U.S. prosecutors are now going after insider trading in the crypto industry.
On Wednesday, prosecutors in New York's Southern District charged and arrested Nathaniel Chastain, a former product manager at the online marketplace OpenSea. The 31-year-old faces one count of wire fraud and one count of money laundering, in connection with a scheme to commit insider trading in non-fungible tokens, or NFTs, "using confidential information about what NFTs were going to be featured on OpenSea's homepage for his personal financial gain."
Each count carries a maximum sentence of 20 years in prison, the Department of Justice wrote in a press release.Â
DOJ officials say it is the first time they have pursued an insider trading charge involving digital assets.
Chastain's alleged scheme was relatively simple.
According to the indictment, Chastain was tasked with selecting NFTs to be featured on OpenSea's homepage. OpenSea kept those homepage selections confidential until they went live, since a main page listing often translated to a jump in price for both the featured NFT, as well as NFTs made by the same creator.
From roughly June to September of 2021, the indictment says, Chastain would secretly buy an NFT just before OpenSea featured the piece on the front page of its website. Once those NFTs hit the main page, he would allegedly sell them "at profits of two- to five-times his initial purchase price."
To cover his tracks, he conducted transactions with anonymous digital currency wallets and anonymous accounts on OpenSea, according to the DOJ, which alleges this happened dozens of times.
"NFTs might be new, but this type of criminal scheme is not," said U.S. Attorney Damian Williams. "Today's charges demonstrate the commitment of this Office to stamping out insider trading — whether it occurs on the stock market or the blockchain."
The FBI's Assistant Director-in-Charge Michael J. Driscoll says the bureau will continue to aggressively pursue actors who choose to manipulate the market in this way.
Up until Sept. 2021, when Chastain's alleged bad practices first came to light, the start-up was relatively lax with respect to restrictions around employees using privileged information to invest in NFTs.
The company has since implemented two new employee policies, including banning OpenSea team members from buying or selling from collections or creators while they are being featured or promoted by the company, as well as barring staff from "using confidential information to purchase or sell any NFTs, whether available on the OpenSea platform or not."Â
The entire episode lays bare the regulatory gap that exists across large swaths of the wider crypto ecosystem. NFTs, in particular, exist in a legal gray zone. They aren't officially considered securities, nor is there much by way of legal precedent around digital assets as a whole. So up until today's arrest, it wasn't clear if prosecutors would go after insider trading of NFTs.
London-based fintech data analyst Boaz Sobrado said the OpenSea scandal makes two things clear. First, the transparency of the blockchain makes it a powerful tool to monitor nefarious behavior, given that all trades are public and recorded forever. But until today's arrest, regulators hadn't done much with that information.
"There's a lot of chat about regulation right now, but what a lot of these bad actors are doing is clearly against the law right now. Regulators don't need their powers expanded to be able to combat this sort of fraud and misleading statements," Sobrado said.
Sobrado noted that money is so loose in the space that people participating in nefarious activity are neglecting the simplest steps to cover their tracks.
"This, again, is indicative of the sort of wanton craziness that is going on in the sector right now," he said. "While the going is good and everyone feels like they're rich, it's not spoken about as much. But as soon as the market turns down, a lot of these people are going to get exposed and a lot of people are going to be angry."
