Tuesday, January 10, 2023

Binance's Time In The Barrel

The bulk of last month's Dominoes was about Binance, the dominant unregulated cryptocurrency exchange, and the risk that in the wake of FTX's collapse it might be the next victim of cryptocurrency contagion. Just as happened with FTX, once the media picked up on reports of problems, further stories came thick and fast. So below the fold are updates on two of the problems facing Binance.

Income Drop

The non-fraudulent way for a cryptocurrency exchange to make money is by charging transaction fees. The more transactions, the more fee income. Last November 1st, one week before FTX suspended withdrawals, I wrote in Greater Fool Supply-Chain Crisis:
Why would retail investors buy? They are facing high inflation and a looming recession, their stock and bond portfolios are evaporating, and their cryptocurrency HODL-ings have evaporated even faster. It isn't just retail:
Meanwhile, institutional digital-asset products this month saw their lowest-ever volume in data going back to June 2020, with average daily trading volume dropping 34% to $61 million, according to CryptoCompare.
Source
The subsequent collapse of FTX, and its spreading contagion, haven't helped. In ‘Spectacular’ Trading Drop Plagues Still-Reeling Crypto Market Vildana Hajric and Olga Kharif write:
In 2022, trading volume on centralized exchanges such as Coinbase, Kraken and Binance plunged more than 46%, according to data compiled by CryptoCompare. On Binance, which remains the leader in terms of market share, spot trading fell 45% to $5.4 trillion. And Bitcoin, the most-traded digital asset, saw trading volumes decline 31% year-on-year, the researcher said in a report.
Eyeballing the graph one can estimate that centralized exchange volume is currently about 90% down from the peak around May 2021, and decentralized exchange volume is down around 90% from its peak around November 2021. This must leave exchanges desperate for non-fee income streams and thus, as Matt Levine suggested in How Not to Play the Game, tempted to cheat commit fraud.

Magic Beans and Bogus Blockchains

Two recent readable summaries of investigations by @cryptohippo65 and DataFinnovation are Dirty Bubble Media's The Binance Scam Chain and Patrick Tan's Binance Built a Blockchain, Except it Didn’t. Dirty Bubble Media summarizes the results of the investigations thus:
The Binance Smart Chain and BNB are cornerstones of the Binance empire. However, recent analyses have called almost every aspect of this blockchain into question. It turns out that, like many things with Binance, a closer look reveals cracks within the fa├žade. The vast majority of BNB tokens appear to be owned directly by Binance, and market analysis suggests that the price has been artifically inflated. Billions of dollars in purported stablecoins pegged to the U.S. dollar on the BSC were not backed with real assets for weeks at a time. The code base for BSC is not open source and appears to be controlled directly by Binance employees. And most importantly, a deep dive into the Binance Smart Chain suggests that it might not function like a blockchain at all…

Magic Beans

FTX imploded in part because much of their reserves consisted on FTT, a token they created. FTX held the vast majority of FTT, and controlled much of the trading in it. This allowed them to manipulate the "price" of FTT and thus the "value" of their reserves of these magic beans. All appeared well, but the "price" of FTT didn't reflect what it could be sold for once it was pointed out that it was a magic bean.

Similarly, Dirty Bubble Media writes:
BNB is the fifth-largest cryptocurrency with a market cap of $42 billion. Based on Binance’s own public records, they directly own between 70-80% of the total BNB. The blockchain analyst @cryptohippo65 examined Binance’s proof of reserves information to determine the allocation of BNB across both Ethereum and Binance blockchains. Cryptohippo65 discovered that the vast majority of BNB on Ethereum and the BSC were likely attributable to customer holdings. This accounted for around 15% of the circulating supply
...
However, nearly all of the BNB on the “governance” chain for the Binance blockchain, called the Beacon chain, appears to be owned directly by Binance. This can be determined by a simple process of elimination: Binance does not include these addresses in their customer proof of reserves address list, yet they clearly control these addresses.

This means that Binance is holding somewhere between $28-32 billion worth of BNB on its balance sheet. Yet BNB’s price is not determined independently of Binance itself, as Binance (unsurprisingly) hosts the largest trading pairs for BNB.
How liquid is BNB?:
Based on data from the last 30 days, the ratio of daily spot trading volume to market cap for BNB was roughly 1%. This is significantly lower than the average ratio for Bitcoin (5.4%) or Ether (3.0%), indicating that BNB liquidity is markedly lower than other major cryptocurrencies. The true BNB volume is likely much lower since a large fraction of this alleged volume is reported by highly questionable microexchanges.
Is there any sign that BNB was pumped the way FTT was? This is where Binance's allegedly "fully backed" metastablecoin BUSD comes in. It is deliberately confusing, because it exists on multiple blockchains. The basis for BUSD is BUSD-on-Ethereum, credibly backed 1-for-1 because it is run by Paxos, not Binance, and Ethereum is a credible blockchain. Binance runs a bridge from BUSD-on-Ethereum to BUSD on multiple Binance operated blockchains. The claim is that a peg-BUSD on these blockchains is matched exactly by a BUSD locked on the Ethereum blockchain.

Source
DataFinnovation showed that this claim wasn't always true. Dirty Bubble Media explains:
DataFinnovation went back in history to examine these peg-BUSD tokens. When he tried to match the number of pegged tokens to the Ethereum BUSD held in reserve, DataFinnovation discovered that the Binance backing wallet frequently ran at a large deficit for weeks at a time
...
In other words, Binance had printed dollar equivalents from thin air. As DF notes, at a minimum this suggests incredible disorganization at Binance. DF also noted something interesting: the periods where pegged BUSD was unbacked correlated neatly with periods of time when BNB prices skyrocketed. It is almost as if Binance needed the money to raise the price of BNB…
DataFinnovation writes:
The run up in price begins exactly when the dramatic unbacked printing starts. Similarly the price stops rising, and then retraces a bit, when the printing stops.

This does not prove anything of course. Doubly so as the BUSD are eventually backed by ERC20 tokens in the peg wallet. But it is suspicious and indicates that pumping of BNB with unbacked BUSD might have occured. At best — at absolute best — Binance was careless during this time as the tick marks on the horizontal axis are almost 7ish weeks apart.

Further this activity occurred nearly 2 years ago in a major stablecoin, branded by the largest exchange, on a major chain. There is surely a lot still to be discovered.

Bogus Blockchains

Maybe I'm naive, but I would think that if the two blockchains and the bridge were correctly implemented it would not be possible to mint unbacked peg-BUSD.

We can assume that Ethereum is correctly implemented, and as far as I know no-one has claimed that the part of the bridge that runs on Ethereum isn't. We don't know about the other part of the bridge. But thanks to research by DataFinnovation acting on a tip from @cryptohippo65 we do know that the Binance Smart Chain is not what anyone should call a blockchain. DataFinnovation documented the research in this Twitter thread and explained it in BNB Beacon Chain: Not A Blockchain?. Patrick Tan provides a summary:
DataFinnovation went ahead to try and sync [the blockchain] from the genesis block, and generated the following error:
panic: Failed to process committed block (285075852:2BDC391C402FF452B83AD484D5C40DA615133C25E60C07352CBC6E45435EA873): Wrong Block.Header.AppHash. Expected 3E60F1573122DC7FAD2C5E4779A21BFEEB578422C915A16DEA70A1A617314720, got 1EDDADB1DC0B8E67A3F10FCE05201A4A59A7C380EC54F3CA83D400317CC49685
...
DataFinnovation goes further to identify where the exact failure to sync can be found, and it’s here and after several attempts, found that the Binance Chain regularly breaks at these timestamps.
Coincidentally, Binance, the centralized cryptocurrency exchange resets its price candles at the same time everyday.

Nonetheless, what DataFinnovation has discovered is that the Binance Chain breaks every 24 hours, without fail, yet somehow the blockchain still runs and validators somehow push past the previous breaks
There are a lot more suspicious aspects to the Binance Chain. Among DataFinnovation's discoveries were not just that the hashes verifying the "blockchain" are routinely rewritten to alter history, but also that:
  • Balances in wallets change with no corresponding transactions on the chain.
  • The two blockchain implentations were forked from the originals (geth and Cosmos) in ways that make identifying differences difficult.
  • Important parts of the implementations are not open-source.
  • Parts of the systems are distributed as byte-code.
  • Non-Binance nodes have to run from binary distributions, not source.
  • The binaries for the test nets and the production nets are different.
  • When questioned via Twitter, the "Binance Chain Chief Scientist" stopped responding.
All of which suggests that trusting the Binance "blockchains" would be foolish, since they have been deliberately built to evade the transparency and consistency that are the goals of blockchain technology. Patrick Tan sums up:
While there have been no allegations against Binance for any form of wrongdoing with respect to its blockchains, that it was potentially issuing an unbacked dollar stablecoin and possibly engaging in pump and dump activities may raise the ire of law enforcement agencies in the U.S. who have had their targets set on the cryptocurrency exchange since 2018 for alleged money laundering and evasion of sanctions.
And so does Dirty Bubble Media:
The value of BNB is, in theory, derived from its use case as the “stock” of the Binance blockchain. We showed above that, like FTT or CEL, BNB ownership is highly concentrated in the hands of Binance itself. In yet another flywheel scheme, Binance appears to have spun up tens of billions of dollars in free assets on paper. We don’t know if Binance has leveraged these tokens; their CEO insists that Binance has no loans. Regardless, it’s clear that the BNB held on Binance’s books are worth far less than what current market prices suggest.

As we have demonstrated, there is substantial evidence that there are major problems with the Binance Smart Chains as well. These include hypercentralization of chain governance in the hands of Binance, periodically unbacked stablecoins, and a closed-end project under the control of a shadow group tied to Binance. Most importantly, DataFinnovation’s analyses suggest that the BSC does not operate like a proper blockchain.
My assessment is that the risk level of Binance is rapidly increasing, and that there are more revelations to come.

5 comments:

David. said...

Emily Nicolle and Muyao Shen report on the response to DataFinnovation's work in Binance Acknowledges Past Flaws in Maintaining Stablecoin Peg Reserve:

"Binance signaled that the “peg,” referring to the amount of BUSD locked as collateral to support its own token, had frayed in the past but is now intact.

“The process of maintaining the backing involves many teams and has not always been flawless, which may have resulted in operational delays in the past,” a Binance spokesperson said in an email to Bloomberg News. “Recently, the process has been much improved with enhanced discrepancy checks to ensure it’s always backed 1-1.”

Binance-peg BUSD is currently fully backed and there was no impact on Paxos’s BUSD, the spokesperson added. “Despite variances in the data, at no point were redemptions impacted for users,” they said, without specifying how long Binance-peg BUSD was undercollateralized for, or when the exchange noticed and fixed the issue."

There are three glaring omissions from this article:

1) There is nothing about why BUSD was undercollateralized and the correlation between those times and huge "price" spikes in BNB.

2) The article doesn't question the implication in Binance's statement that the process of minting peg-BUSD isn't automated by a "smart contract", it "involves many teams" of humans.

3) There is nothing about the revelation that the blockchain underlying the vast majority of BUSD is bogus because its history is routinely rewritten.

David. said...

In the post I wrote:

"Maybe I'm naive, but I would think that if the two blockchains and the bridge were correctly implemented it would not be possible to mint unbacked peg-BUSD"

And in the previous comment I wrote:

"The article doesn't question the implication in Binance's statement that the process of minting peg-BUSD isn't automated by a "smart contract", it "involves many teams" of humans."

I should have put these two together. If Binance had proper automated bridges minting $1B to pump BNB would have required fiddling with the code in the way FTX had backdoors for Alameda. Much better to have manual processes so that the $1B can be blamed on a mistake by some peon in accounting who can be the scapegoat. Not the equivalent of FTX's Gary Wang.

Similarly, one can ask why Binance has a bogus blockchain. If you're going to take the risk of running a major money laundering operation you want to avoid having an auditable blockchain recording what you're doing. There's no way the changes they made to geth and Cosmos were accidental - they needed to break the ability of outsiders to audit the transaction history, and maybe to find ways to skim more of the money transiting the laundry.

David. said...

David Pan reports that Binance Says Signature Sets Transaction Minimum Amid Pullback:

"Binance, the world’s largest cryptocurrency exchange, said Signature Bank will only handle user transactions of more than $100,000 as the bank decreases its exposure to digital-asset markets.

“One of our fiat banking partners, Signature Bank, has advised that it will no longer support any of its crypto exchange customers with buying and selling amounts of less than 100,000 USD as of February 1, 2023. This is the case for all of their crypto exchange clients. As a result, some individual users may not be able to use SWIFT bank transfers to buy or sell crypto with/for USD for amounts less than 100,000 USD,” Binance said in a statement sent to Bloomberg News on Saturday."

Patrick McKenzie suggests an explanation:

"I would assume that $100k is the threshold where a bank might choose to identify in its AML policy that any wires above will undergo secondary screening (sometimes called “enhanced due diligence”) *at the bank.*

And below that the bank might have made a risk-based calculation that routine retail use of a crypto exchange could rely on the exchange’s or sending bank’s AML/KYC policies."

No bank can credibly rely on Binance's AML/KYC policies.

David. said...

Last April Angus Berwick and Tom Wilson reported on How crypto giant Binance built ties to a Russian FSB-linked agency:

"In April 2021, Russia's financial intelligence unit met in Moscow with the regional head of Binance, the world's largest crypto exchange. The Russians wanted Binance to agree to hand over client data, including names and addresses, to help them fight crime, according to text messages the company official sent to a business associate.

At the time, the agency, known as Rosfinmonitoring or Rosfin, was seeking to trace millions of dollars in bitcoin raised by jailed Russian opposition leader Alexei Navalny, a person familiar with the matter said. Navalny, whose network Rosfinmonitoring added that month to a list of terrorist organisations, said the donations were used to finance efforts to expose corruption inside President Vladimir Putin's government."

David. said...

Emily Nicolle reports that Binance Acknowledges Storing User Funds With Collateral in Error:

"Binance Holdings Ltd., the world’s largest crypto platform, acknowledged that it mistakenly keeps collateral for some of the tokens it issues in the same wallet as exchange-customer funds.

Reserves for almost half of the 94 coins that Binance issues, known as Binance-peg tokens or “B-Tokens,” are currently stored in a single wallet called “Binance 8” which also holds customer assets, according to listings visible on its website on Monday. The wallet contains significantly more tokens in reserve than would be required for the amount of B-Tokens that Binance has issued, indicating that collateral is being mixed with customers’ coins rather than being stored separately, as has been done for other Binance-peg tokens according to the company’s own guidelines.'

I'm sure this is an innocent mistake not an indication that Binance's operations are as screwed up as FTX's were.