Insider trading case of former OpenSea employee raises NFT regulatory ‘alarm’

Heading into June, the most sensational scandal in the NFT space was the arrest of a former employee of the trading platform OpenSea.

On June 1, U.S. time, the U.S. Department of Justice (DOJ) disclosed that federal prosecutors for the Southern District of New York and FBI investigators arrested Nathaniel Chastain, the former product manager of OpenSea, in New York, accusing him of wire fraud and money laundering related to NFT insider trading. . If convicted, Chastain could face up to 20 years in prison.

The DOJ alleges that, from June to September 2021, Chastain used OpenSea’s internal trade secrets to purchase certain NFTs that would be listed on the platform in advance, and then sold them for 2–5 times the initial investment price after they were officially listed.

OpenSea is the world’s largest NFT (non-fungible token) trading platform. In the past, news of “inside trading” in the NFT market was always revealed by blockchain data agencies or investors. Now, the Chastain case has been disclosed by the judicial department, becoming the first NFT insider trading case involving DOJ.

The involvement of the judiciary has lifted the cover of “insider trading in the NFT market”, and it has also made industry practitioners begin to think that US regulators may consider including NFTs in the regulatory sequence. Homogenized encrypted assets such as Ethereum (ETH) and Ripple (XRP) have all experienced regulatory torture whether they are recognized as securities, and NFT does not rule out going to such a fate today.

According to an analysis by former SEC officials, the Howey test used to determine whether a transaction qualifies as an investment contract or securities also applies to NFTs, because the characteristics of “buying NFTs, hoping for price increases and making money from them” are not as relevant as investing in securities. big difference. Judging from the statements of law enforcement agencies, even if securities supervision is bypassed, the use of NFTs to carry out money laundering and wire transfer fraud is still an unavoidable crime.

The US Department of Justice intervenes in the chaos of “NFT insider trading”

“Former employees of NFT trading platforms are accused of participating in the first digital asset insider trading scheme.” On June 1, the US Department of Justice (DOJ) disclosed on its official website the case of Nathaniel Chastain, the former product manager of OpenSea, involved in insider trading, 31-year-old Chastain Arrested in New York City that morning, he was charged with wire fraud and money laundering in connection with an NFT insider trading scheme.

The indictment shows that the case involved NFT insider trading on OpenSea, and Chastain violated his obligations to his employer by using inside information in advance for personal financial gain. As part of his job, he is responsible for selecting which NFTs will be featured on the OpenSea homepage, and featured NFTs are confidential until listed on the platform.

From approximately June to September 2021, Chastain used trade secret information to secretly buy dozens of certain NFTs before they were listed, and sold them at a profit of 2–5 times the initial purchase price after listing, “in order to cover up the fraud . As a result, Chastain conducted these transactions using an anonymous digital currency wallet and an anonymous account on OpenSea.”

The Justice Department said in a press release that if Chastain is charged with wire fraud and money laundering, each count carries a maximum sentence of 20 years in prison.

Chastain’s misconduct was first exposed on Twitter in September last year, and OpenSea eventually admitted in an official blog post that some employees had misbehaved and asked the employees involved to leave the company. OpenSea has since implemented two new employee policies, including prohibiting team members from buying NFTs from collectors or creators when the company recommends or promoting them, and prohibiting employees from “using confidential information to buy or sell any NFTs, whether or not those NFTs are on OpenSea. available.”

Nearly a year has passed since this incident. Due to the intervention of the US judicial department, the insider trading of the NFT platform began to gradually evolve from market chaos to illegal crimes. Interestingly, after the Chastain case was disclosed, the surprise of NFT players was not in insider trading, but in the fact that those involved would be brought to justice.

“They are suing NFTs for insider trading, we are all playing the ball,” said some netizens after seeing the news. More people believe that insider trading is very common in the NFT market, and some people simply say, “I can’t imagine any NFT or DeFi developer who won’t profit from insider trading in some way.”

More insiders broke the news also appeared in media reports. NFT trader and creator Fedor Linnik revealed in an interview with VICE that consumers will not know which NFTs are rare until a new series of NFTs are listed or minted on the exchange (in the NFT market, the rarer NFTs tend to be more expensive ), but the developer owns the information. Information disclosure and NFT listing generally occur hours or days after the completion of the project, but unlisted NFTs are usually traded on the secondary market, “creators who know which unlisted NFTs are rarer often use anonymous wallets to buy in advance , in order to profit from subsequent public sales.”

In the past, if an NFT project or platform was revealed to have insider trading, the project party would bear moral hazard or a drop in the NFT price caused by market distrust. In October 2021, the NFT project MekaVerse was reported by users to have insider trading. Although the project team denied this, the NFT series still encountered panic selling, and the floor price fell from 7 ETH to 2 ETH.

Today, the involvement of the U.S. judiciary in the Chastain case also marks that insider trading in the NFT market will no longer be a chaotic phenomenon in the crypto circle or a moral issue for practitioners, and those involved will bear specific legal risks. For consumers, this is a protection, but for entrepreneurs in the NFT space, they are likely to face the securities designation torture that crypto assets encountered years ago.

Chastain case sparks discussion on NFT securities attributes

When DOJ disclosed the Chastain case, the charges and the applicability of existing laws also entered the field of vision of NFT practitioners, and legal professionals concerned about encrypted assets also started discussions on this.

In the indictment, Chastain is charged with wire fraud and money laundering. In the DOJ’s press release, the department directly viewed the Chastain case as the first case of insider trading in digital assets.

“Insider dealing” generally applies to the securities market. According to the definition of the U.S. Securities and Exchange Commission (SEC), insider trading generally refers to the act of buying or selling securities based on material, non-public information about the securities in breach of fiduciary duty or other relationship of trust. So far, the term has never referred to cryptoassets.

In an interview with TechCrunch, former SEC official Alma Angotti explained that the allegations are not surprising, “the misappropriation of confidential information about your employer is fraud, and once you move the proceeds of the fraud through the monetary system, it’s money laundering.” For insider trading on crypto assets In terms of applicability, Angotti believes that NFTs are likely to be a security under Howey’s test. “If you buy a piece of NFT and hope the price rises to make money from it, it’s not much different [from securities].”

The Howey test is used by U.S. regulators to determine whether a certain type of transaction qualifies as an investment contract or securities. If an investment has the expectation of profiting from the efforts of others, it has the characteristics of an investment contract; if it qualifies as a security, the issuer needs to report to the regulator. The department is registered and regulated, while meeting letter approval requirements.

JW Verret, a securities law professor at George Mason Law School, said in an interview with VICE that it was “somewhat misleading” for the government to call Chastain a case of insider trading. “It wasn’t prosecuted as an insider trading case, it was a wire fraud case.”

The existing encrypted assets Ethereum (ETH) and Ripple (XRP) in the market have all encountered hearings from the regulatory authorities on whether they are securities after 2018. Ethereum is finally due to its full decentralization and is not subject to third-party protection. Controlled but not recognized as securities, it is included in the scope of “commodities” under the jurisdiction of the U.S. Commodity Futures Trading Commission (CFTC). Ripple Labs, the company behind Ripple, is still being sued by the SEC for “issuing unregistered securities” until 2021.

From the perspective of the generation of NFT, it is minted by the creator through the blockchain, and then sold to users through the platform. In this way, it looks like a commodity. But from a business model perspective, it has investment logic in the secondary market, and consumers buy it to gain appreciation.

Today, NFTs seem to be in the midst of a “securities or not” fate in the Chastain case, a result not only about who will oversee it, but also about the applicability of relevant laws, such as allegations of insider trading.

OpenSea has tried to distance this incident from insider trading, and its CEO Devin Finzer said last year when commenting on the matter, “We do not consider NFTs as financial assets, so it does not apply (inside trading), which is specific to specific things. the term.”

But law enforcement doesn’t seem to plan to start with the properties of NFTs.

“NFTs may be new, but this type of criminal scheme is not. Nathaniel Chastain allegedly betrayed OpenSea and used his confidential business information to make money for himself. Today’s charges show that the prosecution Committed to eliminating insider trading – whether it’s on the stock market or on the blockchain.”

FBI Assistant Director Michael J. Driscoll said, “As the allegations allege, Chastain launched an age-old scheme to use his knowledge of classified information to purchase dozens of NFTs before they appeared on OpenSea’s homepage. Insider trading. With the advent of any new investment vehicle, such as blockchain-backed NFTs, some people will exploit loopholes for personal gain, and the FBI will continue to aggressively pursue those who manipulate the market in this way.”

The final outcome of the Chastain case still needs to be decided by the court, but judging from the statements and actions of U.S. law enforcement agencies, the NFT market will no longer be a place outside the law.

Posted by:CoinYuppie,Reprinted with attribution to:
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