Binance, the largest cryptocurrency exchange in the world, faces a potential existential crisis, with a growing number of financial regulators scrutinizing the industry's biggest player. So what would happen to crypto if were Binance to fall?

The crypto industry is no stranger to death knells. In 2014, when Bitcoin was a baby, Mt. Gox put it to the test when it got hacked. The industry survived and adopted “not your keys not your coins” as its credo. Bugs have come and gone. There have been a non-trivial number of ponzi schemes. Years later, after a lot of confidence-building and white-knuckling through FUD, disgraced FTX founder Sam Bankman-Fried took the crypto world for a ride.

Things got bleak, but crypto kept on chugging. But is Binance different? Could it be the one that puts a permanent dent in the industry if it crumbles?

“It’s incredibly important to remember that there is a real problem in the short term,” said Jason Allegrante, chief legal & compliance officer for Fireblocks, a digital asset security platform, when asked whether Binance is too big to fail.

Although he is rooting for Binance “for the sake of the industry,” Allegrante told Decrypt he thinks “we need to be aware and encourage people to understand the problem and encourage new companies to enter and create a competitive environment.”

Binance is currently facing heightened regulatory scrutiny in the United States, Germany, France, the Netherlands, and the United Kingdom. The charges range from offering unregulated securities, aggravated money laundering, failure to acquire a VASP license, and operating an alleged pyramid scheme, among others. The countries on this list, due to their size and economic importance, could indirectly put pressure on regulators in other nations to begin similar legal actions.

These charges levied could force the company to close or pause its operations. That could cascade into user funds being frozen–whether by the company or authorities—and Binance would likely initiate bankruptcy processes, as we have seen in previous situations.

Say what you want about the crypto exchange, but it is big. According to a recent CCData report, Binance processed $239 billion in spot and $1.2 trillion in derivatives trading volume in June. That means Binance accounts for 42% of all spot and 56% of all derivatives trading, according to the report. Its two closest competitors, Coinbase and OKX, hold a mere 6% and 5% of the monthly spot trading volume. At one point, more than 90% of Bitcoin trading happened on the platform, according to Arcane Research.

What’s more, the market capitalization of all assets on Binance adds up to a whopping $65 billion, according to GeckoTerminal. Nearly a quarter of those assets, roughly $15 billion worth, are Binance Coin (BNB); Tether (USDT) makes up another $15 billion; Bitcoin (BTC) accounts for $11 billion; Ethereum (ETH) approximately $9 billion; and a variety of stablecoins and other cryptocurrencies make up the remainder.

Therein lies one of the main concerns: What would happen if the platform suddenly shut down and all those funds were frozen? Or, what would happen if authorities ordered the company to freeze withdrawals, like Bahamas regulators did with FTX.

Binance would say that it faces no such threat, but Allegrante also pointed out that concerned users have scrutinized Binance’s terms of service, which the company recently updated on June 16, 2023.

According to its current user agreement, the company reserves full right to modify unilaterally—without notice to customers—its terms. It also reserves the right to freeze user accounts or, under certain circumstances, convert any digital asset on their platform to another. In the past, that’s largely applied to “zombie assets,” or coins and tokens that have been delisted and are still sitting in someone’s account.

But for Allegrante, the terms of service raises some red flags. “Binance can simply auto convert retailers' funds into BUSD, and pump its own tokens,” he said. ”Imagine it starts converting people’s assets into BNB, and Binance can’t pull itself out of that hole.”

Binance had no comment when asked by Decrypt for clarification on when or why it might convert user funds. 

Adding to the mix is the fact that the company’s chief executive officer, Changpeng Zhao (also known as CZ), has built an opaque empire on which the sun never sets. It sprawls across 180 countries, with more than 80 different fiat currencies available for on and off ramps and 120 million users. It owns a plethora of cryptocurrency companies, including Trust Wallet and CoinMarketCap, which it acquired for $400 million in 2020.

Despite its size, some industry insiders told Decrypt the “too-big-to-fail label” doesn’t fit Binance. Chris Martin, head of research for Amberdata, a crypto analytics firm, said “at this stage Binance isn’t, but if it were to fail it would really depend on how it happened to see the effects play out.”

Martin, a former data scientist at Coinbase, is wary of a Mt. Gox style-collapse—which could result in billions worth of user funds being stuck on the platform—cautioning that “the effects across the industry would be felt for years given the volume of crypto held by the exchange.” That’s not beyond the realm of possibility, given the recent collapses of other crypto trading platforms, such as Celsius or FTX.

Nevertheless, where there’s risk, there is also opportunity.

Steven Lubka, head of private clients at Swan Bitcoin, a financial services company, told Decrypt he disagrees with the characterization of Binance as a “too big to fail” company. “Binance is not too big to fail,” he said, explaining that unlike in traditional finance, [the company] “stands no chance of being bailed out by a central bank.”

The concept of “too big to fail” originates from the aftermath of the 2008-2009 financial crisis. It refers to financial institutions—namely banks—who became so systematically important (a fancy way to say big) that the government would bail them out, no matter what.

In the words of infamous Nobel laureate and former head of the Federal Reserve, Ben Bernanke: “A too-big-to-fail firm is one whose size, complexity, interconnectedness, and critical functions are such that, should the firm go unexpectedly into liquidation, the rest of the financial system and the economy would face severe adverse consequences.”

Is it far-fetched to think Binance fits the bill?

Mike Belshe, chief executive officer of crypto custodian BitGo, thinks so. “The digital asset space is bigger than Binance,” he told Decrypt. Founded in 2013, BitGo is one of the oldest security platforms in the digital asset space. Its founder and CEO added: “What we should be focused on is providing more regulated products and services that enable secure participation in the digital asset ecosystem.”

Cryptocurrency companies, however, do not stand in the good graces of the government, nor do they have access to the bailouts traditional financial institutions are accustomed to. The closest the industry has come to “bailouts” is when the FDIC stepped in for Silicon Valley Bank, or the SEC relieved LBRY and BlockFi of their respective multi-million dollar fines. There were also, of course, the so-called bailouts that came from disgraced FTX founder Sam Bankman-Fried, whose own crypto empire was bankrupt months after offering to save other firms.

This leaves, for some, the opportunity for the market to step in.

Lubka thinks that if Binance failed, “it would simply create a disruption that new companies would rush in to fill.” He added that “there would be growing pains, however it would allow new firms to emerge.”

Fireblocks CLO Allegrante echoes the sentiment.

Despite thinking that “carnage” would ensue if Binance collapsed—especially if in an unexpected manner—the barriers to entry in this industry are fairly low. “I don't see a reason why we wouldn't see alternative exchanges coming online,” he said, predicting that in roughly a year the market could have new entrants who are “completely unburdened.”

Binance failing, and potentially bringing the entire house with it, could have devastating effects on the public’s view of this nascent industry, regardless of these optimistic perspectives. Especially as the industry continues to “feel the damage caused by FTX not only to the public image of the industry but also their widespread corporate investments,” said Amberdata's Chris Martin.

Having lived through the 2008 financial crisis, Allegrante reminds us that “confidence and faith play a real role,” and to see CZ’s platform fall “might confirm this is a casino, and we live and die on volatility.”