On June 1, 2022, the U.S. Department of Justice (DOJ) filed criminal charges against a crypto employee in first ever digital asset insider trading scheme.1 The investigation was led by FBI’s National Cryptocurrency Enforcement Team, and it involves Nathaniel Chastain, an OpenSea former executive, who used insider information to profit from buying and selling Non-Fungible Tokens (NFTs).2 Thanks to the transparent nature of the blockchain, the scheme was easily tracked and identified, resulting in charges for wire fraud and money laundering.
According to the indictment, the employee used his advanced knowledge of what NFTs were going to be featured on OpenSea’s homepage to secretly purchase dozens of NFTs shortly before they were featured on the company’s website. After the NFTs were featured, the employee sold them at profits of two to five times his initial purchase price. To conceal the fraudulent scheme, the employee made the purchases using anonymous digital wallets and anonymous accounts on OpenSea.3
What Constitutes Insider Trading for Digital Assets?
Insider trading is the illegal use of “material, non-public information” for profit.4 Insider trading typically refers to violations of securities laws, and, until now, has not been linked to the cryptocurrency market. Because the SEC has not issued any guidance on whether NFTs are securities, the employee wasn’t charged with violating the antifraud provisions of the Securities Exchange Act of 1934 and, specifically, Rule 10b-5 that covers instances of insider trading in the stock market.5 Instead, he was charged with wire fraud – covers insider trading in any asset – for using Open Sea’s confidential business information to obtain money or property by means of false or fraudulent pretenses.6 This charge stems directly from an agreement that the employee signed upon joining OpenSea, requiring all employees to maintain confidentiality of confidential business information received in connection with the work for OpenSea, and an obligation to refrain from using such information for personal benefit. Information about which NFT was going to be featured was confidential because it was not publicly available until the featured NFT appeared on OpenSea’s website. The employee was also charged with money laundering for attempting to conceal the fraud by using anonymous cryptocurrency wallets and OpenSea accounts.7
Although NFT assets are new to investors, insider trading is not. While these charges concern NFTs specifically, they should send a clear message to the entire cryptocurrency industry that the DOJ is investigating and prosecuting insider trading violations that take place on the blockchain. Recently, Coinbase insiders have also been under fire for possible insider trading based on blockchain data that suggests that they have profited from knowing when certain tokens would be listed on the platform.8 Like OpenSea, Coinbase prohibits employees from trading on “material non-public information,” such as when a new cryptocurrency or token will be listed on the exchange.9 If these allegations are found to be legitimate, Coinbase employees might find themselves in a similar situation.
Cryptocurrency Market Manipulation
Market manipulation via rug-pulls and wash trading is also very common in the cryptocurrency market. Market manipulation is another form of insider trading because market manipulators pose as inside traders – tricking investors into thinking they know something others don’t. A rug pull occurs when crypto developers abandon a project and run away with investors’ funds.10 In 2021, rug-pull scams cost investors $2.8 billion.11 Wash trading occurs when a trader (or exchange) manipulates trading volume to deceive other market participants about an asset’s price or liquidity. In 2021, Coinbase was ordered to pay $6.5 million for false, misleading, or inaccurate reporting and wash trading.12 Reducing insider trading is a powerful way to reduce market manipulation, and, in turn, add legitimacy to the cryptocurrency market.
Let Gordon Delic & Associates Help!
Insider trading laws are complex, especially when trying to apply them to open-source nature of the blockchain. Although decentralized and transparent, insider trading rules very much apply to crypto – especially when it comes to misappropriation, sharing exchange listing information, and front running trades. Opening multiple crypto wallets to cover up this behavior will only make matters worse. If you have any questions about possible insider trading violations, or anything crypto related, contact us or give us a call at (208) 900-9509.
References
- https://www.justice.gov/usao-sdny/pr/former-employee-nft-marketplace-charged-first-ever-digital-asset-insider-trading-scheme
- https://s3.documentcloud.org/documents/22048988/chastain-indictment.pdf
- Id.
- https://casetext.com/case/salman-v-united-states-1
- https://www.sec.gov/news/testimony/2011/ts120111rsk.htm
- https://www.law.cornell.edu/uscode/text/18/1343
- https://www.law.cornell.edu/uscode/text/18/1956
- https://blog.coinbase.com/our-employee-trading-policy-at-coinbase-1d4e860b7837
- chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://s27.q4cdn.com/397450999/files/doc_downloads/gov_docs/Copy_of_Coinbase_Global_Inc_Code_of_Business_Conduct_and_Ethics_252092_-_Public_Website_Version.pdf
- https://www.justice.gov/usao-sdny/pr/two-defendants-charged-non-fungible-token-nft-fraud-and-money-laundering-scheme-0
- https://financialpost.com/fp-finance/cryptocurrency/rug-pull-scams-raked-in-over-us2-8-billion-in-crypto-in-2021-report-finds
- https://www.cftc.gov/PressRoom/PressReleases/8369-21
