(Bloomberg) -- A top US regulator’s case against Binance Holdings Ltd. is mushrooming well beyond Changpeng Zhao’s company and rattling American firms that officials say worked with the exchange to trade crypto.

The Commodity Futures Trading Commission’s scrutiny of arrangements that three trading firms had with the exchange has already sent chills across an industry, which relies on US licenses to make markets for securities. The firms weren’t identified in the CFTC’s lawsuit. 

The stakes are particularly high for American trading firms because even as many have dabbled in crypto, equities and other more traditional assets remain their bread and butter. A serious regulatory misstep could have repercussions on their broader ability to conduct business. 

“The risks to US firms are far greater than the risk to Binance,” said Urska Velikonja, a professor at Georgetown Law. “The big risk to them is the ‘lights out’ risk that they lose their license to operate as broker-dealers in the US.”

It’s unclear how the case against Binance, whose global exchange isn’t based in the US, will ultimately play out. However, many US trading firms are registered as brokerages with the Financial Industry Regulatory Authority and overseen by other American authorities. 

Cayman Islands

According to the CFTC, one unidentified US firm used a Cayman Islands subsidiary to trade on Binance. Another traded on Binance by entering into a “services agreement” with an ostensibly unrelated entity organized under the law of Jersey, a British dependency. A third started trading through a Singapore subsidiary, then switched to an entity incorporated in the Cayman Islands as well, according to the complaint filed in federal court on Monday. 

Binance also directed some US customers to use virtual private networks, or VPNs, to obscure their location and directed some “VIP customers” with significant US ties to use shell firms, according to the CFTC. Those VIPs included trading firms based in the US, the CFTC said. 

Arrangements with trading firms were allegedly facilitated through a formal process at Binance called “VIP Handling,” the CFTC said. 

Binance called the CFTC’s lawsuit “unexpected and disappointing.” The exchange said it’d been working with the regulator for more than two years, had beefed up compliance staff, and would continue to collaborate with authorities in the US and elsewhere.

Hayden Hughes, co-founder of social-trading platform Alpha Impact, said that the CFTC’s lawsuit raises the specter of trading firms backing away from Binance. 

“Market makers typically wouldn’t want to be caught in a crossfire between the US regulators and Binance,” Hughes said. 

Cumberland, a major crypto trading firm and subsidiary of Chicago-based DRW, said the suit would hurt liquidity in the digital-asset space, but cautioned traders to take a beat and digest the implications of the lawsuit. 

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There is a possibility that the industry comes out of the suit with “confidence-bolstering regulation and fairer industry standards,” the firm said in a statement posted on Twitter Monday. Cumberland, which was not identified in the CFTC complaint against Binance, declined to comment further.

--With assistance from Suvashree Ghosh and Allyson Versprille.

(Updates with Cumberland comment in twelfth paragraph)

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