A new and detailed investigation by Forbes has raised significant questions about the management and custody of customer assets and stablecoin collateral by Binance. There are many possible explanations for the nature and intent of certain on-chain transactions highlighted by Forbes, and they could be entirely innocuous. But Binance’s so far confused and sometimes contradictory responses to the findings do not inspire confidence, particularly in a post-FTX era of rightfully widespread suspicion of centralized custodians with off-chain balance sheets.
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Forbes reported this week that on a single day, Aug. 17, 2022, $1.78 billion worth of collateral moved out of Binance wallets intended to back stablecoins, particularly b-USDC, a wrapped version of Circle’s USDC. According to Forbes’ on-chain analysis, the facts of which Binance has not disputed, $1.2 billion of this was sent to trading firm Cumberland DRW, with other amounts going to now-collapsed hedge fund Alameda Research, Tron founder Justin Sun and crypto infrastructure and services firm Amber Group.
Crucially, according to Forbes, this outflow was not accompanied by a corresponding reduction in the circulating supply of b-USDC tokens.
Binance’s various attempts to offer an innocent explanation of Forbes’ findings have not provided a unified and consistent – much less entirely compelling – justification for what could, in the worst case, indicate the misuse of customer funds. Before publishing a more focused and detailed account Wednesday morning, Binance officials offered a number of differing, even contradictory explanations. Equally galling, Binance’s responses have continued the petulant and defensive tone of many of its previous dismissals of close investigative attention.
The worst-case scenario
Forbes’ investigation was motivated by mounting evidence of past problems with Binance’s asset management practices. Binance has admitted to Bloomberg that, for certain periods of time, it failed to maintain clear 1:1 backing of its wrapped b-assets in a segregated and transparent manner. In this context, the exchange’s attempt to paint an act of journalistic analysis as “conspiracy theories,” while suggesting the investigation was motivated by nothing but “collecting a lot of views and clicks,” is beneath the dignity of an organization hoping to maintain a leadership position in a high-risk, fraud-riddled industry.
Binance CEO Changpeng Zhao even retreated to the oldest refuge of scrutinized crypto organizations, declaring the Forbes reporting nothing more than “FUD,” or fear, uncertainty and doubt. But this lazy, knee-jerk dismissal, now as ever, ignores a simple reality: Unclear or incomplete answers from the people most obligated to have them are far more serious sources of confusion and anxiety than accepted facts and reasonable questions surfaced by journalists.
The least charitable interpretation of the Forbes findings, articulated as a hypothetical by Lumida CEO and co-founder Ram Ahluwalia on CoinDesk’s “First Mover” program Tuesday, is that Binance was engaged in some form of rehypothecation. That is, that the funds backing b-USDC were loaned to counterparties or otherwise put at risk. Based on this possibility, Forbes has compared its findings to the bad practices that led to the collapse of FTX.
This was broadly the claim made by research firm ChainArgos in a Jan. 2 report that first drew attention to the unusual activity. “Someone received a loan of something like $1 billion for about 100 days,” ChainArgos claimed. “It is not clear exactly what happened … but this is very large, very obviously manual and very recent.”
Another theory, hinted at in Forbes’ reporting, is that rather than high-risk rehypothecation, the transactions’ net effect was to swap USDC for BUSD issued by Paxos (these events predate a recent New York Department of Financial Services order halting that issuance). This would have allowed Binance instead of Circle to collect the rising interest on instruments including U.S. Treasury bonds that back the stablecoins. This would be a perfectly rational business move, but could mean b-USDC was at points effectively backed by BUSD instead of USDC.
An uncoordinated defense
Binance has firmly denied that anything like rehypothecation has occurred. However, the exchange at first offered misaligned explanations of what actually did happen.
In the course of its investigation, Forbes interviewed Patrick Hillmann, Binance’s chief strategy officer. Hillmann’s explanation, included in the original story, seemed to be simply that the on-chain wallets understood to contain backing for Binance’s stablecoins are effectively meaningless. “There was no commingling” of customer funds, Hillman told Forbes, because “there’s wallets and then there is a ledger.” According to Hillman, this off-chain, internal ledger is what really tracks assets owned, or custodied, by Binance, with on-chain wallets acting as, in his words, mere “containers.”
As Forbes points out, this would seem to undermine Binance’s claims of transparency, instead compelling customers to simply trust the exchange to responsibly handle their money. While its various responses repeatedly cite a new proof-of-reserves system as a rebuttal to suspicions, the transactions in question predate that system, undermining that argument. While Binance has a long track record as a trustworthy custodian, this seems like turning a willful blind eye to the new environment of paranoia and distrust following the collapse of FTX.
Further complicating the picture, a Binance spokesperson on Tuesday wrote the following in a statement to CoinDesk, arguably contradicting elements of Hillmann’s claims to Forbes.
"Binance does not, and has never, invested or otherwise deployed user assets without consent under the terms of specific products. Binance holds all of its clients’ assets in segregated accounts which are identified separately from any accounts used to hold assets belonging to Binance.”
Note here the spokesperson refers to “holding” customer assets “in segregated accounts,” not to tracking them on an internal ledger. Contra Hillman’s earlier claims to Forbes, Binance is strongly implying here that customer funds are custodied in segregated on-chain wallets. This implication will itself be contradicted before all is said and done.
"The on-chain transactions identified” by Forbes, the spokesperson continued, “relate to internal wallet management. While Binance has previously acknowledged that wallet management processes for Binance-pegged token collateral have not always been flawless, at no time was the collateralization of user assets affected. Processes for managing our collateral wallets have been fixed on a longer-term basis and this is verifiable on-chain."
Next, on the morning of Feb. 28, Binance CEO Changpeng Zhao took to Twitter to push back against Forbes’ findings. His explanation differed from those previously offered by a C-suite executive and his communications team. Hillman claimed the on-chain transactions highlighted by Forbes meant nothing, with all the real accounting under the hood. A Binance spokesperson told CoinDesk that they were part of “internal rebalancing.” But Zhao characterized them as “some old blockchain transactions that our clients have done.”
“Our users are free to withdraw their assets any time they want,” he continued. “Their withdrawals are turned into ‘received hundreds of millions of shifted collateral.’”
This explanation doesn’t entirely pass the smell test even on its own terms. First, describing these as “blockchain transactions” reads like an attempt to suggest they were not mediated by Binance at all. This would directly contradict characterization of the transactions as “internal rebalancing.” Further, Zhao’s characterization implies that Cumberland DSW alone owned or managed $1.2 billion worth of USDC mirrored as b-USDC on Binance, then cashed it all out on the same day – a decidedly unusual circumstance.
A more reasonable inference would be that the big transaction to Cumberland represents the on-chain reconciliation of a large number of customer moves over time, which would make it both a “rebalancing” and a “customer withdrawal.” But none of Binance’s responses explicitly make that claim.
The remainder of the CEO’s thread reiterates Binance’s track record and cites Binance’s recent implementation of a proof-of-reserves system – even though that process has had its share of missteps.
He also writes that “my Chinese ethnicity is brought up again” in the Forbes article, “as if that mattered.” Zhao has arguably been unfairly targeted because of his ethnicity in the past, particularly in attempts to draw connections between him and the Chinese government. But the Forbes article properly refers to him as “Chinese Canadian,” and only does so one time, when introducing him. The words “China” or “Chinese” do not otherwise appear in the piece. At least in this case, Zhao’s complaint looks like a fairly baseless attempt to distract from and discredit the report’s actual findings.
Vagaries and name-calling
After offering three divergent characterizations of Forbes’ findings (the facts of which, it must be emphasized, they did not dispute), Binance finally released what would seem to be its definitive statement on March 1, a blog post titled “How and Why Assets Move Between Binance Wallets.”
The post still includes its share of confusion, but at least lands on a single explanation of Forbes’ findings: The moves were “simply a case of institutional clients withdrawing their own assets from our platform.” This claim comes with very little detail, inviting further scrutiny that it may or may not withstand.
The post does not rebut the core finding, by Forbes and others, that the “peg wallet” meant to back various wrapped assets has been repeatedly off its proper collateralization level. It does not explicitly state, for instance, that backing assets for b-USDC were simply held elsewhere in Binance’s on-chain custody system. Instead, the post settles for the vaguer claim that "at no time was the collateralization of user assets affected" by peg wallet mismanagement.
The statement essentially reiterates Hillman’s initial point that on-chain accounts managed by Binance do not necessarily correspond to real customer balances. This is common practice among crypto exchanges, but amounts to hand-waving in this context. The post refers broadly to “a vast network of hot, cold and deposit wallets” and to “the fact that the movement of funds between wallets could serve a variety of purposes.” The gist sometimes seems to be “you wouldn’t really understand even if we explained it to you.”
See also: Changpeng Zhao Won't Rescue Binance by Selling out Crypto | Opinion
Binance also strikes an incoherent stance towards journalism and oversight. On the one hand, the exchange touts its transparency and says it welcomes scrutiny. It also again admits it has in the (relatively recent) past failed to properly manage pegged assets. This would seem to justify increased scrutiny – yet the post also repeatedly denigrates journalists as little more than clickbait-hungry, conspiracy-theorizing ambulance chasers.
After the collapse of FTX, Celsius Network and a half-dozen other apparent frauds, this perspective is deeply out of touch with the anxieties of crypto investors and users. Those anxieties have manifested in meaningful outflows from Binance custody and assets over the past month.
It’s unclear whether Binance’s vague, defensive, sometimes confusing responses to the latest round of scrutiny is sufficient to quiet those concerns.