February 26, 2021 | Jon Hautamäki

cryptos & fintech

#11 Legal Analysis of Binance Coin (BNB)

As the worldwide interest towards cryptocurrencies is ever-growing, we started a 12-part article series on the top 12 cryptocurrencies and their legal framework within the EU and the US. Last time we covered the USD Coin and this time we cover Binance Coin (BNB), which has experienced quite the rocket ride the last few weeks, and is undoubtedly one of the currently most discussed cryptocurrencies.

BNB in a Legal Nutshell

BNB was developed by Binance – one of the largest cryptocurrency exchanges in the world. BNB was launched through an initial coin offering (ICO) of 100 million BNB tokens in 2017, whereby Binance raised approximately 15 million US dollars in the ICO.

BNB is a utility token on Binance, which main function is to reduce the transaction fees of Binance’s customers when they use Binance’s services. In layman’s terms, when a customer uses Binance’s services, his transaction fees will be lower if he pays for them in BNB rather than in fiat currency or other cryptocurrencies.

BNB can also be used as a payment method and for participation in token sales on Binance. In addition, BNB powers the Binance decentralized exchange.

Lastly, though the BNB supply was initially capped at 200 million tokens, Binance has committed to burn (as in permanently remove) 100 million tokens to battle inflation. This makes BNB – in principle – deflationary provided that tokens are burned as initially informed.

U.S. Regulation of BNB

The Financial Crimes Enforcement Network (FinCEN) has stated that based on their interpretation the Bank Secrecy Act applies to cryptocurrencies. This also means that FinCEN has interpreted that its money services business regulations apply to cryptocurrency exchanges and administrators. Thus, these regulations apply to US-based service providers offering BNB.

Each U.S. state has their own regulation on money transmission and virtual currency. As cryptocurrency exchanges are usually involved in fiat-money transmissions, they are obligated to follow money transmission regulations. Furthermore, New York and Louisiana have their own cryptocurrency licences, which are a stricter way of regulating cryptocurrency exchange operations.

In addition to the state-specific regulation, also the national authorities have varying views of the legal nature of cryptocurrencies.

The Office of the Comptroller of the Currency (OCC) has stated that national banks and federal savings associations supervised by the OCC may provide cryptocurrency custody and cryptographic-key hosting services on behalf of customers. The OCC has emphasized that the banks and federal savings associations must be vigilant with anti-money laundering regulations and Know-Your-Customer procedures prescribed under the Banking Secrecy Act and other federal banking laws. As is apparent, the aforementioned obligations relate to BNB.

The Securities and Exchange Commission (SEC) has stated that both cryptocurrencies and utility tokens may be considered as securities. SEC mainly considers assets as securities, if they fulfil the so-called Howey test which determine whether a transaction represents an investment contract, whereby such transactions are also considered as securities subject to applicable securities regulation. Under the Howey test, the following questions determine the legal nature of a transaction:

1. Did purchasers of a financial instrument contribute money (or valuable goods or services)?

2. Did purchasers invest in a common enterprise?

3. Were purchasers reasonably expecting to earn profits through that enterprise?

4. Were the expected profits derived from the efforts of others (e.g. a third party)?

Based on the above criteria, it is evident that the Howey test has been constructed around centralized activities, whereby its overall applicability regarding decentralized cryptocurrencies can be questioned from a legal perspective. However, as the decentralized nature of BNB is somewhat unclear considering that Binance is the official entity behind BNB, it may be that the SEC could consider BNB to be a security (as is the case with XRP and Ripple), though as of now, SEC does not consider BNB to be a security nor would SEC have any jurisdiction in this regard.

Finally, the Commodity Futures Trading Commission (CFTC) defines all cryptocurrencies as commodities for the purposes of the Commodity Exchange Act. Thus, if cryptocurrencies are commodities, the CFTC would have jurisdiction over margined, leveraged, or financed transactions in all cryptocurrencies that involve investors that do not qualify as “eligible contract participants,” as defined in Section 1a (18) of the CEA (so-called “retail” investors). In addition, by virtue of being deemed commodity transactions, all cryptocurrency transactions would enable the CFTC to also act as the anti-fraud and anti-manipulation authority.

EU Regulation of BNB

In the EU, the regulation is somewhat more straightforward. Virtual currencies are defined in the Fifth Money Laundering Directive (5AMLD, EU 2018/843) and are defined as a digital representation of value i) that is not issued or guaranteed by a central bank or a public authority, ii) is not necessarily attached to a legally established currency and does not possess a legal status of currency or money but is accepted by natural or legal persons as a means of exchange and iii) which can be transferred, stored, and traded electronically. Thus, the EU’s anti money laundering regulations including customer due diligence, risk assessments, fitness and properness test for managers and other regulations apply to cryptocurrency exchange operators and custodian wallet providers.

Some EU Member States e.g. Finland, Malta, Netherlands and Austria have also established a cryptocurrency license system that imposes stricter regulations to the cryptocurrency exchanges, custodian wallet providers and other cryptocurrency service providers. These can include capital requirements, customer protection schemes and stricter data security obligations.

In short, BNB is considered as a cryptocurrency and not a security. Entities trading BNB are obligated by the Member State’s implementation of 5AMLD and other national regulation. The new preliminary proposed cryptocurrency regulation will change the definition cryptocurrency, implement stricter regulations to cryptocurrency operators and introduce measures to prevent cryptocurrency market manipulation, which may have an impact on wide range of cryptocurrencies.

26.02.2021 JON