, seeking to establish a foothold, are more prone to such practices. The need for stringent regulations and global standards is evident. As the cat-and-mouse game between fraud detection and perpetrators continues, the hope is that with evolving forensic tools and regulations, deceptive practices like wash trading will become uneconomical and obsolete.
Why Is Wash Trading a Concern?
- Misleading Appearance: As mentioned, wash trading gives a false impression of market activity. New or uninformed traders might enter the market based on this misleading data, leading to potential losses.
- Market Manipulation: Wash trading can be used to manipulate the price of a cryptocurrency. By creating artificial demand, the price can be driven up, allowing the manipulator to sell at a profit.
- Trust Erosion: For the crypto industry to thrive, trust is crucial. Practices like wash trading erode this trust, making it harder for new investors to enter the market and for the industry to gain mainstream acceptance.
SEC’s Accusations On Binance US: Wash Trading
In 2019, Binance.US, an offshoot of the global crypto giant Binance, marked its debut with a trading volume of nearly $70,000 in bitcoin within the first hour. However, this demand wasn’t driven by external traders. Binance’s CEO, Changpeng Zhao, indicated in an internal communication that the activity was self-generated. This revelation raises questions about the authenticity of trading volumes in the crypto world, spotlighting the controversial practice known as “wash trading.”
Wash trading involves an entity trading assets with itself or a related party, creating an illusion of genuine market activity. This can artificially boost both asset prices and apparent trading volume. While wash trading in traditional markets like stocks and bonds has been illegal in the U.S. for decades, its prevalence in the crypto sector has become a growing concern. This is particularly true as trading volumes have become a key metric for crypto exchanges to attract users.
Last month, the SEC took legal action against Zhao and Binance.US. The regulator alleges that a company under Zhao’s control artificially boosted trading volumes on the U.S. platform. This was reportedly done using multiple user accounts associated with Sigma Chain, a Swiss trading entity controlled by Zhao.
The SEC’s claims suggest that, a day after Binance.US’s 2019 launch, nearly 70% of the trading volume for a particular token resulted from wash trading between Sigma Chain accounts and those owned by Zhao and other senior staff. Binance.US has refuted these allegations, emphasizing their belief in the legitimacy of the trades in question.
A recent study set to be published in Management Science suggests that over 70% of trading volume on crypto exchanges is due to wash trading. This would have resulted in a misleading volume of over $6 trillion in Q1 2020. Notably, U.S.-listed Coinbase, considered regulated due to its New York license, showed no evidence of wash trading during this period. However, the study found that Binance, the global counterpart, engaged in wash trading for about 46% of its total volume.
Internal communications from Binance.US, as disclosed by the SEC, indicate that the platform’s officials were conscious of the potential for wash trading from its inception. The SEC alleges that Binance.US did not have any trade surveillance mechanisms in place until at least February 2022.
The Justice Department is currently investigating both Binance and Binance.US. Following the SEC’s lawsuit, Binance.US’s market share has dwindled to just over 1%.
The Current Progress In Binance Vs. SEC Case
Following Binance’s trouble, several key executives including the CEO left the exchange. Binance’s U.S. branch is resisting regulators’ demands for internal business records, according to a recent court filing. BAM Trading, the operator for Binance.US, claims the U.S. Securities and Exchange Commission’s (SEC) requests are excessively broad and burdensome. The SEC seeks these documents for its case against BAM, which it accused in June of running an unregistered securities exchange. BAM’s legal team has labeled the SEC’s demands as vague and oppressive.
Court documents revealed this week indicate that Binance CEO Changpeng ‘CZ’ Zhao loaned $250 million to BAM Management U.S. Holdings. Of this amount, Paxos, a New York-based Binance USD issuer, transferred $183 million to BAM Trading. Following a significant lawsuit against Binance by the SEC, Binance US’s legal team responded to the regulator’s inquiries about particular financial actions, as shown in the June 6 unsealed court documents.
On Thursday, September 21, 2023, Binance and its co-founder Changpeng Zhao (CZ) submitted a joint motion to dismiss allegations from the U.S. Securities and Exchange Commission (SEC). Binance contends that the SEC’s claims lack a basis in current securities laws, especially as lawmakers are actively discussing the cryptocurrency landscape. The defense highlighted the SEC’s attempt to hold them accountable for token sales from 2017, a time when clear guidance on such transactions was scarce.
Binance and CZ argue that the SEC doesn’t have the jurisdiction to take action on these past transactions. Additionally, Binance believes the SEC’s allegations don’t meet the Howey Test’s criteria, which determines if a transaction is considered a security. The SEC’s lawsuit accuses Binance of bypassing U.S. securities law registration requirements when offering various crypto assets.
Binance urges the court to reject the SEC’s claims, asserting that the contested crypto assets aren’t securities. They also challenge the SEC’s stance that foreign platforms must register in the U.S. if Americans access them online, arguing that this oversteps the agency’s jurisdiction outside the U.S.
Conclusion
The SEC’s allegations against Binance.US over “wash trading” practices have sent ripples throughout the cryptocurrency industry. Such high-profile regulatory confrontations can undermine investor confidence, potentially leading to market volatility. For emerging markets like crypto, where trust and transparency are paramount, accusations of deceptive practices can deter new investors and prompt existing ones to reconsider their positions.
Furthermore, this situation underscores the urgent need for clear regulatory frameworks in the crypto space. As regulators worldwide grapple with how to oversee digital assets, the outcome of this case could set a precedent, influencing future regulatory actions and shaping the trajectory of the crypto industry.
