So far, the main impact of the SEC lawsuit against Binance appears to be the crippling of its U.S. arm. The agency’s broadside, launched on June 5, prompted banks serving Binance.US to cease allowing its customers to use dollars for purchasing the tokens they trade on the platform, a hit that if not reversed, will chase traders away in droves. And if granted by the courts, the SEC’s proposed asset freeze would deliver a death blow. Though the American affiliate is now imperiled, it represents a tiny part of the Binance empire that as recently as December, controlled two-thirds of all the buying and selling of cryptocurrencies. What’s been mostly overlooked is the extreme vulnerability of Binance.com, the giant global exchange, to a loss of confidence and steep fall in price in its native self-created coin, BNB. (You can read my earlier feature for Fortune about how Binance makes its money here.) Put simply, Changpeng “CZ” Zhao built his entire empire on the faulty foundation of BNB. And now, as demonstrated by its recent sharp decline, the inevitable cracks are showing, and the fissures threaten to bring down the entire edifice.
It’s even possible that the SEC action mainly targeting the U.S. operation could also inflict big damages on Binance.com. In the complaint, the regulator names the parent of the global exchange, Binance Holdings Ltd., as a defendant. The complaint, for the first time, establishes the SEC’s position that BNB is a “security,” which to be lawfully sold and traded to U.S. customers must be registered with the agency. Of course, neither Binance nor any other coin issuer has sought approval from the SEC. Hence, the suit asserts that Binance.com unlawfully sold BNB in the U.S. as part of its 2017 initial coin offering (ICO), stating that “Binance’s ICO was marketed and sold to investors globally and Binance imposed no restrictions on U.S. investments in BNB.” The action further charges that Binance.US violated securities laws by selling BNB to more than 40,000 U.S. investors. “It’s highly possible that the SEC could seek large penalties not just from Binance.US, but from the big exchange because of the allegedly illegal sales cited in the complaint,” says Alex More, an attorney at Carrington Coleman in Dallas who represents a number of cryptocurrency clients.
How BNB forms the backbone of the Binance system
Binance’s financial strategy centers on boosting the value of BNB. In an August 2019 podcast, CZ declared, “Equity is a virtual concept inside somebody’s head. Tokenomics, the new way of having a token, is much better.” The rub: Binance has succeeded in inflating the token’s price so outrageously beyond its inherent value that BNB is overdue for a steep fall—and its descent now appears to be underway. CZ has skillfully worked the levers on both sides of the price dynamic. Binance lifts demand by granting customers that use it for trades a 25% discount on commissions on spot transactions, and 10% off for futures. It also keeps the amounts in circulation extremely low by giving further breaks to clients who park lots of BNB in their accounts: Hold over $100,000 in BNB, and you qualify for an 80%-plus markdown on commissions.
At the same time, Binance systematically shrinks the supply by “burning” coins in each quarter, meaning that it permanently removes the BNB from circulation. Binance doesn’t purchase those tokens on the open market. Rather, it scuttles coins either held on its balance sheet or owned by its founding team. Since its launch in 2017, Binance has eliminated 45 million, or almost a quarter, of the original 200 million BNB.
The squeeze caused by enticing customers to pay in BNB, and also passively hold the coins, and by ratcheting down the amount in circulation, ignited a price explosion virtually unrivaled in the history of capital markets. In the 2017 ICO, Binance sold the coins for 15 cents each. When both crypto prices and Binance’s trading volumes soared at the start of 2021, BNB scored a moonshot. In November of that year, it reached $623, notching a market cap of over $100 billion. Its 4,000-fold jump over four years dwarfed the 20 times gain in Bitcoin during the same period.
But following the CFTC suit that preceded the SEC onslaught, BNB hit the skids. From $348 on April 16, it fell as low as $227 on June 12, before rebounding to $237 the next day in the euphoria over the surprise consumer price index report. Despite that overall 31% drop in just two months, BNB still sports a gigantic valuation of $37 billion. To put that number in context, it’s 71% the value of General Motors.
What’s BNB really worth?
Along with its obvious appeal for speculation, BNB does command fundamental value. Its “highest and best use” comes as a kind of “frequent flier” mile used to secure discounts on trades. As a result, its basic worth aligns closely with Binance’s revenues. The more money the exchange collects from trading, the greater the dollar value of the markdowns secured via using BNB. Binance’s trading volumes peaked in 2021 at around $2 trillion a month, or $24 trillion for the year, according to figures from CryptoCompare. Even at those frenzied, summit numbers, BNB was grossly overvalued.
But since late March, owing in part to the back-to-back blows from the CFTC and SEC, Binance’s turnover has dropped around 35% from 2021 levels to an annualized rate of $15.5 trillion. Binance charges maximum fees of 10 basis points (one-tenth of 1%) for spot trades and three basis points (bps) for futures, the latter accounting for over three-quarters of all transactions. But it heavily discounts both categories not just for paying in BNB, but to reward high dollar volumes of trades, and big amounts of BNB and BUSD, its stablecoin, in customer accounts. By Fortune’s estimates, Binance is netting less than 5 bps on the average trade. Hence, its total revenues are running at a yearly rate of roughly $7 billion to $8 billion. So we’ll take a midpoint estimate of $7.5 billion. And that’s a highly optimistic estimate.
Of that number, approximately $2 billion are spot trades. On those, the 25% discounts from paying in BNB are potentially worth $500 million a year in savings to customers. On the $5.5 billion in futures business, the discount is much lower at 10%—meaning BNB could reduce client fees by $550 million. Add it all up and BNB is good for reductions of just over $1 billion a year. To get a “present value” for BNB, we need to assign a multiple, the equivalent of a P/E for stocks, to that roughly $1 billion. Since Binance is shrinking, not growing as in the past, the multiple must be extremely low. Matt Sekerke, a fellow at the Johns Hopkins Institute for Applied Economics, deems a factor of five is appropriate. “And even that’s a best case, generous number,” he told Fortune. That math puts BNB’s current value at around $5 billion. That’s one-seventh of its current market cap.
The existential danger posed by a further fall in BNB
In a past investigative story on Binance, this writer reckoned that the exchange now holds between 60 billion and 70 billion BNB on its balance sheet. It apparently amassed that total from collecting loads of the coins from clients who used BNB in order to secure deep fee reductions. Also, CZ has stated repeatedly that the company never sells any of the BNB it collects, although it does pay some salaries and bonuses in the coins. I ran the 60 billion to 70 billion figure past a spokesperson for Binance, who did not object to the estimate.
At current prices, Binance holds a BNB hoard “worth” $15 billion. That sounds like a safe cushion. But it’s not. “It’s not as if Binance is like a typical company getting sales in a foreign currency and hedging in case that currency declines in value against the dollar, for example,” says Sekerke. BNB is a coin Binance invented, and whose price it largely controls. As long as Binance achieved gigantic margins, it could afford to bank all the BNB flowing in, and send almost none of it out for operating expenses.
But now, Binance’s falling revenues could force it to use a large portion of the arriving BNB to pay salaries, rent, and mounting legal expenses. Keep in mind it’s mainly obligated to cover those costs in hard currencies, in dollars and euros, not in BNB. A switch to dumping BNB instead of hoarding it would have the opposite effect of the strategy that created the bubble: It could trigger a race to the bottom. A falling BNB price would undermine traders’ willingness to hold it as a ticket to discounts. They’d start selling their coins, and sans the markdowns that BNB provides, reduce their trading on Binance.com, lowering its revenues.
The reversal in the BNB flywheel would severely hammer Binance’s balance sheet and endanger its ability to cover operating costs denominated in fiat currencies. CZ’s dream of touting “tokenization” as the new capitalism is a fantasy that may soon cost him his company.
