As the crypto industry warns of offshoring, Binance represents the worst-case scenario for U.S. regulators

Proof of State is the Wednesday edition of Fortune Crypto where Leo Schwartz delivers insider insight on policy and regulation.

With the crypto industry facing a deluge of regulatory backlash, the common refrain among U.S. entrepreneurs is that aggressive action will push them offshores, where they can freely frolic in the sandboxes of more hospitable regimes, like the Bahamas or Dubai. This tired rhetoric often elicits eye rolls—traditional bankers have been using the argument for years, after all—but Monday’s stunning salvo from the CFTC against Binance illustrates what it really means to let crypto operate outside of the control of U.S. regulators.

The lawsuit from the CFTC alleges that Binance, the famously stateless exchange, had not only found loopholes to offer its unregistered, exotic derivatives products to customers in the U.S., it was encouraged to do so at the behest of its founder and CEO, Changpeng “CZ” Zhao. The CFTC, naturally, did not appreciate the fact that the exchange was pushing customers to evade U.S. regulations.

Reading through the complaint, it’s obvious why Binance would try to operate illegally in the U.S. despite the inevitable crackdown. In October 2020, a Binance employee informed CZ that one Chicago-based trading firm was responsible for 12% of the exchange’s volume. CZ replied to make sure the firm wasn’t connecting with a U.S.-based IP address.

VPN shenanigans aside, the CFTC’s allegations reveal the true nature of Binance’s operational black box. The exchange was not only offering preferential treatment to VIP clients but also to itself through 300 “house accounts” directly or indirectly owned by CZ and affiliated companies. When the CFTC inquired about how Binance accounts conducted their own proprietary trading on the exchange, the company refused to respond.

The CFTC stops short of calling this insider trading but notes that none of the house accounts were subject to anti-fraud or anti-manipulation surveillance or controls. The complaint also implies that Binance’s employees may not abide by the exchange's “relatively new” insider trading policy. CZ, of course, denied that the exchange trades against its own customers for profit.

Reading through the allegations, I was reminded of a similar case brought by the Department of Justice against an ex-employee of Coinbase, who used advanced knowledge of token listings to profit handsomely. The tipoff initially came after a Crypto Twitter sleuth deduced that insider trading was likely occurring, and Coinbase quickly opened an investigation.

Coinbase is far from a perfect company and has its own share of money laundering skeletons in its closet. Even so, it has demonstrated a willingness to operate within the bounds of U.S. regulation, recently working with the New York Department of Financial Services to settle its compliance issues, as well as swiftly stamping out insider trading in the case of the rogue employee.

Even if Binance is innocent of the accusations from the CFTC, the allegations make clear that the company is operating mostly outside the reach of U.S. regulators, just like another exchange that faced an ignominious end. That's not to mention the increased market share of Tether in the wake of banking-induced shakiness to USDC. If companies are pushed offshore, customers will keep finding ways to use them regardless of where they are based—and Binance will just be the beginning.

Leo Schwartz
leo.schwartz@fortune.com
@leomschwartz

This story was originally featured on Fortune.com

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