Binance: funds stored in banks?

It appears that the world’s largest exchange, Binance, is developing a new service that would allow institutional clients to keep collateral directly in the bank. 

This is reported by Bloomberg, citing recent communications that have taken place between the exchange and some of its professional clients. The idea would be to provide them with a special setup that would allow them to use bank deposits as collateral for margin trading in the spot and derivatives markets. 

The initiative would be used to reduce the risks from loss of funds on the exchange’s wallets, but would be aimed only at large investors and speculators. 

The banks chosen would be FlowBank, based in Switzerland, and Bank Frick, based in Liechtenstein.

For now, however, these should still be considered only rumors without confirmation, as the only source is Bloomberg, which cites four anonymous people who would be familiar with the matter. 

The risk of the custodial service

Crypto exchanges cannot be considered high-security custodians of funds. 

For one thing, there have been several crypto exchanges that have been hacked, and have also suffered large thefts of customers’ funds, but it is also necessary to take into account those exchanges that, without being hacked, have gone bankrupt, thus no longer having sufficient funds available to return their customers’ deposits. 

Binance is one of the exchanges that have proven to be more secure over time, but it is certainly not 100% secure. 

It even has insurance, but that does not necessarily cover all the funds of all customers. 

To be fair, in the European Union’s new cryptocurrency regulation, MiCA, there would be a requirement for crypto exchanges to keep customer funds in separate accounts, but what Binance wants to offer goes far beyond just account segregation. 

Binance: the hypothesis under consideration

As far as fiat currencies are concerned, banks are often considered to be solid as far as the custody of funds is concerned. 

To be fair, even banks sometimes close or fail, but for example recently all depositors of failed US banks have had their funds returned due to the Fed’s intervention. 

If Binance can offload the burden of having to custody huge amounts of fiat currency onto others, it certainly reduces risk, if only by diversifying custodians. 

Even though there is still no certainty about the exchange’s possible new service for large investors, the hypothesis cited by Bloomberg is to entrust selected banks with customers’ cash, locking them in through a tripartite agreement that would allow the exchange to lend them stablecoin as collateral for margin trading. 

In turn, customers’ fiat money held at banks could be invested in money market funds to earn interest, helping to offset the cost of borrowing stablecoins. 

The role of stablecoins

On Binance, the overwhelming majority of crypto trades are not in fiat currencies but in stablecoins, and futures contracts also trade in stablecoins. 

As a matter of fact, the use of fiat currencies on Binance actually seems marginal, compared to the use of stablecoins, but there is always the problem of collateral. 

In fact, stablecoins add an extra risk, because in addition to the custody of the tokens there is also the custody of the collateral. With the hypothesis being explored, the collateral of stablecoins would be kept in banks in fiat currency, thus reducing the risk. 

Therefore, this is a complex hypothesis, dedicated only to large customers, and related only to the use of stablecoins. After all, banks store fiat currencies, whereas on crypto exchanges stablecoins are mostly used. 

It is also worth mentioning that stablecoins are by far the favorite on crypto markets because they can be moved easily and quickly, unlike fiat currencies that often require longer timelines, sometimes more complex transfers, and severe limitations. 

For example, it is possible to easily move stablecoins directly from one exchange to another, whereas it is not possible to do so with fiat currencies. 

Binance and risk reduction

Risk reduction is one of the main challenges crypto exchanges must overcome if they are to grow further and be able to support trading volumes even vaguely comparable to, for example, the stock market. 

Binance has been working on risk reduction for a while, already offering partially insured deposits, verification of collateral, institutional-level custody services, and now perhaps bank deposits for collateral of stablecoins. 

Zeroing out these risks is absolutely impossible, but it is possible to significantly reduce them. 

Let’s not forget that just a few months ago, one of the world’s largest crypto exchanges, FTX, went bankrupt, and most of its customers have yet to even be able to claim back the funds they lost. 

Risk reduction also comes through diversification of custodians, because if the custodian of all funds is just one, in case of closure, theft or bankruptcy all its users risk losing everything. 

Since it is not a matter of eliminating risks completely, as that is impossible, but of only reducing them, custodian diversification can for all intents and purposes be useful precisely in trying to reduce the risks.