The Binance exchange has admitted a mistake in storing users’ cryptocurrencies. What’s the problem?
Binance, a major cryptocurrency exchange, stores collateral for some of its issued tokens in the same wallet as customer funds. The day before, representatives of the trading platform officially acknowledged this fact and promised that the error will be corrected. In theory, this practice of holding different types of assets together makes it much more difficult to manage collateral for the exchange’s liabilities, and this could already lead to a liquidity crisis at a critical time. We tell you more about what is happening.
How does Binance store cryptocurrencies?
Reserves for nearly 94 of the tokens issued by Binance, also known as B-tokens or Binance-peg tokens, are stored in a wallet called “Binance 8”. The wallet contains significantly more assets than would be required for the volume of such tokens issued by Binance. This means that the collateral for the tokens is mixed with customer assets rather than being stored separately, which is against the rules of the exchange itself, among other things.
As a reminder, Binance-peg or "Binance-linked" tokens mean tokens that exist in the BNB Chain network, with their value tied to another asset. For example, Binance-Peg Cardano are Cardano ADA tokens based on the BNB Chain network. With these tokens, users can transact with selected crypto-assets within a single blockchain, making it much easier to do so. The very need for B-tokens is that cryptocurrencies usually work exclusively within their own blockchain.
Here’s how a Binance spokesperson commented on the situation in an interview with Bloomberg.
“Binance 8 is a cold wallet exchange. Collateral assets were previously transferred to this wallet in error and are listed accordingly on the “B-Token Proof of Collateral” page, i.e. proof of collateral for B-tokens. Binance is aware of this error and is in the process of transferring these assets to separate token-only wallets.
Binance’s rules regarding B-tokens
As a reminder, the underlying popular digital assets are only compatible with the blockchain on which they were created, so you have to find ways to allow the coins to be used on other networks. Binance issues its own versions of coins like Ether or Stablecoins on its BNB Smart Chain and BNB Beacon Chain blockchains. This simplifies user activity and makes it easier for users to interact with crypto-assets.
The tokens in question must be backed by one-to-one reserves of the original coins, and the reserves must be stored in special wallets to separate them from customer and exchange funds. These rules are spelled out in Binance’s policy. The lack of separation means it is difficult to verify how many coins Binance holds in reserve to meet potential redemption requests for the amount of tokens issued.
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A spokesperson for the exchange also stated that all user assets on Binance “have been and continue to be secured at a 1:1 ratio”. All this is happening even despite the exchange’s “misstep” in the “Binance 8” wallet situation.
Overall, “Binance 8” holds more than $16.5 billion in assets in various tokens other than B-token-related ones. This means there are more than enough crypto-assets on the platform, so it is unlikely that the exchange will be conditionally insolvent.
Funds in the Binance 8 wallet
Until November last year, cryptocurrency asset management, while sometimes questionable, was not yet a hot topic of discussion within the industry. But then there was the collapse of the FTX platform, caused precisely by the mismanagement of the company’s funds. As a reminder, former FTX CEO Sam Bankman-Fried is suspected of embezzling customer funds, though he himself continues to deny all allegations.
Proof of Binance’s reserves
The bankruptcy of FTX has spurred a new trend within the industry – the publication of proof of the exchange’s reserves. In this regard, Binance was one of the first to start sharing data about its assets after the collapse of FTX. However, even this initiative has received plenty of criticism. Experts have repeatedly reproached the company for needing data not only on reserves, but also on the exchange’s liabilities in order to understand its financial situation. As we already know, some platforms do this.
The collapse of FTX has also borne other fruit. The day before, the New York Financial Services Department (NYDFS) outlined basic customer asset management rules in an open letter to cryptocurrencies. It’s about exactly how crypto clients should be segregated from one another, how coins should be used by custodians, and how to ensure proper disclosure of companies’ finances. The new rules apply to companies that operate in New York state and hold what is known as BitLicense, a business licence issued by the state’s public body since 2015.
How cryptocurrencies are regulated
Here’s a quote from a NYDFS letter published by news outlet Decrypt.
As custodians of other people’s assets, organisations that deal in virtual currencies, hold other people’s assets and act as custodians must use robust fund management processes similar to traditional financial services providers.
Buying cryptocurrency
As a reminder, asset custodians play a crucial role in the financial industry by ensuring that client funds, whether funds or stocks, are stored in an organised and secure manner. The regulator’s new recommendations relate specifically to cryptocurrency companies in this area. The authority has recommended that other people’s digital assets be kept separate from those belonging to the company itself. This applies to coins both on the blockchain and in the balance sheet.
Customers’ crypto should also not be misused – a particularly relevant point in light of the collapse of the FTX exchange last year. Misuse of funds was one of the main reasons for its bankruptcy.
Custodians are also obliged to provide their clients with written information about specific arrangements in the disposal of their funds. Regulator officials said NYDFS experts conducted a “thorough analysis of the current regulatory landscape,” studied market trends and spoke to prominent figures in the crypto industry as well as other US regulators.
Former Kraken executive Jesse Powell
Overall, the new rules published are fairly straightforward, but the concept of BitLicence itself raises more questions. In the past, disagreements over its key principles were the reason for the withdrawal of cryptocurrency exchange Kraken from the state of New York in 2015. Kraken CEO Jesse Powell said at the time that issuing such licences was a direct abuse of state regulatory authority.
We think this mistake by Binance is dangerous enough - but only in the current coin market environment. Still, cryptocurrency enthusiasts have not yet recovered from the shock of the FTX collapse, which means any atypical asset transactions on trading platforms will still cause apprehension and even panic. Fortunately, this crypto exchange still has huge amounts of assets in its cold vaults, so users obviously have nothing to worry about.
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