An attempt to explain why Binance users lost an estimated $8.6bn during a flash crash
Being compliant becomes a concern and an undeniable asset for the sustainability of this industry. Things have really taken off as we see with the Binance cases. The exchange is facing refusals to cooperate (Clear Junction, Santander, Barclays…), is banned or almost banned in several countries (in Britain, the Cayman Islands, Hong Kong, Lithuania, Italy, Poland, Thailand,…) with regard to the unregulated high-risk products it offers such as Futures and tokenized stocks. It is in fact very difficult to regulate an operator like Binance which does not really have a physical headquarters. This makes it very difficult to enforce some consumer protection obligations.
Leveraged tokens event
On 19th May, there was a big sell-off on the crypto market which had obviously an impact on other products delivered by Binance including Leveraged Tokens. These tokens are linked to a leverage level determined by an automatic mechanism and backed by Futures contracts of the concerned asset. These leveraged tokens can be UP (long position) or DOWN (short position) and the leverage can be comprised between +/- 1.25 and 4. Within this day, we observed some chaos:
Magical! All the price tokens goes down whatever the position. Looking at the leverage on SUSHIUP:
We see that SUSHIUP tokens had leverage positions higher than 4x, up to 50x, contradicting the theoretical functioning! How is it possible? There are many suspicions on the fact that the variation causing Binance hadn’t enough funds to assume the losses associated at the leverage. Also, it couldn’t open new contracts to satisfy the demand. Therefore, the rebalancing mechanism was forced to increase the leverage and carry losses on users. Moreover, the platform interrupted the service for about 1 hour, which avoided users from closing their positions. Customers associations are preparing legal proceedings due to this event.
Liquidity in USDT on Binance
Bad news like bans and lawsuits can lead users to claim their money back. Withdrawals begin to be limited in some countries. The question is : can Binance return all the money to the users ? We can therefore question the risk management of the structure about the reserves. When we look at Binance’s USDT reserves, on June 26th 2021, Binance had 1.9 billion USDT and on July 20th 2021, Binance had only 24 million USDT, which represents approximately a decrease of 98,7% in held funds. As a reminder, Binance’s total 24-hour volume from June 19 to June 20th was approximately $63 billion. Compared to the USDT holdings of other exchanges with much less volume such as Huobi or Bitfinex, 24 million may seem quite ridiculous given Binance’s market share.
The printing of Tether and effects on the market
Tether (USDT) is known to continuously increase his supply backed by some “cash and money-market securities”. But since June 1st, Tether no longer prints, why?
Many rumors are circulating : the Chinese debt detained to back the USDT supply restrain new issuances, there are no enough demand to make new issuances, Tether avoid to issue because of the Fed investigation…
Today Tether lead the game. It’s the biggest stablecoin in the market with over 64 billion in market cap. It allows users to cash out, hedge against volatility and avoid tax events. As a results, the majority of market pairs are denominating in USDT and theirs inflows and outflows drives the markets. It has the reputation to “boost” the Bitcoin price. And some people think new issuances are needed to revive the market.
The leveraged tokens event gave us the opportunity to get a glimpse of the consequences that the lack of liquidity produces. As the USDT printing press is on pause, Binance is currently unable to refinance. Let’s imagine that there is a panic movement due to new announces and people can’t hedge them or cash out due to lack of liquidity. What will be the consequences on the market? Could we experience the same thing as with MtGox closure?
What future for the regulation?
The fact is that the crypto market needs regulation to grow. Maybe exchanges will have to maintain a proper leverage ratio and keep certain levels of reserve, like in the banking system, to avoid phenomenon of bank run. Also, regulators are becoming more vigilant about issuances of stablecoins and the quality of their backings’ assets. As we seen recently, Changpeng “CZ” Zhao, CEO of Binance, communicate more than ever to become compliant. It is not a coincidence. Since July 26th, Binance lowered futures leverage limit to 20x instead of 125x before. Also, CZ announced his intention to take Binance US public.
