Former FTX CEO Arrested, Binance Trembles

Yesterday was a difficult day for both Binance and the former CEO of FTX.

According to data revealed by Nansen, from Monday 12 to Tuesday 13 December it recorded a net volume of outflows of more than $2 billion, in ETH and ERC20 tokens, and $3 billion overall. 

As the chart shows, this is the first time this has happened since June, and in the past five months, the flows had always been positive. 

Right now it appears Binance holds just under $60 billion in cryptocurrencies and tokens, most of it in BUSD (26%) and USDT (20%), Followed by BTC (15%), BNB and ETH (10%). 

The reaction of Binance Coin (BNB)

Yesterday’s fear also significantly affected BNB, or Binance Coin. 

On Sunday 10 December, its price was around $290, but yesterday it fell as low as $262. However, thanks to yesterday afternoon’s good performance of the financial markets as a whole, it has now risen slightly to $275. 

So this was evidently a temporary scare, but it had a significant impact. It is enough to mention that compared to seven days ago, BNB is losing 5%, whereas instead, for example, BTC is gaining 4.5%, and ETH 4.2%. 

However, it is worth noting that compared to last year’s highs, BNB right now is at -60%, while BTC is still at -74% and ETH at -73%. 

So despite what has happened in the past two days, BNB during the current bear market is still performing better than the two major cryptocurrencies. 

Moreover, today the fears that drove BNB’s price down over the past two days seem to have faded. 

The causes of Binance’s problems, FTX among the top ones

It is possible that what caused so many users to withdraw their funds from the exchange were rumors that there were problems with the proof provided regarding reserves. 

These were not definite reports, but rumors that in fact questioned the quality of such evidence. 

However, the source was the Wall Street Journal, which lent credibility to these rumors. 

In fact, in its article, the WSJ reports that, according to an investment manager and former member of the Financial Accounting Standards Board (FASB), the Mazars audit firm’s report regarding the exchange’s reserves would be deficient. In fact, it would lack information regarding the quality of internal controls, and how Binance’s systems liquidate assets to cover margin loans.

In addition, according to the WSJ, there would also be a lack of information about Binance’s corporate structure. so much so that Binance’s Chief Strategy Officer, Patrick Hillmann, was unable to indicate what the parent company was because the company has reportedly been in a phase of corporate reorganization for nearly two years.

The WSJ report also indicates that Binance would only be 97% collateralized, not taking into account Out-Of-Scope assets pledged by customers as collateral for In-Scope assets provided through lending and margin trading services. In fact, this generates a negative balance in the Customer Liability Report.

If, on the other hand, In-Scope assets are included Binance would be 101% collateralized, as stated by Mazars. 

Raising these rumors was Duke University School of Law professor and former head of the SEC’s Office of Internet Enforcement, John Reed Stark. 

According to Reed Stark, who worked at SEC Enforcement for more than 18 years, this would be a “red flag.” 

The problem

As can be seen from the statements reported in the WSJ, though, the solvency of the exchange is not being questioned. 

There are two problems highlighted. 

The first is a credibility problem, which means that Mazars’ report cannot be considered irrefutable proof of Binance’s solvency. However, this does not mean that the exchange is insolvent, but only that the evidence it has provided in this regard is not sufficiently robust so that any doubts can be dissolved. 

Something similar has been happening for years to Tether, which has never had a solvency problem, and this year until proven otherwise has clearly demonstrated that it is solvent. Even Binance so far has always proven to be so. However, there is a lack of certainty that it can be so in the future, although this is a problem that virtually all companies have. The difference here is the level of risk, and the length of time the company will surely remain solvent with current resources. 

The second is a technical problem with the methodology by which reserves are calculated. 

The WSJ analysis reveals that the 101% calculated by Mazars would in fact be correct, but only if In-Scope assets were included in the count. However, WSJ believes it is better not to include them, because they are only pledged assets, and in that case the total coverage would drop to 97%. 

Again, this does not at all mean that the company is insolvent, but only that it may have trouble covering all In-Scope assets. 

In other words, the spot markets, i.e., those where only and directly tokens and cryptocurrencies are traded, would be fully hedged, while for the domestic derivatives market the hedges are partly provided by assets pledged by clients borrowing funds.

This, for example, is not much different from a bank making loans using the paychecks of a worker with a permanent contract as collateral. 

The links between Binance and FTX

Coincidentally, it was just yesterday that Sam Bankman-Fried (SBF), the founder and former CEO of FTX, was arrested

Binance, and in particular its CEO Changpeng CZ Zhao, were the first to initiate on a large scale the process that led to the huge demand for withdrawals from FTX that drove it into insolvency. 

SBF himself, once FTX went bankrupt, had publicly declared that CZ had won. 

Over the years, SBF, using the funds that FTX customers deposited on the exchange, built up a dense network of personal relationships, even and especially political ones, against huge donations to the various candidates, particularly Democrats. 

In addition, thanks to his parents, he also always had excellent contacts in academia. 

One would think that perhaps some of SBF’s friends took the opportunity to somehow try to get revenge for what CZ did to FTX in November. 

But there is a big difference: FTX did not collapse because of Binance, but because of its bad, perhaps even illicit, management. CZ only lit the fuse, but SBF itself had built the bomb at the start. 

Indeed, while Binance does not seem insolvent at all, even after the WSJ’s indiscretions, FTX on the other hand had certainly been insolvent for some time, only lacking sufficient drawdown volume to show it publicly. It is worth noting that FTX’s bankruptcy came after repeated withdrawals totaling about $6 billion

In contrast, in recent days Binance has held up very well to the high volume of withdrawals, described by CZ himself as “business as usual.” 

It is also worth adding that the Mazars report was published only last week, so the timing is entirely consistent with sincere behavior on the part of the WSJ. 

Now that this brief period of fear regarding the tightness of Binance seems to have passed, all that remains is to see if everything will return to normal, or if similar assumptions should arise again in the near future. 

However, it is important not to forget that it is quite commonplace for competitors vying for the same customers to publicly attack each other to perhaps try to discredit the opponent so as to weaken them. So it is not at all unreasonable to imagine that attacks against Binance may also involve other crypto exchanges. 

Source: https://en.cryptonomist.ch/2022/12/14/former-frx-arrested-binance-trembles/