Special Report-How crypto giant Binance built ties to a Russian FSB-linked agency

[April 23, 2022]  By Angus Berwick and Tom Wilson

VILNIUS (Reuters) - In April 2021, Russia's financial intelligence unit met in Moscow with the regional head of Binance, the world's largest crypto exchange. The Russians wanted Binance to agree to hand over client data, including names and addresses, to help them fight crime, according to text messages the company official sent to a business associate.

At the time, the agency, known as Rosfinmonitoring or Rosfin, was seeking to trace millions of dollars in bitcoin raised by jailed Russian opposition leader Alexei Navalny, a person familiar with the matter said. Navalny, whose network Rosfinmonitoring added that month to a list of terrorist organisations, said the donations were used to finance efforts to expose corruption inside President Vladimir Putin's government.

Binance's head of Eastern Europe and Russia, Gleb Kostarev, consented to Rosfin's request to agree to share client data, the messages showed. He told the business associate that he didn't have "much of a choice" in the matter.

Kostarev didn't comment for this article. Binance told Reuters it had never been contacted by Russian authorities regarding Navalny. It said that before the war it was "actively seeking compliance in Russia," which would have required it to respond to "appropriate requests from regulators and law enforcement agencies."
 

The encounter, which has not been previously reported, was part of behind-the-scenes efforts by Binance to build ties with Russian government agencies as it sought to boost its growing business in the country, Reuters reporting shows. This account of those efforts is based on interviews with over 10 people familiar with Binance's operations in Russia, including former employees, ex-business partners and crypto industry executives, and a review of text messages that Kostarev sent to people outside the company.

Binance has continued to operate in Russia since Putin ordered his troops into Ukraine on Feb. 24, despite requests from the government in Kyiv to Binance and other exchanges to ban Russian users. Other major payment and fintech companies, such as PayPal and American Express, have halted services in Russia since the Kremlin launched what it calls a "special operation" to demilitarise and "denazify" Ukraine. One of Binance's main rivals in Russia, EXMO.com, said on Monday it would no longer serve Russian and Belarusian clients and was selling its Russia business. Some smaller crypto exchanges remain.

CEO Changpeng Zhao, widely known by his initials CZ, has said he is against the war and "politicians, dictators that start the wars" but not against "the people on both sides of Ukraine and Russia that are suffering." Zhao didn't comment for this article. Binance referred Reuters to Zhao's previous statements on the matter.

Legal representatives for Binance told Reuters that "active engagement with the Russian government has now stopped due to the conflict." On Thursday Binance told users it was limiting services for major clients in Russia because of the latest European Union sanctions on Moscow.
 

Binance's trading volumes in Russia have boomed since the war began, data from a top industry research firm shows, as Russians turned to crypto to protect their assets from Western sanctions and a devaluing rouble. In one recent message to an industry contact, Kostarev said Binance's priority was to ensure the market stayed open, so the exchange wasn't "making a fuss." He didn't elaborate.

Asked by Reuters to clarify Kostarev's message, Binance said the war and economic crisis could accelerate crypto's adoption among working-class Russian citizens looking for alternative payment means. Binance added that it is aggressively applying sanctions imposed by Western governments, but would not unilaterally "freeze millions of innocent users' accounts."

GRAPHIC: Binance in Russia's war - https://graphics.reuters.com/FINTECH-CRYPTO/mopanbbnava/chart.png



THE FREEDOM OF MONEY

Since its launch five years ago in Shanghai, Binance has grown to dominate the unregulated Russian crypto sector with an estimated four-fifths of all trading volumes, market data shows. Binance said it doesn't comment on "external data projections" and, as a private company, doesn't share such information publicly.

Zhao, in 2019, told Russians that Binance's mission there was to increase the "freedom of money" and "protect users." Russians flocked to the platform, seeing it as an alternative to a banking system closely monitored by a state they distrusted.

In line with a draft law to regulate crypto companies, Binance agreed with Rosfinmonitoring to set up a local unit in Russia through which authorities can request client data, the Kostarev messages reviewed by Reuters show. Asked whether it had proceeded to set up this local unit, Binance responded, "Should we consider establishing a local entity in Russia in the future, Binance will never share data without a legitimate law enforcement request."
 

Navalny's chief of staff, Leonid Volkov, told Reuters that Russia's proposed regulatory framework could let the Kremlin identify the opposition group's crypto donors. Since Navalny's arrest in January 2021, his anti-corruption foundation has publicly encouraged backers to donate via Binance, telling them this was the safest way to do so because, unlike with bank transfers, authorities would not know donors' identities.

"These people will be in danger," said Volkov, who runs the foundation from Lithuania. If Binance wants to protect its customers, Volkov went on, it should "never do anything with the Russian government." The Kremlin declined to comment on Navalny's crypto fundraising or Binance's operations.

In response to Reuters' questions, Binance said that before the war it was supportive of legislation that would bring clarity to regulation. But the Ukraine conflict and Western sanctions on many Russian banks had made it "virtually impossible for any platform to initiate or consider future plans in the region."

People close to Binance said it supported the draft law because, once passed, crypto exchanges would be required to partner with Russian banks, allowing customers to deposit and trade significantly more funds.

The finance ministry said in early April it had finished drafting its "bill on the regulation of digital currencies." People involved in the discussions say the government wants to move quickly to write the bill into law. One lawmaker told parliament's official newspaper last month the crypto legislation would help mitigate damage to the Russian economy from sanctions.

Among the agencies helping develop the law is Rosfinmonitoring, responsible for combating money laundering and terrorist financing. Though nominally independent, it acts as an arm of the Federal Security Service (FSB), the main successor to the Soviet-era KGB, five people who have interacted with Rosfin said. Rosfin's director, Yury Chikhanchin, is a security services veteran, according to his official biography.
 

Marshall Billingslea, a former head of the Financial Action Task Force, a global watchdog which sets standards for authorities combating financial crime, told a conference last year that Rosfin was "firmly under control of the FSB" to ensure that only state-sanctioned transactions were made into and out of Russia. Billingslea said it was "no surprise" to see Rosfin declare Navalny's network a terrorist organisation after his arrest.

Rosfin, in a written response to Reuters' questions, said it fully complies with international standards of operational independence in areas including regulating the activities of virtual asset service providers. Chikhanchin didn't comment.

At least one other crypto exchange did not agree to provide client data to Rosfin due to concerns about how the information could be used and the FSB's influence on the unit, according to a person familiar with the discussions. Others in Russia's crypto sector said they were also sceptical about the draft law.

"No one knows if the proposed local office system will be used for good or bad," said Mike Bystroff, a partner at the Moscow-based Digital Rights Center law firm, who represented Binance when it successfully challenged a ban on its website in January 2021.

Binance's willingness to engage with Rosfin through 2021 contrasted with its approach elsewhere. Some national regulators have accused the company of withholding information. Britain's regulator said in August last year a Binance UK unit was "not capable of being effectively supervised" after it refused to answer questions about Binance's global business. Liechtenstein's regulator, in a 2020 report, said Binance's dealings with the body were "non-transparent" as it declined to provide financial information on request. In an article published in January, Reuters reported that Binance cancelled plans to seek a licence in Malta in 2019 due to Zhao's concerns about the level of financial disclosure required.

Lawyers for Binance said it was "false equivalency" to conflate "distinct issues of our client's responsiveness to law enforcement disclosure requests, with licensing applications for its own business that would involve wholly different types of disclosures." Binance said it was "the most active participant in the industry" working with law enforcement to "develop best practices, mitigate/thwart new methods of criminality and prevent illicit proceeds from entering the marketplace."

Binance said any suggestion that it refuses to share data with authorities making legitimate requests is "absolutely false." It said it has strict policies and procedures to assess such requests and reserves the right to decline "when there is no legal purpose."

"DON'T BE AFRAID"

Zhao first travelled to Russia as Binance CEO in October 2019. At a tech forum in Moscow, he told an audience to stop being "a slave" to traditional finance. His slideshow cited the 18th century philosopher Jean-Jacques Rousseau: "A man is born free, but everywhere he is in chains."

Changpeng Zhao, CEO of Binance, speaks at the Delta Summit, Malta's official Blockchain and Digital Innovation event promoting cryptocurrency, in St Julian's, Malta October 4, 2018. REUTERS/Darrin Zammit Lupi/File Photo

Binance targeted Russia for expansion, noting in a 2018 blog post the country's "hyperactive" crypto community. The exchange partnered with Belize-based payment company Advcash to enable users to deposit and withdraw roubles using bank cards. Advcash said the partnership is still active.

Binance gradually took a commanding share of the Russian crypto market. By mid-2021, Binance's trading volumes in Russia had made it the exchange's second-largest market globally after China, including among "VIP" clients who trade large amounts of crypto, a person with direct knowledge of the company's data said. In March this year, Binance processed almost 80% of all rouble-to-crypto trades, according to data from researcher CryptoCompare, worth some 85 billion roubles ($1.1 billion).

"People just trusted it. It was always a step ahead of competitors," said Maksim Sukhonosik, a Russian crypto trader and co-founder of blockchain consulting firm Colibri Group.

However, in 2020, Binance began drawing the attention of Russian authorities, who were at the time hostile to cryptocurrencies. Russia's communications watchdog banned its website for allegedly carrying prohibited material about buying crypto. Binance challenged the decision in court and the ban was withdrawn in January 2021, according to statements Binance posted in its Telegram group for Russian users.

Binance told Reuters the lawsuit was dismissed on procedural grounds because the firm wasn't properly notified. The regulator did not respond to requests to comment.

Navalny was arrested that month on his return to Russia, after recovering from poisoning with the nerve agent Novichok. He, along with the U.S. and British governments, blamed the FSB for the attack, an accusation Russia rejects. The FSB did not respond to questions for this article.
 

A core part of Russian prosecutors' case against Navalny was the financing of his foundation. At his trial, they accused him of stealing over 350 million roubles, then worth some $4.8 million, that the foundation received as donations. Navalny denied the charge. Volkov told Reuters that security forces interrogated thousands of supporters who donated through Russian banks. None of these donors had used digital currencies, he said.

Navalny's crypto fundraising surged after his arrest. The more than 670 bitcoin that supporters have donated via Binance and other exchanges would now be worth almost $28 million, according to blockchain data, though Volkov said the real amount raised is less because the bitcoins were sold upon receipt at a lower price.

When a Russian court outlawed Navalny's foundation in June 2021, ruling it to be an "extremist organisation," the network told supporters on Twitter to "learn how to use cryptocurrencies" and recommended they open Binance accounts. In a later how-to guide, the foundation advised donors to upload identity cards to Binance to verify their accounts, noting there were no instances yet of any crypto exchange providing information to Russian authorities. "You don't need to be afraid," the guide said.

After the explosion in Navalny's bitcoin donations, the FSB started exploring how to identify his crypto donors, according to the person familiar with the matter. The FSB, the person said, instructed Rosfin to find a way to achieve that goal. Responding to questions from Reuters, Rosfin said it is prohibited from disclosing measures to combat terrorist financing. It said Navalny was involved in "terrorist activity."

GRAPHIC: Rouble riches - https://graphics.reuters.com/FINTECH-CRYPTO/zjpqkddkdpx/chart.png
 

"OUT OF THE SHADOWS"

In April 2021, a Russian non-profit organisation called the Digital Economy Development Fund invited Binance to a private meeting with Rosfin at a government building in Moscow, according to the invitation seen by Reuters. The organisation is headed by a former top advisor to Putin on internet policy, German Klimenko, and was set up in 2019 to develop Russian technologies. The fund's website says one of its partners is the Russian trade and industry ministry. Kostarev, the Binance director, chairs the fund's committee on digital currencies.

Neither the Digital Economy Development Fund nor Klimenko responded to emails seeking comment.

Another exchange, OKX, originally Chinese but now based in the Seychelles, was also invited, a person familiar with the meeting said. An OKX spokesperson said the company declined the invitation, without giving a reason.

At the meeting, according to Kostarev's messages, Rosfin said it wanted exchanges to register with the agency so they could receive its requests for client information. Kostarev wrote to the business associate to say he didn't view the demand as a problem. He told the associate the FSB was interested in crypto, too. He didn't elaborate.

Asked about Kostarev's meeting with Rosfin, Binance said, "We did not work with, collaborate, nor partner with that organization." Five months later, Rosfin sent Binance a questionnaire, reviewed by Reuters, seeking more information on the exchange's background checks on clients and its "preferred channel of communication" with authorities for requests on crypto transactions. Asked about this communication, the firm said, "Binance takes its compliance obligations seriously and welcomes opportunities to consult with regulators."
 

Kostarev told the business associate in a message around the time of the questionnaire that Binance was stepping up efforts to engage with the government on crypto regulation. Rosfin was prepared to support Binance in this, Kostarev wrote.

But the Russian central bank was opposed to Moscow regulating cryptocurrencies and allowing the market to flourish out of concern that it would encourage criminal activity. Many of the world's central banks, whose mission includes controlling money supply, have similar qualms about the wild world of crypto. Governor Elvira Nabiullina told Russia's parliament in November "a responsible state should not stimulate their distribution." A spokeswoman for the central bank declined to comment.

In January of this year, Binance announced it had hired a senior central bank official, Olga Goncharova, as a director for the Greater Russia region. Goncharova would build "systematic interaction" with authorities in Russia, Binance said.

After Nabiullina proposed a ban on crypto use on Russian territory later that month, Kostarev told the business associate in a message that Binance was "in a war" with the central bank. All other Russian government agencies wanted to legalise digital currencies, Kostarev said. Support for crypto was indeed building in Moscow. Following Nabiullina's call for a ban, a top official at the finance ministry publicly backed the law that would require crypto exchanges to turn over names of their customers, saying it was necessary to ensure "transparency."

Putin then intervened. In a televised meeting with ministers on Jan. 26, he asked the government and central bank to reach a "unanimous opinion" on crypto regulation. He noted Russia had "certain competitive advantages" in the sector, such as surplus electricity, the most crucial input for the power-hungry creation of cryptocurrency.

Two weeks later, the government approved a plan for crypto regulation, drawn up by agencies including Rosfin and the FSB, that would bring the "industry out of the shadows."

Kostarev tweeted in response to an article on the announcement, "Finally some good news."
 

In a document describing the proposed regulatory framework, the government said that without such a system law enforcement "will not be able to respond effectively to offences and crimes." The government would create a database of cryptocurrency wallets related to terrorism financing, the government said, and exchanges would have to disclose information about their customers to Rosfin. The finance ministry submitted an early version of the draft law on Feb. 18.

Six days later, Russian forces invaded Ukraine. Binance's rouble trading exploded as Western nations imposed sanctions on Russia and the Kremlin limited foreign currency withdrawals. CryptoCompare's data shows Binance's average daily volume for rouble transactions for the initial three weeks of the war was almost four times higher than during the month before.

On Binance's Russian Telegram group, some volunteer customer representatives, known as Binance Angels, endorsed traders' posts thanking Binance for not blocking accounts, including one message asking Binance not to "fall for this war crap." Binance has enlisted hundreds of Angels around the world to promote the exchange to local crypto traders.

"Binance does not interfere in politics," one Angel wrote. Binance told Reuters that Angels are not spokespeople for the company.

Binance also drew praise from Putin's United Russia party. One lawmaker, Alexander Yakubovsky, speaking to the official parliament newspaper on March 14, called Binance the "leading experts in our country" advising politicians on crypto regulation. The company "is under strong pressure from countries unfriendly to Russia," he said. Binance said they had never met or communicated with Yakubovsky and his opinions were his own.

($1 = 78.2830 roubles)

((Reporting by Angus Berwick in Vilnius and London and Tom Wilson in London; edited by Janet McBride))

[© 2022 Thomson Reuters. All rights reserved.]This material may not be published, broadcast, rewritten or redistributed.  Thompson Reuters is solely responsible for this content.