Uncover the truth behind the colossal $4 billion fine levied on Binance by US regulators as we, Clem Miller and Steve Davenport, unravel the complexities of cryptocurrency exchanges and their dance with legality. Brace yourself for a deep examination into the world of digital currencies, where AML and KYC violations are just the tip of the iceberg. We dissect Binance's intricate operations—storage solutions, transaction facilitation, and the international custodial maze—that make it both an innovation powerhouse and a regulatory nightmare. Amidst the ongoing battle to define cryptocurrencies as a store of value or a security, we shed light on the broader issues plaguing the crypto exchange industry.
In the shadow of the Silicon Valley Bank collapse, we contrast the resilience of crypto entities like Binance against traditional financial institutions. Through our conversation, explore how the absence of a crypto FDIC and the elusiveness of digital asset valuation shape the industry's response to crises. Get an inside look at management behaviors during turbulence, the congressional role in crypto regulation, and the uncertain future of crypto ETFs. As the year winds down, we stress the paramount importance of capital preservation in the volatile crypto market, advocating for cautious investment over chasing uncertain growth. We extend heartfelt thanks and holiday cheer to you, our listeners, and promise to return with more insights to steer you through the unpredictable tides of 2024.
Uncover the truth behind the colossal $4 billion fine levied on Binance by US regulators as we, Clem Miller and Steve Davenport, unravel the complexities of cryptocurrency exchanges and their dance with legality. Brace yourself for a deep examination into the world of digital currencies, where AML and KYC violations are just the tip of the iceberg. We dissect Binance's intricate operations—storage solutions, transaction facilitation, and the international custodial maze—that make it both an innovation powerhouse and a regulatory nightmare. Amidst the ongoing battle to define cryptocurrencies as a store of value or a security, we shed light on the broader issues plaguing the crypto exchange industry.
In the shadow of the Silicon Valley Bank collapse, we contrast the resilience of crypto entities like Binance against traditional financial institutions. Through our conversation, explore how the absence of a crypto FDIC and the elusiveness of digital asset valuation shape the industry's response to crises. Get an inside look at management behaviors during turbulence, the congressional role in crypto regulation, and the uncertain future of crypto ETFs. As the year winds down, we stress the paramount importance of capital preservation in the volatile crypto market, advocating for cautious investment over chasing uncertain growth. We extend heartfelt thanks and holiday cheer to you, our listeners, and promise to return with more insights to steer you through the unpredictable tides of 2024.
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Clem Miller:
Welcome everyone to Skeptics Guide to Investing. I am Clem Miller and today we are going to talk about crypto brokerage platform Binance. Steve Davenport and I will dig into the recent $4 billion of fines which were assessed against Binance by US regulators. When FTX was failing last year, they reached out to Binance for a possible lifeline, but that request was rejected and, of course, the rest was history, with SBF going to jail as sort of the last step in that process. So how do these players Binance and FTX fit together, and what do these recent fines about Binance say about that company and about the broader world of crypto exchanges and crypto itself? What does Binance actually do, steve, in the crypto space?
Steve Davenport:
Binance is a crypto exchange platform. The main entity is Binance Holdings, which operates globally with different subsidiaries in each country. These entities are all trying to operate with various levels of regulation and awareness of governments. I feel a little bit like Alice in Wonderland when I go into the various structures to look in glasses, and I feel that lots of work is being done to avoid real oversight. Binance has been avoiding the question of where it is headquartered so it can pick a more favorable location.
Steve Davenport:
The Binance US has told US investors and VIPs that it has less capability than other Binance entities, and by capabilities I think they mean access to liquidity from some third parties of questionable intent. The large clients are advised to use other entities versus Binance US for their activity so they could do more with greater anonymity. The fines of over $4 billion were for two main violations AML, which means anti-money laundering, and KYC, which is know your clients. The most common usage of these platforms involves moving money anonymously, so illicit entities can fund operation between various countries. Illicit entities could be and this is not an all-inclusive list, just an example terrorist groups, organized crime or individuals looking to get out from under oppressive regimes. The story gets complicated, but I think we need to keep it as simple as we can.
Clem Miller:
So, Steve, I want you to tell me more about what Binance actually does, but I'll just make a comment that I think that an organization that seems to be so focused on doing or facilitating illegal activity is probably something that we should all be avoiding with a 10-foot poll. So, Steve, can you tell us a little bit more about exactly what they do?
Steve Davenport:
But let me just try to understand that when we think of what's happening with cannabis in the US, I think that it is again one of those assets that's on the fringe, and crypto is in a similar place, but I would say in a more nefarious place than with cannabis. So sometimes I think that you're right. Anything that is involved in an activity that we don't have laws around is something we should be worried about. But you are keeping me , C lem. I think of Binance as a financial organization with four main areas. One, it allows the storage of various crypto assets, so it is a platform and a custodian for the various coins and currencies. Two, it executes transactions in between these crypto assets and doing so, it allows people exposure through futures. It also allows people exposure through options, and I think what it does is it allows people to say I'm invested in crypto. Three, it provides funding for traders in crypto and margin loans against these assets.
Steve Davenport:
This is an area where hedge funds and others look to take their exposure to crypto and leverage it. 3 to 1, 5 to 1, 10 to 1. And if you think about daily returns in the 3 to 4% range, you being on the right side of that trade with a margin loan could be very profitable or very dangerous. Number four they create accounts for custodies in other various national locations, so it makes sense for you to be trading with someone in South Africa, trading with somebody in Russia in these crypto exchanges. They're willing to be the person who has that situation established, and US regulators have struggled to determine whether crypto is a store of value like a bank, or is a security which trades supply and demand.
Steve Davenport:
The volatility of crypto makes it feel more like a security than a currency or a store of value. Cryptos move in very gradual ways based on interest rates and a country's economic policies. Crypto moves significantly based on rumors and fears. As a store of value, it feels too volatile, as if security is difficult and impossible to determine how to value it. Usually we look for cash flows of an asset or security underlying asset to determine what's real.
Clem Miller:
So you know. I would add, so you know, there's crypto, which are the tokens themselves which are traded, and then, of course, there are the exchanges which trade these things, many of which, over the last two years, have gone bankrupt or have in some way or another, been fined. You know, binance is not the first, ftx is not the first, you know. One of the things you mentioned is obviously the AML and KYC concerns, and you know, you point out that, you know these are roles that are similar, you know, to a banking role, and I would point out that you know, indeed, you know, aml and KYC doesn't apply just to banks, it applies to really any kinds of financial institutions. So you know, it's not doesn't tell us anything about whether you know what this exchange.
Clem Miller:
How should we should characterize the exchange? But, Steve, what like? Where are we in terms of trying to figure out what you know? An entity like Binance or any of these other entities that have, you know, previously been fined or gone bankrupt? You know, how would you characterize these things? Where are we with this choice of calling them? You know what they are.
Steve Davenport:
Well, it feels to me like it's a pretty big message that's being sent by US regulators. The fines look to be saying the firm failed in AML and KYC and I think that those two failures get addressed a little bit by the magnitude of the fines. The current laws don't really address many of the new characteristics of crypto. Just as, like we talked about with artificial intelligence. It's a little bit like the Wild Wild West. All the profits from Binance since inception for the eight years add up to about one and a half billion in earnings. So the fine of four billion seems to send a very big message. It's taken away all of their earnings, twice. So I thought that it could have been closed down like FDX. But I read a concern from regulator that said the closing of Binance could cause 'systematic failures', and I have to take a deep breath and think about that. How on earth could this entity be created in such a way that if it fails, it's going to have systematic repercussions?
Clem Miller:
So RE Mission. So I'm going to push a little bit back, not on you, but on that regulator that you read. We have this entity in the US government called the Financial Stability Board, which was created after the global financial crisis. Its role is to identify entities that are systemically important financial institutions, in other words, entities that the government considers too big to fail, and where they apply certain additional safeguards and criteria in an effort to make sure that they actually don't fail. So there are no crypto firms on that list. It's all large banks, but nevertheless, even though they're not on that list, maybe there are ways in which this entity, or maybe other crypto entities, might cause destabilizing risks. I suppose one part of it might be just like Binance refusing to fund FTX. Maybe Binance has its own dependencies with other companies, but I don't know. What do you think, steve, about how the economic system might be destabilized by Binance failing?
Steve Davenport:
I think it's very frightening. I mean, this is what they're saying about a company that when we talk about closing a company down because they're not adding stability. We saw the failure of Silicon Valley Bank and other banks who were doing things that were beyond the rules and regulations that they were expected to be upholding. They had a compliance, resigned eight months before Silicon Valley Bank failed. Analysts saw insiders getting loans and yet the company went through fire sale over a weekend. We had to have the company go into a sale at the end Sorry, not a bankruptcy, but a sale over the weekend, supported by the government.
Steve Davenport:
And I guess I would say why didn't this happen with Binance? How can FTX and SPF lead to indictments and violations of Binance leads to fines? If it is too big to fail, then why isn't there a process where we could have others look to buy up the assets and continue the marketability for these, versus find them and say we hope you will perform better, but we're always going to be here to support you. So this is usually the clearing of prices as firms fail become interesting to people who are willing to manage the higher risks, and I think the fact that regulators may not publicly talk about this being a significant firm, but in the back of their mind it is a significant firm, should make us all wonder what is going on in these areas, in these spaces, that they can't see a normal dissolution of assets the way they would do in a Silicon Valley bank case Find an investor over the weekend who will take over the assets and ultimately keep some stability in a space that they obviously have a lack of understanding and a lack of control because these companies have been operating this way for years.
Steve Davenport:
So the process of regulating entities assumes that you are protecting the investor or the account holder from harmful or illicit behavior. I don't think I can do that and say that about finance. With all the attention on Fed meetings, amas and Ukraine, it feels like the crypto problems are getting a free ride. There is nothing to see here, just a few fines.
Clem Miller:
I can see two reasons, Steve, why nobody's bailed out Binance, or nobody's bailed out the others, for that matter. One is that the FDIC is there to backstop banks, and so insured depositors and, on an exceptional basis, uninsured depositors up to a certain amount were covered by the FDIC, and so the FDIC was able, in those cases like Silicon Valley Bank and Signature Bank and First Republic Bank, to do what was necessary to create some buyouts by other banks. I think that's one reason why you don't have that.
Steve Davenport:
That was wrong. Clem right, yeah, it was wrong to do it's the wrong incentive, and so all I'm saying is, if we see these instances where failures cannot happen in a normal manner and they continue to happen, then do we still have the same underlying assumption of strength?
Clem Miller:
Right, yeah, well, and the other reason I was going to say there's two reasons why Binance is different than a bank in terms of being bailed out the one I just mentioned about FDIC. Second one is going back to a point you made, which is that there's no way to price crypto.
Steve Davenport:
Well, that's a whole separate discussion. I guess I'm saying is the market's unstable and it's impossible to value.
Clem Miller:
Right. So talking about a bank failure when banks buy out other banks, there's a room that they create it's online these days, but it used to be not online. There's a room where they put all the documentation on loans, and so banks can come in and look at the loans and reach their own decision as to quality of those loans. So those loans have a value to them. They might discount the value, but there's a value to them and in these cases, there's no set value, no documentable value, other than all the volatility that you see in terms of the prices of these tokens.
Steve Davenport:
Yeah, I think that we've all been through that with the Wellington Trust and the M&T Bank, and what happens over weekends and people wanting to spend more time with their families, when there's questions about lawsuits against you. There's all kinds of things that happen in markets. And I guess my main point is there's so many warning signs here. There's so many ways that we could look at this and say this should be an example for a lot of other people about how you invest and how not to invest, and I think right now we're talking about soft landings and hard landings instead of talking about the dysfunction in these markets.
Clem Miller:
So, Steve, so I know we're moving along in time here, but do you think the shortened attempt? So let me say this, Let me ask you this Do you think that Zhao he's the owner of the company is? Do you think he's going to face an SPF sentencing or something less harsh?
Steve Davenport:
I believe that because of their critical nature at this point in crypto that I think he will serve less. I think that he's fortunate in some ways because when SPF was prosecuted, almost the entire management team at FTX had already plead guilty to the government and they were cooperative witnesses. I don't see the same thing happening with Binance. I see the organizations staying together and ultimately I think that is going to mean a better situation for him and his ultimate prosecution. Because they don't have as much information, they don't have as much of an open book where people are willing to, and there is still a question about ongoing ownership. So if he is prosecuted and he does own the shares, what do we do in terms of having somebody be responsible for those while he's serving time? I think there's too many questions here and it's too different than the SPF and FTX situation.
Clem Miller:
So, just thinking this through, do you think that Congress is capable of thoughtful legislation? You think that in a presidential year there'll be progress on this? And what about this issue with ETFs for crypto investors? Is there something that seems to be in the regulatory hopper at the moment?
Steve Davenport:
Yeah, I guess I'd say that. I think that the meme stocks and SPAC and some of the other things that have occurred in the last two or three years give me more inclination, that the attention span of investors has gotten so short that I think that they will kick this down the road, and I think we've waited long enough for something significant to happen in this area, but it doesn't seem like it's going to happen. I believe that we're going to focus on the soft landing in 2024. I think we're going to focus on getting back to normal and I think we're going to be focused on presidential election, and I think that bringing up regulation of FTX and bringing up regulation of Binance and bringing up the situation involved in crypto will probably be low on people's list of things they want to do before going away to campaign. I like to think Congress, even in a non-election year, should have enough of an attention span. I don't think they do so, just as they know that their voters are important. I think they're going to listen to the voters and right now I think it's inflation, inflation, inflation.
Steve Davenport:
But I believe that we need to see the ETFs move forward and crypto exposure gained through ETFs will be a way to stabilize this space. I think much of the price discovery and transparency of these vehicles will make people have to find clarity on who is in charge and how do these assets being regulated. So while I think it might be too early for ETFs to be in place, I think they might accelerate what is a problem that everybody knows they need to address. But until there's a clear vehicle and how it operates, I think there's going to be a period here what I'll call of price discovery, and I think that as we start to do more and more price discovery and more and more of these ETFs come out, I think that it will be positive for this industry and this space.
Clem Miller:
So, Steve, I'm going to ask you if you have other thoughts on this, but before we do, I want to turn to our mailbag and then ask you about that. So, steve, here's the question we have in our mailbag what investment opportunities do you see in the crypto space today?
Steve Davenport:
I see slim and none Until the grayscale Bitcoin ETF and other ETFs are approved. I think there's little to see here. I think what we're when we see Bitcoin up around $42,000, I think they say it has something to do with lower rates. They say it has something to do with less expensive energy costs. In order to mine, I just believe that this asset is floating in a price based on rumor and innuendo and I don't think it's really floating in price because of changing an underlying value, so I can't invest in it.
Clem Miller:
Yeah, I really don't invest in anything having to do with crypto. The closest I get to this is that I do have investments in Mastercard and Visa, which allow for some trading of crypto in very small percentages on their platforms Mastercard and Visa. I don't invest in any of the so-called mining companies. I don't invest in crypto tokens themselves or in Coinbase, which is the publicly traded exchange. Just don't do it. I stay away from that. I'm too conservative an investor to dabble in this token universe. So, steve, I'm going to ask you do you have? I want to make sure that you cover all any point you want to make. So do you have other thoughts that you want to bring up at this point?
Steve Davenport:
I just summarized my four points on this topic of finance. I think the finance finds are a strong signal and a good signal that companies need to operate if they want to operate according to certain rules and regulations and AML and New York client KOSC or two that are very important. I'd say there's continued confusion in this space. I don't think it's near the point where we should be considering investment. I think the laws and regulations need to improve.
Steve Davenport:
I hate to say this, but I don't think we're doing a good job, as I'm sure regulators look like and feel like they're doing a good job, but I think there's a lot more that needs to happen. And the last item is kind of like where you ended, with, which I'll end it Stay where there is more clarity and a high likelihood of return of your asset, as well as return on your asset. I'd be concerned about some of these cryptos and coins going to zero and I think that the first goal is to keep the asset and then grow it as a second goal, and I think we're going to have a hard time with this Finance and other assets in this space.
Clem Miller:
So thanks for listening. Yeah, thank you, Steve, for a really great discussion, Another really great discussion, and we look forward everybody to talking to you next time.
Steve Davenport:
All right, and I wish everybody a happy holiday and a happy new year. We'll be back in 2024 with more ideas and more skeptical discussions. Thank you all.