Changpeng Zhao, who is more commonly known as ‘CZ’ sent a message to all the platform’s ‘Binancians’ earlier this month to clarify how Binance approaches fund management within different types of wallets.
CZ explains the purpose of the email as to “answer a few follow-up questions from the community about how funds and wallets are managed at Binance.”
He begins by addressing two foundational facts. The first is that the platform holds all of its clients’ crypto assets in segregated accounts. CZ ensures that these accounts are identified separately from any accounts used to hold crypto assets belonging to Binance.
He follows this up by confirming that the platform deploys its own wallet infrastructure to safeguard both its and its users’ assets.
CZ’s email continues by describing exactly how Binance wallets work and operate.
“There are deposit wallets, one (or more) address per user per blockchain,” the email reads. “You deposit to your deposit address. Our system monitors the blockchain and adds that balance to your account on Binance.com.”
Once the deposit is verified on-chain, users are able to use the coins on Binance according to their wishes. However, CZ warns that coins “may or may not move from that address right away.”
He explains that the platform periodically ‘sweeps’ coins into a hot (or cold) wallet. The main difference between these two types of wallets is that hot wallets are connected to the internet. Cold wallets on the other hand store coins and user data in hardware devices offline.
The logic behind why exchanges sweep tokens is to minimise the number of transactions and gas fees. This ultimately helps to reduce overall user fees.
“Generally speaking,” continues CZ, “large amounts will be swept more quickly, and we may wait for a few deposits to sweep the small amounts or wait for the network gas fees to be low to sweep.
“A key reason we remain so competitive is that methods like this keep gas costs low, savings we then pass on to our users with some of the lowest trading fees in the industry.”
When users want to withdraw, Binance sends them funds from the hot wallet and deducts the amount from their account balance. If the hot wallet gets below a certain amount, figures are replenished from the cold wallet.
“If the hot wallet gets too large from the sweeping, we will move some funds to a cold wallet,” the email continues.
Essentially, all future sweeping is processed directly to the cold wallet. Again, this is to reduce both the number of transactions and gas fees.
CZ explains that there are certain exceptions when a large deposit comes in. “In this scenario, we may sweep directly to the cold wallet. And when a large withdrawal is requested, we may process it directly from a cold wallet.”
“With that context, I hope you can see that other than instances of deposits and withdrawals, the sweeping and moving of funds between the deposit, hot and cold wallets are totally independent of user account balance updates.”
When users trade on Binance, a commission is deducted from each trade. This commission is then moved to an account owned by the Binance platform. This commission forms the majority of the platform’s revenue. It is used to cover operational costs, servers, vendors and employee paychecks.
Any remaining provide is held in the original account. CZ explains how the platform has remained profitable four months after its founding; remaining resilient throughout two bear markets.
Binance invests significant resources in ensuring full compliance with all laws and regulations to which it is subject.
Accordingly, Binance holds all of its clients’ crypto assets in segregated accounts. More specifically, Binance maintains ‘customer balances’; internal accounting (or ledger) entries within the Binance system which record customer entitlements to crypto assets.
Each customer of Binance has an account/unique identifier (UID). This is a ledger-based (off-chain) account (or sub-account) within the Binance system that has a UID and associated login credentials, against which the client’s balances are recorded.
This ensures that Binance at all times records crypto-assets belonging to its customers and distinguishes them from those crypto-assets which belong to Binance. Binance conducts a daily reconciliation of all crypto assets that are held by Binance on behalf of its customers.
“We only spend our own funds,” the email states. “We do not use client funds to deal on our own account.”
CZ confirms that Binance is building segregated on-chain customer crypto-asset wallets to adhere to compliance requirements under the forthcoming European MiCA regulation in Europe.
CZ uses his email to answer some of the platform’s users’ most pressing questions. Namely, why does it use its own wallet infrastructure to safeguard user assets and its own assets?
As one of the largest custodians of crypto assets, security is naturally high on its list of priorities.
This is being achieved by significant security investments. This includes hiring the best people and employing the best technology. “It is one of the single largest investments that we make each year,” CZ says.
“We believe that our wallet infrastructure is one of the most secure in the industry. And that Binance is the best place to safeguard crypto.
“We have considered the use of third-party wallet software. However, we have reviewed other wallet vendors and are much more confident in the security of our own ecosystem than what we have seen from other vendors.
“Furthermore, creating a self-sufficient ecosystem has shielded Binance customers from being exposed to the types of contagion risk we have seen with the implosions of other industry players like Celsius, Voyager, and now FTX.
“Last but not least, no other wallets or custodial solution handles the sheer variety of coins we support or hold. For the reasons above, we safeguard our assets, as well as our customers’ assets, on Binance,” the email concludes.
How does Binance verify the safety of user assets?
CZ explains how this is achieved through Merkle Tree proof-of-reserves; being “the best way.”
It allows users to verify the account balance in the final reconciliation with the total wallet balance. It is designed to ensure the existence of funds. More importantly, it’s very difficult to fake or corrupt.
“With blockchain technologies, we can make our industry far more transparent than traditional financial industries. Binance will continue to lead by example and move the industry forward,” says CZ, marking the end of his email.
The most important question of all, and perhaps the elephant in the room, is why did CZ feel the need to send such an email?
Although transparency is always appreciated at any level, Binance unfortunately found itself at the wrong end of the aforementioned FTX collapse.
On a wider level, its competitor’s collapse shook consumer confidence in crypto, and more specifically Binance’s ability to manage funds accordingly.
The platform experienced high withdrawals, no less than $3billion in funds, in the hours following FTX’s collapse. On top of these woes, the platform is under investigation by the US Justice Department for money laundering violations. These violations allegedly saw it process $10billion in illegal payments in 2022 alone.
However, in just a matter of hours, the crypto industry will enter a brand new year, which could become a major opportunity for the embroiled platform to open a new chapter. One of transparency and unwavering consumer trust. This leaves just one question to be answered: will it be enough?