Binance's Custodial Arrangements: Whose Keys? Whose Coins?

For months, cryptocurrency FTX (and its majority owner, Sam Bankman-Fried) have been the lender of last resort in crypto markets and pretty much the only distressed acquirer around. Now we learn that FTX has itself failed and is getting scooped up in a distressed acquisition by Binance. Does this remind anyone of Bank of America's purchase of Merrill Lynch and Countrywide in 2008? We'll see if the transaction closes, but at the very least it poses the question of whether Binance stands on any stronger ground than FTX? Binance's revenue has been way down this year, but who really knows its financial condition? It's not a public company, so there's limited visibility into its financial condition.

Here's what I do know about Binance, however, and it gives me real pause: Binance.us's Terms of Use disclose absolutely nothing about its custodial arrangement for crypto holdings. From the documents on Binance.us's website, it is impossible to determine the legal relationship between Binance.us and its customers and hence the type of counterparty risk they have from dealing with the exchange. That's scary.

Binance is quite clear about the manner in which US dollars are held for Binance.us customers. They are either held at Prime Trust, LLC, a Nevada trust company, for the benefit of Binance's customer or in an omnibus BAM Fiat Wallet account at Silvergate Bank, which is supposed to be eligible for FDIC pass-through insurance. So customer dollars should be fairly safe, if the representations are correct.

But customer crypto? It's striking how silent Binance is about customer crypto holdings given how much ink it spills on customer fiat holdings. It's also striking how silent Binance is on the issue given the negative attention Coinbase attracted until it updated its user agreement to invoke UCC Article 8. (I'm still waiting on a referral fee for that service....) I've written at length about crypto platforms' custodial arrangement, and Binance is truly the outlier among large exchanges in terms of not addressing the legal nature of the custodial relationship. Other platforms don't always address it clearly, but they at least make some motions in that direction. But not Binance.

There's a few hints about the crypto holdings in Binance materials, however. Binance's educational pages note that "Your regular Binance account is also a custodial wallet." Ok. What does that mean in terms of legal relationship?

Well, Binance.us represents that it is "not holding any fiat monies and/or Digital Assets as your trustee, and is not acting as your broker, futures commission merchant, intermediary, agent, trustee, advisor or in any fiduciary capacity."  Similarly, the Terms of Use have the customer "acknowledge and agree that: (1) BAM is not holding any fiat monies and/or Digital Assets as your trustee, and is not acting as your broker, futures commission merchant, intermediary, agent, trustee, advisor or in any fiduciary capacity". So, it would seem that there's no express trust relationship, at the very least.

There's also a little language in the staking section of the Terms of Use that isn't encouraging: 

Your funds’ private keys may be held in either hot or cold storage (in a wallet), as determined solely by BAM in accordance with its internal security policies and procedures. You should also know that your funds, as well as funds belonging to other customers, may be staked to a proof-of-stake validator node so as to enable our Staking Services offering, as described in these Terms of Service.

From that it sure sounds as if Binance might commingle customers' funds and even tie them up. 

Given that Binance doesn't invoke UCC Article 8, it's unclear what the legal relationship is between Binance.us customers and Binance.us. Is it a trust relationship? There's no express entrustment language (and express disclaim thereof), and many states don't recognize constructive trusts without a judicial order. Perhaps there's a statutory trust via state money transmitter statutes, but it's not clear that those hold up in bankruptcy because the trust is an ipso facto trust that springs upon insolvency or bankruptcy. (Let me also note that while Binance.us has money transmitter licenses from a number of states, it is noticeably not licensed in either California or New York, and that despite the availability of a special NY Bitlicense. Not good signaling at the very least.) Perhaps it's a bailment? If so, commingling could destroy the bailment. Or maybe it's just a plain old deposit, meaning that Binance.us customers are unsecured creditors of Binance.us. If we've learned anything from Voyager and Celsius, it is that these are not issues that will be resolved quickly in the case, but which might take months, and in the interim the customers do not have access to their funds. Binance might be an even more complicated situation than Celsius or Voyager because it isn't clear if Binance.us maintains its crypto wallets separately than Binance.com. If there's commingling there, good luck to US consumers if any Binance entity fails.

So the question Binance.us customers really ought to be asking is what is the nature of their legal relationship with Binance? Who actually owns the crypto?