CZ is heavily fined, sparking a hurricane of speculation in the cryptocurrency circle

Binance CEO CZ receives hefty fine, triggering whirlwind of speculation in crypto community

Source: Xiao Sa Lawyer

On June 5, 2023, the US Securities and Exchange Commission (SEC) filed a lawsuit against Binance Holdings Ltd., the operating entity of the global leading virtual asset service provider (VASP) “Binance,” and Binance’s affiliated company in the US, BAM Trading Services, along with Binance’s founder, Zhao. Shortly after, rumors circulated that the SEC and Binance had reached some undisclosed settlement, but the terms of the settlement remained unknown. In November 2023, the SEC disclosed the related settlement conditions with Binance, and the exorbitant settlement fees and penalties are like a butterfly flapping its wings in the South Pacific, which will have a profound impact on the global VASP industry in the near future.

The background of the related events and the specific details of the settlement case have been comprehensively introduced by the Xiao Sa team. Today, the Xiao Sa team will focus on analyzing the impact of the Binance settlement case on the global virtual asset industry and VASPs from the perspective of compliance obligations.

01 SEC’s view on Binance’s related business operations

The then Chairman of the SEC, Gary Gensler, stated that the SEC accuses Zhao and Binance of organizing and establishing a network full of deception, conflicts of interest, and improper disclosure of information, and intentionally guiding high-net-worth clients to evade relevant compliance regulations. Specifically, from the disclosed complaint, we can find that the SEC primarily accuses Binance of “three crimes”:

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1. Unregistered and unlicensed operations. The SEC believes that the relevant entities of Binance have not complied with the registration and licensing requirements stipulated in the US Securities Act of 1933 and the Securities Exchange Act of 1934. This includes (1) the three entities sued, Binance, Binance.US, and BAM Trading, all should have been registered but were not, and (2) Binance and BAM Trading provided and sold digital assets without registration.

2. False access restrictions. Binance publicly claimed that US customers cannot access the Binance.com platform. However, in reality, Binance has been assisting and guiding high-net-worth clients to access it through VPN.

3. Market manipulation and consumer deception. The SEC believes that Binance did not conduct proper platform trading supervision. The controlling person, Zhao, and other personnel have engaged in a large number of wash trades and matched trades, causing false prosperity in the virtual asset market and leading to consumer misconceptions.

Considering the “three crimes” mentioned above, the SEC initially had three goals, but the most fatal one was to demand Binance and related entities to surrender all illegal profits. From this perspective, although the billion-dollar settlement is indeed shocking, Binance has already minimized its losses to the maximum extent.

02 Profound impact of the settlement case on the virtual asset industry and VASPs

Starting from the virtual currency bull market and the rapid development of integrated technologies such as blockchain, AI, and others in 2021, regulatory focus has increasingly shifted to the field of emerging technologies. The combination of virtual assets and blockchain has the potential to significantly impact existing economic systems and could easily be exploited as a tool to evade regulation. Therefore, the Saje team believes that regulation of the virtual assets industry and VASP will only become stricter.

From this perspective, for practitioners in the virtual assets and emerging technology industries to excel in their respective fields, they must first operate in compliance. Otherwise, even the best technologies cannot create long-term value. Currently, the days of unchecked growth for VASP are long gone. Although most countries, regions, and jurisdictions have not yet implemented specific regulatory measures for VASP, they have set numerous red lines that VASP must not cross through analogous regulations, judicial precedents, administrative orders, or other means. Moreover, compliance obligations vary across different countries and regions, greatly increasing the operating costs for VASP.

The Saje team believes that following the settlement, the SEC’s allegations against An can be considered supported to some extent. This is likely to lead to similar investigations, prosecutions, and severe penalties for other VASP (especially virtual currency trading platforms) and underlying technology and infrastructure companies, with far-reaching consequences. Additionally, the Saje team reminds us that in terms of regulating emerging technologies, global regulators are essentially feeling their way across the river, learning from each other and considering their own national circumstances to complement each other’s strengths and weaknesses. This directly leads to a certain degree of convergence in regulations regarding virtual assets and VASP among different countries. Therefore, the settlement of An has important reference value for practitioners in China, particularly those operating in the Web3 industry in Hong Kong.

03 Post Settlement, VASP Compliance Practices and Key Insights

In the SEC’s complaint, we can see that regulatory agencies are gradually forming a relatively strict set of criteria for determining whether virtual assets are financial securities. In the case of the United States, although the Howey Test has been heavily criticized, it remains one of the most commonly used criteria by American judicial agencies. Under the premise that virtual assets constitute financial securities, regulatory agencies often choose to conduct substantial penetration oversight of VASP, treating them similarly to traditional financial products such as securities, and attaching strict “shackles” of information disclosure to VASP.

(I) Licensed operation is the protective weapon for VASP

In dealing with cases related solely to virtual assets and VASP, the Saje team has found that some practitioners in the field believe that they should only adhere to the “code is law” principle in the virtual assets field, and whether they have a legitimate operating entity or the necessary qualifications in the real world is not important. This perception is actually incorrect.

As mentioned earlier, regulators are currently more inclined to categorize various virtual assets issued by VASPs, such as virtual currencies and NFTs, as financial securities. In such a regulatory environment, obtaining relevant operational qualifications is very important. Currently, there are not many countries globally that have clear and targeted operational qualification systems for virtual assets and VASPs. Hong Kong in our country is a pioneer in this regulatory model. The conditions for obtaining relevant licenses can refer to the previous article by the Xiaosa team titled “Xiaosa Team | After the JPEX Case, the Hong Kong Securities and Futures Commission Can’t Sit Still……“. For countries and regions like the United States that do not have a specific system for granting virtual asset operational qualifications, the Xiaosa team suggests consulting the local financial regulatory system before operating such businesses. This allows for the possibility of applying for relevant financial product licenses and operating in compliance with the local financial regulatory system.

For VASPs that have already started operating but are still “driving without a license,” the Xiaosa team recommends gradually starting to comply with local traditional financial regulatory rules and regulations while avoiding malicious incidents that harm consumers. It is also important to avoid prematurely “registering” with regulatory agencies.

(II) Substantive compliance is very important.

Those who have been following the Chinese virtual asset market for a long time are already familiar with the two documents issued by China in 2017 and 2021 regarding the clearance of virtual currency-related businesses, namely the “Notice on Preventing Risks of Token Offering Financing” and the “Notice on Further Preventing and Dealing with Risks of Virtual Currency Trading Speculation.” After the September 24 notice, the vast majority of virtual asset practitioners and VASPs quickly withdrew from mainland China and fulfilled their obligations for ongoing compliance in subsequent operations. In particular, VASPs with good compliance not only used conventional methods to prohibit users with specific IP addresses from accessing their services, but also implemented multiple protection measures such as strict KYC requirements and geolocation to prevent residents of mainland China from accessing and using related services with the goal of achieving compliance.

However, the Xiaosa team has found that some virtual asset platforms are still using methods similar to that of certain security software, where users can access and use related services as long as they use a VPN. Some compliance managers of VASPs believe that the use of VPNs is a voluntary action by users and there is no legal or normative document specifying the level of severity or specific effective measures required to “prohibit user access to services.” Therefore, driven by interests, some VASPs still have a sense of luck.

The Xiaosa team reminds everyone that from the settlement cases, we can see that the United States has started to judge the measures taken by VASPs to fulfill their compliance obligations based on substantive criteria. Such behavior of skirting the rules is being clearly identified as non-compliant. Therefore, VASPs should not harbor any more feelings of luck.

(III) Information Disclosure is Important

In addition to the volatile market conditions, the virtual asset industry and VASPs are heavily criticized for not establishing an effective information disclosure system. So far, the Saje team has hardly seen any regulatory authorities in any country or region designing appropriate information disclosure systems for VASPs. Therefore, most countries and regions can only refer to existing financial and securities market disclosure rules to protect the users’ right to information and related investment rights.

From the perspective of the recent case settlement of Mo An and SEC, activities such as wash trading and match trading that occur frequently in the virtual asset industry have become part of the regulatory red line, as they may lead to user misunderstandings. This actually contradicts some VASP operation strategies. The Saje team understands that in the current non-mainstream virtual asset industry, project operators and VASPs need to maintain the liquidity of their products in order to achieve sustainable operations. However, the Saje team suggests that wash trading, as a simple and convenient way to maintain product or platform liquidity, should not be continued. This manipulation of the market can lead to various serious legal risks. If such behavior is transferred to the traditional financial field, it would be considered market manipulation, potentially leading to criminal risks depending on the circumstances.

Platforms should focus on the quality of their products, rule design, and legitimate external marketing to promote project liquidity and visibility, gradually moving away from the quagmire of wash trading.

04 In Conclusion

The settlement case between Mo An and SEC is not only a milestone event worthy of being recorded in the development of virtual assets, but also a butterfly in the South Pacific ready to stir up a regulatory storm by flapping its wings. This case provides numerous reference guides for regulating virtual assets in the United States and offers important ideas for VASPs to achieve compliance during a time when targeted regulations have not yet been issued. The Saje team recommends that VASPs in China, especially those in the Hong Kong region, promptly conduct compliance reviews and remain vigilant to prevent various legal risks.

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