Crypto true believers enjoyed a brief nirvana in 2021, watching BTC’s peak at over $68,000 in November and an NFT bubble that created new markets (and a few new millionaires) out of thin air. Many hoped we were finally seeing the beginning of a revolution in global finance that would make large sectors of TradFi irrelevant. Recent regulatory actions indicate some may have underestimated the importance of crypto compliance.
While there is little doubt that digital money and cryptocurrency are slowly integrating into global finance, the US crypto sector is seeing a hard reset from TradFi regulation titans – the US government, agencies, and courts.
If 2021 was the crypto wild west heyday, 2022-2023 saw the Sheriff come to town.
FTX Collapse Sets the Stage
In November 2022, FTX collapsed, exposing an $ 8B loss of investor funds. On November 2, 2023, a jury convicted FTX’s ex-CEO Sam Bankman-Fried of all seven counts of fraud and conspiracy he faced. The sentencing hearing will occur March 28, 2024.
Crypto spectators will remember the tweetstorm and rumor mill swirling as FTX reached out to Binance’s CEO, Changpeng “CZ” Zhao, his arch-rival, in a last-ditch effort to shore up FTX. CZ declined, triggering a host of conspiracy theories as to his true motives.
Crypto Compliance Shake-up at Binance
CZ had little time to rest easy. The Justice Department has been looking into Binance, the world’s largest cryptocurrency exchange, since 2018. Earlier this year, Justice began investigating Binance over whether it allowed Russian users to evade sanctions following the Russian-Ukrianian war.
On June 5, the Securities and Exchange Commission filed a lawsuit against the exchange and affiliated companies, stating that the firms allegedly lied to customers and misappropriated funds.
In November, the U.S. Justice Department charged Binance, the largest cryptocurrency exchange globally, with several legal violations, including breaking the Bank Secrecy Act, operating as an unregistered money-transmitting business, and violating international sanctions.
Here is a brief overview:
Unlicensed Money Service Business:
Binance operated as an unlicensed money services business (MSB) from August 2017 to October 2022. It failed to register with FinCEN, allowing the exchange to gain market share quickly while avoiding US regulations and attracting many US users.
Money Laundering Checks:
Binance processed billions of dollars in transactions without adequate “know your customer” (KYC) checks. Its anti-money laundering controls were weak, attracting criminals and facilitating transactions involving illicit activities.
Binance Upping the Ante With National Security Issues
Operating unlicensed MSBs for US consumers is one thing. When an exchange’s actions give the appearance of illegally aiding countries sanctioned by the US government for political reasons, you have to wonder, “What were they thinking?”
Attorney General Merrick Garland said during a press conference, “Binance employees knew and discussed that the company was serving thousands of users in sanctioned countries, and they knew that facilitating transactions between US users and users in sanctioned countries would be in violation of US law. But they did it anyway.”
Binance had a significant customer base in sanctioned jurisdictions, including Iran. From January 2018 to May 2022, Binance processed transactions worth at least $898.6 million between US customers and those in Iran.
Binance didn’t report suspicious transactions linked to groups designated as terrorist organizations, including Hamas, Islamic State, al Qaeda, and Palestine Islamic Jihad. Binance’s wallets interacted with wallets associated with these groups.
Binance admitted guilt and agreed to pay over $4 billion to settle these charges. Binance’s settlement is one of the largest in the industry involving criminal charges against a company executive. The fine is one of the most considerable penalties for a corporate defendant.
Binance’s CEO, Changpeng “CZ” Zhao, also pleaded guilty to federal crimes and agreed to pay Zhao will pay a $ 50 million fine out of his personal funds. He has also resigned as CEO.
Separately, the US Treasury Department and CFTC announced additional settlements with Binance. Treasury Secretary Janet Yellen said that Binance’s settlement over money laundering and sanctions was the largest in Treasury history.
Timeline of Crypto Compliance-Related Legal Actions Against Binance
Binance’s settlement brings the Justice Department’s investigation to a close. Here is an overview of the timeline where you can see the evolution of litigation from the different US agencies.
- February 15: Suspicions against Binance date back to 2018, with several US law enforcement investigations.
- March 1: US Congress, led by Senators Elizabeth Warren and others, scrutinized Binance, demanding answers to various allegations.
- March 27: The Commodity Futures Trading Commission (CFTC) charged Zhao and Binance with seven counts of trading irregularities and market manipulation.
- May 5: The Justice Department investigated Binance for violating sanctions against Russia.
- June 5: The Securities and Exchange Commission (SEC) filed 13 charges against Binance, including unregistered securities sales and allowing US customers to use their exchange.
- July 6: A leadership exodus began at BinanceUS.
- August 2: The Justice Department considered fraud charges against Binance, leaning towards fines or nonprosecution agreements.
- August 14: Binance.US sought a protective order against the SEC.
- Sept. 13-14: Binance.US cut a significant part of its workforce and saw the departure of its CEO.
- September 19: Binance.US won a minor victory against the SEC in court.
- September 21: Binance sought to dismiss the SEC case against them.
- October 23: Binance filed a motion to dismiss the CFTC’s suit.
- October 26: Following a significant drop in Zhao’s wealth, US Congress members urged the Justice Department to take action against Binance and Tether.
- November 21: JD files indictments against Binance and Zhao, leading to Zhao stepping down from Binance as part of the settlement deal, which included over $4 billion in penalties.
SEC Moves Against Kraken
On November 20, the SEC filed suit against Kraken exchange, accusing Kraken of illegally earning hundreds of millions since September 2018 by facilitating crypto asset securities trading.
The agency claims Kraken acted as an exchange, broker, dealer, and clearing agency without proper registration, denying investors critical protections such as SEC inspections and conflict of interest safeguards.
Kraken’s platform reportedly provides a marketplace for securities transactions, handles customer trades, buys and sells securities for itself, and intermediates in settling crypto asset securities transactions, functioning as a clearing agency.
The Crack in Kraken’s Fundamentals – Co-mingling of Funds
The twist in Kraken’s case is that the SEC also alleges Kraken has weak internal controls that pose risks to customers, including the commingling of customer funds and assets with its own, which an auditor identified as a significant loss risk.
Co-mingling of funds is one of the most fundamental fiduciary no-nos. From local credit unions to large banks, financial institutions know co-mingling is prohibited. If the allegation is correct, we’re left wondering: what were they thinking at Kraken?
Here is the timeline of the SEC’s actions against Kraken:
- September 2018: The SEC alleges that Kraken has been unlawfully facilitating the buying and selling of crypto asset securities, operating as an unregistered securities exchange, broker, dealer, and clearing agency. They accuse Kraken of intertwining these services without proper registration, depriving investors of various protections.
- February 2023: Kraken agreed to cease offering or selling securities through crypto asset staking services or programs. Kraken paid $30 million in disgorgement, prejudgment interest, and civil penalties to settle the SEC’s charges.
- November 20, 2023: The SEC officially charged Kraken as an unregistered securities exchange, broker, dealer, and clearing agency. The complaint included allegations of commingling customer funds with its own and poor recordkeeping practices, which presented risks to customers. The SEC seeks injunctive relief, conduct-based injunctions, disgorgement of ill-gotten gains, interest, and penalties.
Crypto Industry Response
Unlike Binance’s complete reversal and admission of guilt with Justice Department allegations, Kraken strongly disagrees with the SEC’s complaint, asserting that it does not list securities and intends to defend this position.
Kraken criticizes the SEC for insisting on the registration of crypto exchanges without clear legal support or a defined registration process. The exchange points out that it has long supported effective market regulation tailored to crypto’s unique risks and benefits.
Kraken’s position is that Congress should take action to provide regulatory clarity in the US. They are disappointed with the SEC’s “regulation by enforcement approach,” which it believes negatively affects American consumers, innovation, and US global competitiveness.
Moving Ahead with Crypto Compliance
The future of US crypto exchanges is still not 100% clear, and we all know that uncertainty leads to volatility. Experts recommend that some of the best ways to protect yourself are diversifying your portfolio, doing your own research (DYOR), setting goals and limits, and managing your emotions. Some also recommend keeping some or all of your crypto in a cold wallet.
If you trade crypto assets, ZenLedger can help simplify at least one area of your life by helping you aggregate transactions across wallets and exchanges, compute your capital gain or loss, and populate the IRS forms you must file yearly.
You can even identify ways to harvest tax losses and offset other capital gains or up to $3,000 worth of ordinary income each year.
This material has been prepared for informational purposes and should not be interpreted as professional or legal advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.