What happens to Bitcoin if Binance goes down?

After the spectacular collapse of the U.S. cryptocurrency exchange FTX, investor confidence in the cryptocurrency ecosystem is very low. Hence, the ongoing media reports and social media rumors about higher-than-usual outflows from the world’s largest crypto exchange Binance are raising alarm bells among crypto investors and the wider investing community.

Binance’s controversial proof of reserves report, intended to calm investors down, has seemed to further fuel speculation about the company’s finances. The report’s release has led to widespread online speculations that Binance is not 100% collateralized, raising significant concerns over the exchange’s solvency.

Bitcoin, which experienced a meteoric rise of some 73,000% from 2012 to December 2022, is again facing the negative repercussions of bad actors within the cryptocurrency ecosystem, albeit entirely separate and independent from Bitcoin itself. If Binance were to go under, what would happen to Bitcoin?

Controversy Surrounding Binance’s Audit

Led by Changpeng Zhao, commonly known as “CZ”, the crypto exchange hired Mazars, an audit firm used by former U.S. President Donald Trump, to develop an audit report. The focus was on the exchange’s assets, held in custody for its users. Binance has maintained on several occasions, including on December 13, that it has more than enough funds to cover all of its customer funds.

Still, Mazars’s report was not well received by the public, with many on Twitter labeling it fake and alleging that auditors think Binance is just 97% collateralized.

John Reed Stark, former Chief of Internet Enforcement at the US Securities and Exchange Commission (SEC), said:

“Binance’s “proof of reserve” report doesn’t address the effectiveness of internal financial controls, doesn’t express an opinion or assurance conclusion, and doesn’t vouch for the numbers. I worked at SEC Enforcement for 18+ yrs. This is how I define a red flag,”

Stark also slammed Binance for hiring Mazars to prepare its proof of reserves report instead of using the services of one of the big four audit firms.

According to blockchain intelligence platform Nansen, fears over Binance’s collateralization triggered massive withdrawals at the exchange, with investors pulling out more than $2 billion in just two days. The figure marks the highest net outflows at Binance since FTX’s implosion.

Binance then temporarily paused withdrawals of the USDC stablecoin. However, the exchange said it halted withdrawals while it carries out “a token swap” – swapping one cryptocurrency for another without using fiat currency.

Still, it could be that substantial withdrawals suggest that investors are looking to move their assets to another platform or take them into self-custody, following the proof of reserves report, which didn’t exactly calm market participants as intended. Additionally, Reuters recently reported that the exchange and its founder, CZ are both facing a potential lawsuit from the U.S. Department of Justice (DoJ) for potential money laundering and criminal sanctions violations.

Other crypto exchanges are also witnessing substantial outflows since the fall of FTX, one of the largest crypto exchanges at the time. As the FTX situation continues to develop – in a degrading manner – the exchange’s founder and former CEO Sam Bankman-Fried were arrested in the Bahamas and charged with defrauding investors by U.S. authorities.

What Happens to Bitcoin if Binance Becomes Insolvent?

The outlook for risk assets has meanwhile improved after the latest consumer price index (CPI) print, which confirmed that inflation in the U.S. is easing, raising hopes over a more dovish monetary policy approach by the Federal Reserve.

However, that may not be particularly true for Bitcoin and other digital assets as crypto-specific news continues to hamper investor confidence. Shaky confidence and potential troubles at Binance could seriously hurt the crypto ecosystem.

Bitcoin fell over 20% in early November on the FTX collapse with about $250 million wiped out of the total crypto market cap in response to the FTX fallout. Many fear that the breakdown following a potential collapse of Binance could be much worse, yielding severe and long-term consequences for the entire ecosystem centered around Bitcoin.

First, the overall risk sentiment surrounding Bitcoin and crypto is much worse than at the time before the FTX collapse. Second, while FTX was mostly focused on the U.S., Binance is a genuine global crypto exchange. Any major troubles at Binance could create a snowball effect and ignite a new round of extreme withdrawals, ultimately leading to more bankruptcies.

This week, investment titan VanEck predicted that Bitcoin price could remain under pressure in early 2023 as several major mining firms are on the brink of a collapse.

VanEck said Bitcoin could plunge to as low as $10,000 in the first quarter of 2023, before eventually recovering to $30,000 later in the year. The Q123 selloff would “mark the low point of the crypto winter,” according to Matthew Sigel, head of digital assets research at VanEck.

However, the recovery could only occur without negative crypto-specific news, like FTX or Binance.

The Importance of Self-custody is Growing

Earlier this year, the fall of the crypto lender Celsius Network eradicated over $4 billion of user funds. Similarly, more than $1 billion of customer funds are missing after FTX’s fall. While these collapses have no direct links to Bitcoin, they highlight the important issues related to centralization, precisely what the Bitcoin network initially attempted to solve.

Hence, one of the key takeaways from the FTX drama is the increasing need for the self-custody of digital assets. As evidenced by several examples this year, centralized exchanges offer a convenient way for users to store digital assets. Still, they feature no guarantee that users will be able to recover those funds if several possibilities arise – from hacks to bad actors with inside access.

Earlier this week, Ray Youssef, the CEO of crypto exchange Paxful, encouraged users to switch to self-custody and move their crypto funds to external hardware wallets. He wrote in a tweet:

“Will be sending an email every week strongly advising our people to never keep savings on any exchange, including @paxful. This is the way! Self custody your savings ALWAYS!,”

Similarly, Congressman Warren Davidson, the U.S. representative from Ohio, discussed the importance of self-custody during a Congressional hearing on the collapse of FTX.

Conclusion

Despite the reassurance from Binance, which insists it can still attract deposits while withdrawals are stabilizing, the crypto community is increasingly nervous about the financial state of the world’s largest digital asset exchange.

A Binance breakdown, albeit seemingly unlikely, is poised to produce a much stronger, negative impact on the entire crypto community, given the company’s global footprint and importance, if it were to happen. Potential troubles at Binance, which come just over a month after the FTX collapse, could spark another major selloff in Bitcoin. While this would be an evident catastrophe for many, long-term Bitcoin investors would likely see it as an attractive buying opportunity.