How Insider Trading Is Hurting Everyday Crypto Investors

Do we need regulation to prevent insider trading in crypto?

The Department of Justice recently charged an OpenSea executive with insider trading, the first ever such case in digital assets. Meanwhile, the SEC has reportedly launched a probe into how insider trading is handled at crypto exchanges. As insider trading in the cryptocurrency world comes under the spotlight, we take a look at what it is and how it impacts crypto investors.

What is insider trading?

Insider trading is where a person makes trades based on confidential information. For example, perhaps you work for a company that's about to announce a big merger or disappointing annual results. If you buy or sell stock because of that information, it's insider trading and you could be prosecuted.

In stock investing, there are rules and processes to stop insider trading. This is especially the case for companies that are registered with the SEC, as they have systems in place to prevent it. Corporations may appoint compliance officers, create training programs, and introduce blackout periods to restrict trading around key events. Even then, it hasn't been stamped out completely.

How does insider trading impact crypto?

In the cryptocurrency world, there are fewer established systems and processes. Plus, most cryptocurrencies aren't classed as investments that need to follow SEC rules. But it seems that insider trading rules don't only apply to SEC-registered assets. And ignorance of the law is no defense.

At the start of June, the Department of Justice announced it would bring charges against OpenSea's Nathaniel Chastain. It's alleged that Chastain, who was responsible for choosing which NFTs would be featured on the platform's homepage, secretly bought some of those items beforehand. He then profited when the prices increased. OpenSea is one of the biggest NFT marketplaces in the world.

U.S. Attorney Damian Williams said, "NFTs might be new, but this type of criminal scheme is not. As alleged, Nathaniel Chastain betrayed OpenSea by using its confidential business information to make money for himself. Today's charges demonstrate the commitment of this Office to stamping out insider trading -- whether it occurs on the stock market or the blockchain."

Another area that's coming under scrutiny is people buying cryptocurrencies shortly before they get listed on major crypto exchanges. Since prices often increase after new listing announcements, this can be a way to make a quick buck for those who know in advance. Fox News recently reported that the SEC has written to several exchanges to ask for more information. If authorities can prove that exchange employees are trading based on non-public listing information, we may see further digital asset insider trading charges.

How insider trading is hurting crypto investors

There's a reason the SEC comes down hard on insider trading in the stock market: It creates an uneven playing field and can hurt ordinary investors. Fundamentally, insider trading erodes trust in the crypto and NFT market. It means that when you buy crypto or an NFT, you can't be sure that the price hasn't already been pushed up by someone who unfairly knows something you don't.

Crypto exchanges say they have systems in place to stop employees from profiting from confidential information, but it isn't clear how strict they are or how deep the problem runs. For example, The Wall Street Journal published details of an analysis by Argus, a crypto compliance company. It showed 46 different crypto wallets had bought one particular token shortly before it was listed on various exchanges. The trades netted over $1.7 million profit, and that's only from one token listing.

The challenge is that there's so little in the way of crypto regulation, so crypto investors are relying on individual companies to essentially self regulate. That means trusting, for example, the senior team on a crypto project to not buy or sell the coin or token before a big announcement. Or hoping that crypto exchange employees won't seek to profit from advance knowledge of, say, a new listing.

However, this may not be enough. There's a good chance that additional investor protections and controls on insider trading will be part of additional crypto regulation in the U.S. Following President Biden's executive order, a new regulatory framework is in the pipeline, and a lot hangs on how strict the new rules will be.

Bottom line

Authorities such as the DoJ and SEC don't want to wait for new regulation, especially if they can use existing rules to prosecute unethical behavior. In the OpenSea case, the DoJ is prosecuting Chastain for wire fraud and money laundering, not specifically insider trading. Several industry insiders believe the OpenSea case is the tip of the iceberg and that the DoJ's case is only the start. In addition to increased regulatory controls, we may also see additional enforcement actions in the coming months.