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Thursday, November 30, 2023

Blockchain vs. Old-World Paradigm: The Struggle Just Began

Explore the emerging conflict between blockchain technology and traditional systems. Understand the complexities and potential of this technology as it begins to reshape finance, governance, and societal norms, signaling a significant shift in the global paradigm.

The crypto industry has grown to the extent that it can’t be ignored by the world's major governments. Since all governments need to govern, it’s no wonder why the crypto drowned in all sorts of regulatory bills demanding a wide range of restrictions from mandatory ID disclosures to outright bans.

Binance CEO CZ: “DeFi will be more prominent than CeFi in The Next Six Years”

Let’s recall that in one of the previous articles we wrote, in a statement commemorating Binance’s sixth anniversary on July 14, Binance CEO CZ predicted that DeFi will be more prominent than CeFi in the next six years with more people using DeFi products and interact directly with blockchain networks. He added that DeFi would provide financial services to people who do not have access to traditional financial institutions such as banks.

In February 2022, a Binance spokesperson told CNBC that “… crypto is meant to provide greater financial freedom for people across the globe. To unilaterally decide to ban people’s access to their crypto would fly in the face of the reason why crypto exists”. Well said!

Yet, over the recent months, something has definitely gone awry. Now Binance’s former CEO CZ is facing jaw-dropping charges from the U.S. financial regulators including a lump sum penalty of $4 billion for “violation of anti-money laundering practice” (hopefully, there will be more details soon) and his forceful retention in the U.S. while he’s waiting for the charges to be presented at the trial court. In his last week’s X tweet, CZ wrote: “Today, I stepped down as CEO of Binance. Admittedly, it was not easy to let go emotionally. But I know it is the right thing to do. I made mistakes, and I must take responsibility. This is best for our community, for Binance, and for myself.”

Simultaneously, another prominent CEX exchange, Kraken, is eyeing similar charges in Europe, and many other crypto CEXes do feel increased pressure to present evidence of loyalty and compliance. But… to comply with what exactly? 

There’s still no adopted basic international cryptocurrency legislation, let alone its code of ethics. Repeated attempts to equalize cryptocurrency laws to ordinary securities and exchanges laws invariably lead to nonsense, inherently controversial conclusions, a fact that was remarkably demonstrated by the recent defeat of SEC, the U.S. Securities and Exchanges Commission, in its multiyear litigations against Ripple Labs (XRP).

Meanwhile, the U.S. Commodity Futures Trading Commission (CFTC) has recently warned cryptocurrency exchanges that the “same measures as Binance could be taken against them in the future”. CFTC Commissioner Christy Goldsmith Romero emphasized that the agency will take a “tough approach” to cryptocurrency platforms if they violate trading rules (was it just trading?). The financial regulator “will not tolerate the use of VPN services,” requests to users to confirm that they are not in the U.S., or any other actions that can be used to circumvent Know Your Customer (KYC) procedures.” She emphasized that access to U.S. customers is a privilege, not a right. “We will vigorously pursue crypto platforms operating in the U.S. market if they seek to circumvent the CFTC's regime designed to protect customers,” Romero said. 

Another CFTC commissioner, Caroline Pham, confirmed that the agency will use its international powers and “prosecute cryptocurrency companies for violations, even if they are not U.S.-based”. It sounds like the beginning of a real crusade, doesn’t it?

History of Binance’s Persecution and Downfall

Binance once hailed as a leading cryptocurrency exchange, has faced a series of setbacks since its inception. The platform's rapid growth turned it into a global powerhouse, but its journey has been littered with continuous struggle for a new era, on the one hand, and bitter controversies — on the other. 

Binance emerged in 2017 as a promising crypto exchange, growing fast and offering a wide range of cryptocurrencies, low transaction fees, and superb security. Its founder and CEO, Changpeng Zhao, CZ for short, inspired trust in the market, with his commemorable wittiness and assertiveness, so its popularity skyrocketed. The platform's user-friendly interface and aggressive marketing strategies propelled it to the forefront of the cryptocurrency industry. In just a few years, Binance became synonymous with success.

However, as Binance's reputation kept growing, so did the attention of regulators worldwide. Authorities finally voiced concerns over the lack of transparency (apparently discretionally applying the very same standard securities and exchanges law as a benchmark), potential money laundering (seemingly this charge had finally found evidence, but so far there is not much detail), and security issues on the platform (were acknowledged by CZ who said all those instances were promptly investigated and cracked down on). 

In 2019, Binance faced investigations by regulatory bodies in various jurisdictions, including the United States, Europe, and Japan. In 2020, Binance encountered a significant security breach, resulting in the loss of millions of dollars worth of cryptocurrencies. Although the exchange quickly took measures to address the issue and compensate affected users, the incident raised doubts regarding its ability to safeguard users' funds.

Throughout its downfall, Binance also weathered allegations of market manipulation and insider trading. Several reports surfaced, claiming that the exchange allowed specific traders to exploit the platform for personal gain, giving rise to concerns about fair trading practices.

As regulatory pressures intensified, Binance found itself embroiled in legal battles and faced hefty fines. Finally, authorities in different countries accused the exchange of non-compliance with anti-money laundering regulations and failure to obtain necessary licenses. These charges resulted in substantial financial losses and a tarnished reputation for the once-celebrated exchange.

Binance's downfall and the subsequent charges it faced can be attributed to a combination of factors, including lax regulatory compliance, security breaches, and allegations of market manipulation. The platform's exponential growth and global presence made it a prime target for scrutiny. Although Binance is striving to restore its reputation and comply with regulatory requirements, its journey serves as a cautionary tale about the need for transparency and accountability in the cryptocurrency industry.

Why Binance’s Woes Send Fresh Alarm to Centralized Exchanges, Rather Than to Crypto Industry as a Whole?

CeFi companies like Binance, Coinbase, and Kraken are among the most prominent examples in the industry. These companies offer exchange services that users can access by creating an account and often using fiat cash to fund initial deposits to convert them into cryptocurrencies and start trading them. Even though the primary function of these platforms is to facilitate the transfer of tokens, they are all de facto linked to real bank accounts, and that is exactly where their greatest problems and vulnerabilities lie. 

This is how CeFi inadvertently becomes transparent to regulatory authorities. They must feel now like puppies on a tight leash. There are several powerful monitoring and control tools allowing law enforcement authorities of many countries to collaborate with special services to trace any and every footprint of an individual (whether under investigation or just out of curiosity) if that individual only once used his or her bank account to initialize a given crypto wallet or a centralized crypto exchange account. This oxymoronic pairing becomes not only more and more toxic nowadays, but also increasingly meaningless: how would one pretend to decentralize as long as he or she is linking centralized assets to what must be immune and sterile from the old-fashioned, increasingly complicated and oppressive system?

For example, the cryptocurrency Asset Tracking tool examines the entire lifecycle of a cryptocurrency account. Investigators can use specialized blockchain forensic tools and traditional forensic methods to search, verify, and analyze the entire history of the origins and transaction activity of digital wallets and cryptocurrencies. In July 2022, FSB Published its first warning. “Crypto-assets and markets must be subject to effective regulation and supervision at the national and international levels commensurate with the risks they pose”. In October 2022, the FSB published another paper called “International Regulation of Crypto-Asset Activities”: Proposed Framework — Consultation Issues”. It looks like no one took those warnings seriously.

SEC Methods, Tools, and Authorities over Cryptoexchanges

Cryptoexchanges continuously evolve and innovate, making it challenging for regulators to keep up with new technologies and trading methods. The rapid pace of innovation in the crypto industry can outpace regulatory responses, creating gaps in oversight. However, since fiat currency transfers involve the movement of traditional currency (such as USD) into cryptoexchanges, the SEC, along with other regulatory bodies, can easily focus on various aspects of traditional finances such as ensuring that such centralized cryptoexchanges have robust Know Your Customer (KYC) and Anti-Money Laundering (AML) procedures in place. By monitoring fiat transfers, the SEC can identify potential instances of money laundering or non-compliance with regulatory requirements.

CFTC Methods, Tools and Authorities over Cryptoexchanges

In its turn, the CFTC (U.S. Commodity Futures Trading Commission) interprets the term “virtual currency” to mean any digital representation of value that serves as a medium of exchange, and any other digital unit of account that serves as currency, regardless of format (token, coin, or digital unit) decentralized (via smart contacts). The U.S. Commodity Futures Trading Commission has limited oversight of the virtual currency spot market. However, it has full authority to engage in anti-fraud and anti-manipulation enforcement activities in commodity markets, where some virtual currencies and their derivatives, such as Bitcoin and Ethereum, are traded as commodities.

FSB Methods, Tools, and Authorities over Cryptoexchanges

In its turn, another stringent watchdog, The Financial Stability Board (FSB), plays a significant role in overseeing and addressing risks to the global financial system, including those related to cryptoexchanges such as policy recommendations, which may include guidelines for regulating crypto assets and centralized cryptoexchanges, addressing issues such as broad investor protection, anti-money laundering, and market integrity.

Also, the FSB boasts of its productive international cooperation among regulatory and supervisory authorities of various countries, since it serves as a platform for collaboration, sharing information, and coordinating efforts to address various financial risks. 

The FSB conducts risk assessments and monitors developments in the financial markets, which may affect the fiat part of the cryptoasset sector. The FSB is empowered to identify areas of concern and inform policy discussions and actions related to centralized cryptoexchanges.

The FSB engages with standard-setting bodies, such as the International Organization of Securities Commissions (IOSCO) and the Financial Action Task Force (FATF), to ensure consistent regulatory approaches across jurisdictions. Collaboration with these bodies aims at establishing international standards and guidelines for regulating centralized cryptoexchanges.

Finally, The FSB collaborates with national regulatory and supervisory authorities to promote effective oversight of centralized cryptoexchanges. This cooperation involves sharing information, conducting assessments of national regulatory frameworks, and coordinating responses to emerging risks and challenges.

OFAC Methods, Tools, and Authorities over Cryptoexchanges

“Last, but not the least”, The Office of Foreign Assets Control (OFAC) is an agency of the United States Department of the Treasury that administers and enforces economic and trade sanctions. 

Among other important functions of OFAC that may surprisingly interfere with centralized cryptoexchanges, is its authority to designate individuals, entities, and even entire countries as sanctioned parties. These designations impose various restrictions, including freezing assets, prohibiting transactions, and blocking access to the U.S. financial system. In that case, the agency may just forward a relevant inquiry to a supervisory board of such an exchange, and the latter wouldn’t be able to ignore such a request as long as it is connected to physical bank accounts. Therefore, unlike in the case of DEXes where there’s simply no exact party to send such an inquiry to, centralized cryptoexchanges are expected to comply with these requirements and bring evidence, if requested, they do not facilitate transactions involving sanctioned entities.

Anyway, OFAC expects cryptoexchanges to implement robust compliance programs to detect and prevent transactions that violate U.S. sanctions. That includes conducting due diligence on customers, screening transactions, and reporting any suspicious activity. 

OFAC also has the authority to take enforcement actions against individuals or entities that violate US sanctions regulations. These actions can include civil penalties, criminal prosecutions, and other legal measures. Cryptoexchanges found in violation of sanctions regulations may face significant penalties and reputational damage.

How DEXes are Superior to CEXes by Their “Fiatless” Nature

So now, after we briefly learned about the plethora of such U.S. law enforcement institutions, we realize how important it is for cryptoexchanges to operate independently and outsource the execution of any fiat funding options to third parties — such as e-wallets, qazi-money remittance services, etc. When it comes to privacy, DeFi offers a level of near-anonymity, whereas centralized exchanges that have AML policies in place divulge the identity of address owners to law enforcement agencies. Its permissionless nature is one of its biggest advantages. Anyone can participate from anywhere without using a central authority. This democratizes financial services and is especially beneficial for the unbanked or underbanked.

Only DeFi so far gives us complete control over our funds. P2P trading on DEX does not require users to entrust funds to a third party. This level of financial autonomy, along with a drastic cost reduction, will remain a key selling point for many DeFi users. 

Cryptos and decentralization wouldn’t have occupied so much space in our lives if global finances were in good order. Many prominent investors keep voicing their concerns tirelessly. So the main question of an honest financier is “What else a personal financial freedom would mean if not related to decentralization?”

Made by 0xDEFCAFE, 2023