The King is dead, long live the king. On Tuesday, November 21, Binance, what was the world’s largest cryptocurrency exchange, and the CEO, Changpeng Zhao (CZ), both pled guilty to having engaged in criminal activity. With the U.S. government finally prosecuting the largest crypto-criminals, perhaps now cryptocurrencies can emerge from the shadows and grow towards their potential.

Digital assets and blockchain technology have been touted as revolutionary, and perhaps that is true. The ability to transmit cryptocurrency, “money”, at any time, nearly instantaneously, and without middlemen certainly has appeal. Even the idea of a digital asset as an investment, without further utility, is a valid potential use case. The problem with the digital asset class was that the potential was overshadowed by some participants.

Many of the early-movers in the cryptocurrency industry have been alleged to violate financial rules and regulations, and in the case of Binance and FTX founder Sam Bankman-Fried, proven to have engaged in criminal activity.

The newest generation of participants in the digital asset space are different. There are firms seeking to develop the technology and work within the established financial services industry. Perhaps the developments will be more evolutionary than revolutionary. By working within the rules these firms will bring about changes that may be adopted by more people and the greater economy, and perhaps equally importantly, accepted by the U.S. regulatory authorities.

Cryptocurrency and digital assets are not new, but perhaps the milestone events of the collapse of FTX, and what may be the end of Binance, are the beginning of a new era. With the removal of those seeking to skirt of disregard the law, legitimate businesses now have the opportunity to thrive. We may be seeing what in hindsight will be revealed as the real beginning of the digital asset class.

The Monitorship

As part of the plea arrangement with the government, Binance agreed to pay $4.3 billion, the largest penalty in US Treasury and FinCEN history, and Changpeng Zhao stepped down as CEO and will be subsequently sentenced to fines and a prison sentence that may be as long as ten years.

Binance was permitted to continue operations, but under numerous conditions, some of which as specified in the consent agreement with the Financial Crimes Enforcement Network (FinCEN). Those conditions are what are likely to fatally cripple the company.

The settlement agreement with Binance includes a complete exit from the United States, and a five-year monitorship where the U.S. Treasury Department will retain access to books, records, and systems of Binance. The Monitor will provide reports that will be made available to FinCEN, Office of Foreign Assets Control (OFAC), the Commodity Futures Trading Commission (CFTC), and the Department of Justice. Interestingly, the Securities and Exchange Commission (SEC) was not a party to the settlement, and Binance still must address the SEC concerns.

The monitor agreement also specifies additional scrutiny of the top 35 customers by revenue both immediately, and annually throughout the term of the monitorship. Plus, Binance must review all transactions from 2018 through the end of 2022 and file all Suspicious Activity Reports that should have been filed during that period.

The Case for the End of Binance

Binance engaged in criminal conduct. In addition to numerous law-abiding customers, Binance actively solicited those engaging in questionable or criminal conduct.

In his remarks announcing the Binance settlement, Attorney General Merrick B. Garland quoted a February 2019 Binance internal chat when one compliance employee wrote that they needed a banner that said: “is washing drug money too hard these days – come to Binance; we got cake for you.”

Who will be the Binance customers of the future?

Criminal customers do not want their activities shared with the U.S. government. People engaged in tax evasion or avoidance definitely would prefer not to have the IRS privy to their trading activity. Entities not resident in the USA also do not generally wish to have their activities and information shared with the U.S. government, often for entirely legitimate reasons.

Under the terms of the settlement agreement customers of Binance will likely have more of their information shared with multiple U.S. government agencies than those customers would experience at any other exchange provider – including those based in the USA.

That means the big question is what type of customer will continue with Binance?

What advantage will Binance hold over competitors that overcomes all the baggage that comes with remaining a customer of Binance? Will those advantages be enough to overcome both the scrutiny of the monitor and the stigma that may attach to customers who elect to interact with an organization that pled guilty to serious criminal charges?

If the competitive advantage of Binance was that they were willing to circumvent compliance obligations, what is their leading differentiator going to be now?

What did Binance Do?

Binance pled guilty to having engaged in criminal conduct from the very beginnings of the company. These were not victimless crimes.

The Department of Justice (“DOJ”) press release of the settlement noted “The violations include failure to implement programs to prevent and report suspicious transactions with terrorists — including Hamas’ Al-Qassam Brigades, Palestinian Islamic Jihad (PIJ), Al Qaeda, and the Islamic State of Iraq and Syria (ISIS) — ransomware attackers, money launderers, and other criminals, as well as matching trades between U.S. users and those in sanctioned jurisdictions like Iran, North Korea, Syria, and the Crimea region of Ukraine. By failing to comply with AML and sanctions obligations, Binance enabled a range of illicit actors to transact freely on the platform.”

The DOJ continued, “Binance willfully failed to report well over 100,000 suspicious transactions that it processed as a result of its deficient controls, including transactions involving terrorist organizations, ransomware, child sexual exploitation material, frauds, and scams.”

Outside of the settlement announced this week by the DOJ, the SEC still has thirteen outstanding charges against Binance and CZ. The charges include operating unregistered exchanges, broker-dealers, and clearing agencies; misrepresenting trading controls and oversight on the Binance.US platform; and the unregistered offer and sale of securities.

The Future

The digital asset class may have the potential to bring substantial benefits to the world’s financial system as claimed by the proponents, or it may not. The development of the asset class was held back by bad actors such as Binance, and we have not given cryptocurrency a real chance to prove value.

Binance was cheating, and they rigged the game. They were not playing by the same rules as legitimate businesses. Consider the impossibility of winning a game of the family favorite Monopoly when playing against someone who takes money from the bank at will. The honest players are quickly forced out of the game, or they quit in frustration. Binance may not have stolen money from customers, but through the lack of a level playing field they certainly grew at the expense of legitimate competitors. The harm to competitors, and the digital asset class itself, is unmeasurable.

The price of Bitcoin
BTC
rallied to over $38,000 on Friday morning from under $36,000 immediately after the Binance news, and from around $16,000 the beginning of the year. If the positive market reaction to the guilty plea from Binance is any indication of the future, it looks like the digital asset class is at a new beginning.

The rally in the Bitcoin
BTC
price is great to attract attention but is not the signal of the coming greater adoption of cryptocurrency. The real signal is the investment discussions happening in the backrooms. The outlaw cowboy culture of the early days of crypto is fading quickly, and robust businesses are appearing as digital assets grow into a viable asset class. The key to visualizing what is going to happen to the future of crypto currency is to follow the money, and investment dollars are flowing into real businesses.

The institutions, venture capital firms, and angel investors place their bets on the future by investing in early-stage companies, and where they place their money is a sign of what they expect to happen. In many cases, the investments manifest the future because companies that are well-funded early tend to become the leaders of tomorrow.

Today institutions are investing in well-regulated companies with experienced leaders at the helm. The quiet backroom discussions are about supporting the firms that are going to work within the established financial system, and to facilitate the realization of the potential for the asset class. The conversation has changed.

Very young entrepreneurs without material financial services experience are no longer easily raising gobs of money to start fanciful new businesses, and investors are recognizing that regulation impacts all aspects of financial services – although perhaps that realization was a little slower in coming and hitting a little harder for some.

Six years ago, I left my career as a Managing Director working for global investment banks, and cofounded LevelField Financial to serve customers who are interested in the digital asset class. The vision remains straightforward: vertically integrate the leading customer service and user experience of a fintech firm with the trust, financial strength, and regulatory advantages of a full-service, FDIC insured, U.S. chartered bank.

Whenever people interact with cryptocurrency and the financial system, they must use the services of an intermediary. Banks in the USA are arguably the safest institutions for consumers. Since the introduction of the Federal Deposit Insurance Corporation (FDIC) in 1934, not a single penny of an insured deposit has been lost from bank failure. Digital asset class participants should not have to rely upon firms that have not earned that same level of trust.

In order reach the potential represented by digital assets there first must be closer integration with the established financial services industry. Market participants need seamless and easy transitions between banking and the digital world. In areas that involve money, and particularly for companies that safeguard other people’s money, change must be through evolution and not revolution.

Along the way we have met company founders that also saw the potential of digital assets and had ideas to integrate digital assets and blockchain technology into mainstream financial services. They, too, left solid careers to build something new, and our experiences of the past few years are similar.

Today we are holding discussions with investors at every scale, and they are interested in companies like ours that are clearly operating within the regulatory framework. Compliance and adherence to best-practices are sought after attributes. The questions on almost every investor’s mind are now about regulations, and finally the investment community has moved to my company’s area of strength.

The early fundraising efforts were difficult. The single biggest question we received from investors in the crypto-community was “Why a bank?” For people not familiar with the asset class, the sentiment back then was reversed. Perhaps our experience was best represented by a question we received from the general counsel of a billionaire family. He derailed our pitch meeting and did not allow us to present our company because all he wanted to talk about was “Why Bitcoin?”

Today digital assets are a recognized financial asset class and are components of well-diversified portfolios of mainstream investors. The cryptocurrencies with the larger market capitalizations, like bitcoin and perhaps a few others, are perceived as a growing asset class with unique investment characteristics.

In 2018, I was physically spat upon by a young man (wearing expensive sneakers and trying desperately to look cool) for suggesting that cryptocurrency was an investment and will evolve to where it is today. He was horribly offended that I believed in a future for cryptocurrency that encompassed everyone. He believed that he should be allowed to do what he wanted. Crypto had no rules, so he had no responsibility to stay within the rules when taking other people’s money to grow his business. He wanted to get rich, and the establishment should leave him alone to do as he pleased. I sometimes wonder what became of him. Did he obtain his dreams of wealth, or did it all come crashing down?

Later that same year I gave an address at a large conference and spoke about the need to play by the rules. My talk was about the great potential for digital assets, and my concern that the asset class could not grow without ensuring that investors were protected. My worry was not about price volatility, but rather commonsense concerns about ensuring the strength of financial intermediaries.

History has taught us that regardless of the asset class, worrying about protection of customer assets and reducing the potential for bad actors to abscond with funds are legitimate concerns. I did not realize it at the time, but I was talking about some of the most well-known firms in the space. My fears were realized in the bankruptcies of firms such as FTX, Celsius, Quadriga, and the like. Back in 2018 my speech was met with derision and loud booing.

The cryptocurrency community is excited by the possibility of the listing of exchange traded funds (ETF) for bitcoin and other digital assets. Prior to creation and listing an ETF must receive permission from the Securities and Exchange Commission (SEC), and such permission has not yet been forthcoming. The mere fact that cryptocurrency market participants are waiting on regulatory developments is another sign that the market has evolved substantially. What must my sneaker-wearing friend be thinking?

The price of bitcoin recently hit a yearly high in the mid-thirty thousands, and with the rally volume is returning to the cash markets. This is no doubt a good thing for the asset class. Still. the best sign of the future of cryptocurrency is not found in the price action, but rather in the long-term investment activity in the supporting infrastructure.

The conversations in the back rooms suggest that the digital asset class is here to stay. We know, we are engaging in those investment discussion. The next generation of companies supporting the digital asset class will play by the rules and facilitate mass adoption. The positive sentiment is encouraging.

US District Judge Analisa Torres in New York ruled on Thursday that Ripple Labs Inc. sales of the XRP
XRP
token to institutional investors is a securities offering, but such sales are not securities when sold to the general public. The court did not rule on whether secondary market sales of XRP are offers or sales of securities.

The court order was in response to motions for summary judgement from both the SEC, as plaintiff, and Ripple Labs, Inc., Bradley Garlinghouse, and Christian A. Larsen, as defendants. The judge granted partial motions for both sides.

The actual case is still to be heard, and the judge will be setting a trial date.

In the meantime, there is still no certainty whether a secondary market sales of XRP constitutes the sale of a security. What is decided is that when Ripple Labs sold XRP to the general public through a digital asset exchange that such sales were not the sales of securities. Questions are still open about transactions over-the-counter or when the buyer and seller identities were known to each other.

A good step forward, and more clarity is necessary so that all the questions are answered.