After the spectacular collapse of the American cryptocurrency exchange FTX, investor confidence in the cryptocurrency ecosystem is very low. Therefore, ongoing media reports and social media rumors about higher than usual outflows from the world’s largest cryptocurrency exchange Binance are sounding alarm bells among cryptocurrency investors and the investment community in general.
Binance’s controversial test reserves report, meant to calm investors, appears to have further fueled speculation about the company’s financials. The release of the report has led to widespread speculation online that Binance is not 100% guaranteed, raising significant concerns about the solvency of the exchange.
Bitcoin, which experienced a meteoric rise of around 73,000% between 2012 and December 2022, is once again facing backlash from bad actors within the cryptocurrency ecosystem, albeit completely separate and independent from Bitcoin itself. If Binance went under, what would happen to Bitcoin?
Controversy surrounding the Binance audit
Led by Changpeng Zhao, commonly known as “CZ,” the crypto exchange hired Mazars, an auditing firm used by former US President Donald Trump, to develop an audit report. The focus was on the assets of the exchange, held in escrow for its users. Binance has maintained on several occasions, including on December 13, that it has more than enough funds to cover all of its client funds.
Still, the Mazars report did not go down well with the public, with many on Twitter labeling it false and claiming that auditors believe Binance only has a 97% guarantee.
John Reed Stark, former Head of Internet Compliance for the US Securities and Exchange Commission (SEC), said:
Binance’s “proof of reserve” report does not address the effectiveness of internal financial controls, does not express an opinion or assurance conclusion, and does not vouch for the numbers. I worked at SEC Enforcement for over 18 years. This is how I define a red flag.”
Stark also criticized Binance for hiring Mazars to prepare its Proof of Reserves report instead of using the services of one of the Big Four auditing firms.
According to For blockchain intelligence platform Nansen, fears over Binance’s collateral prompted massive withdrawals on the exchange, with investors pulling out more than $2 billion in just two days. The figure marks the highest net outflows on Binance since the FTX implosion.
Binance then temporarily halted withdrawals from the USDC stablecoin. However, the exchange said that he stopped the withdrawals while conducting a “token swap,” exchanging one cryptocurrency for another without using fiat currency.
Still, it could be that the substantial withdrawals suggest investors are looking to move their assets to another platform or into their own custody, following the test-of-reserves report, which didn’t exactly calm market participants as intended. Additionally, Reuters recently reported that the exchange and its founder, CZ, are facing a potential lawsuit from the US Department of Justice (DoJ) for potential criminal sanctions violations and money laundering.
Other crypto exchanges are also seeing substantial outflows since the crash of FTX, one of the largest crypto exchanges at the time. As the FTX situation continues to unfold, in a demeaning fashion, the exchange’s founder and former CEO, Sam Bankman-Fried, has been arrested in the Bahamas and charged with defrauding investors by US authorities.
What happens to Bitcoin if Binance goes bankrupt?
Meanwhile, the outlook for risky assets has improved after the latest release of the Consumer Price Index (CPI), which confirmed that inflation in the US.
However, that may not be particularly true for Bitcoin and other digital assets, as crypto-specific news continues to hamper investor confidence. Shaky trust and potential issues on Binance could seriously harm the crypto ecosystem.
Bitcoin fell over 20% in early November on the FTX crash with around $250 million wiped out of total crypto market capitalization in response to the FTX fallout. Many fear that the crash that follows a potential Binance crash could be much worse, with serious and long-term consequences for the entire Bitcoin-centric ecosystem.
First, the overall risk sentiment surrounding Bitcoin and cryptocurrencies is much worse than it was at the time before the FTX crash. Second, while FTX was primarily focused on the US, Binance is a true global crypto exchange. Any major issue on Binance could snowball and trigger a new round of extreme withdrawals, ultimately leading to more bankruptcies.
This week, investment titan VanEck predicted that the Bitcoin price could remain under pressure into early 2023 as several major mining companies are on the brink of collapse.
VanEck said that Bitcoin could drop to as low as $10,000 in the first quarter of 2023, before finally recovering to $30,000 later in the year. The Q123 selloff “would mark the low point of the crypto winter,” according to Matthew Sigel, VanEck’s head of digital asset research.
However, the recovery could only happen without crypto-specific negative news such as FTX or Binance.
The importance of self-custody is growing
Earlier this year, the crash of crypto lender Celsius Network wiped out more than $4 billion of user funds. Similarly, over a billion dollars in client funds are missing following the fall of FTX. While these crashes have no direct ties to Bitcoin, they do highlight important issues around centralization, precisely what the Bitcoin network initially tried to solve.
Therefore, one of the key points in the FTX drama is the growing need for self-custody of digital assets. As several examples this year demonstrate, centralized exchanges offer a convenient way for users to store digital assets. Still, they offer no guarantee that users will be able to recover those funds if various possibilities arise, from hacks to bad actors with insider access.
Earlier this week, Ray Youssef, CEO of cryptocurrency exchange Paxful, encouraged users to switch to self-custody and move their crypto funds to external hardware wallets. The wrote in a tweet:
“We will be sending out an email every week strongly advising our people to never save savings on any exchange, including @paxful. This is the way! Safeguard your savings ALWAYS!”
Similarly, Congressman Warren Davidson, the US Representative from Ohio, discussed the importance of self-care during a congressional hearing about the collapse of FTX.
Despite the reassurance of Binance, which insists that it can still attract deposits while withdrawals stabilize, the crypto community is increasingly nervous about the financial state of the world’s largest digital asset exchange.
A Binance crash, while seemingly unlikely, is about to have a much stronger negative impact on the entire crypto community, given the company’s global presence and importance, if it were to happen. The potential problems at Binance, coming just over a month after the FTX crash, could spark another Bitcoin selloff. While this would be an obvious catastrophe for many, long-term Bitcoin investors would likely see it as an attractive buying opportunity.
Guest post by Shane Neagle of The Tokenist
Shane has been an active supporter of the movement towards decentralized finance since 2015. He has written hundreds of articles related to developments related to digital securities: the integration of traditional financial securities and distributed ledger technology (DLT). He continues to be fascinated by the growing impact that technology has on the economy and on everyday life.
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