Crypto insider trading is not an inside joke anymore

As crypto goes mainstream, insider trading is becoming a valid concern, but how do you control a space as maverick as crypto?

Crypto might not have made it to mainstream just yet, but it surely deserves to be called an industry. As a matter of fact, even “industry” is starting to sound odd for a space that brings together mining companies, trading platforms, DeFi protocols, NFT marketplaces, DAOs and pretty much everything down to crypto dating apps. These days, crypto is more of a sector.

What’s more, it’s a sector packed with mind-boggling money. In 2021, crypto investors realized gains of $162.7 billion, according to data published by Chainalysis. That’s more than the average yearly government spending of Sweden.

Total estimated realized cryptocurrency gains by country, 2021
Source: Chainalysis

A little under a third of that sum was made in the United States, which has the most stringent anti-insider trading laws in the world. Whether or not they apply to crypto assets, to be honest, nobody knows.

What is insider trading?

Insider trading occurs when a person in possession of material nonpublic information about a company trades the stock of that company before the information goes public.

At first, ages ago, the rule only applied to company officers and those owning considerable amounts of the company’s equity securities. The rule was then expanded to insiders’ friends and family members.

Nowadays, insider trading is more of a blanket term. It applies to anyone who acquires non-material information, whatever their position. In a high-profile case the Securities and Exchange Commission (SEC) prosecuted in 2017, Amazon financial analyst Brett Kennedy shared the company’s non-public 2015 first-quarter earnings with his fellow University of Washington alumni Maziar Rezakhani, but he charged him $10,000. Is that what you’d expect from a friend?

It’s worth noting that not all insider trading in the US is illegal. As long as insiders disclose their trades to the SEC on time and refrain from trading on material nonpublic information, they face no consequences.

Illegal insider traders, however, risk both civil and criminal penalties. A single instance of willful insider trading by an individual can cost up to $5 million in fines and result in imprisonment for up to 20 years. For businesses, penalties can climb to as much as $25 million.

What do insider trading laws cover?

Most people know that insider trading law in the United States applies to public securities, and that it’s enforced by the SEC.

In recent years, the Commodity Futures Trading Commission (CFTC) has clamped down on insider trading in commodities, arguing that the Dodd-Frank Act passed in the wake of the financial crisis of 2008 gave the CFTC the same powers the SEC wields in securities.

There’s a debate among scholars on whether anti-insider trading law should also cover real estate.

Right now, it doesn’t. In fact, real estate agents refer to the concept of insider trading as “imperfect information,” the industry’s Holy Grail.

Say Mr. A is selling his parcel, demanding a modest price. Unbeknownst to Mr. A, the land is rich in natural gas. Mrs. B runs some research or gets a tip from her geologist friend, and buys the parcel with fabulous profits.

There’s nothing wrong with it. Mrs. B has no obligation to disclose her “imperfect information” to Mr. A. Or the SEC, or the CFTC.

This is where we come across coins, because ultimately, insider trading laws boil down to asset classification. The SEC considers cryptocurrencies to be securities, but the CFTC believes digital assets should be treated as commodities. Other countries, including the UK, tend to interpret them as property.

How to detect insider trading? Crypto edition

If crypto assets are deemed to be subject to insider trading laws in the US, either the SEC or the CFTC will have to extend its surveillance to crypto projects.

All right. Which ones, though? Exchanges, for sure. NFT marketplaces. DeFi protocols, at least some. But crypto offers so many ways to make money, and deciding what will fall under insider trading rules is difficult, if not impossible.

At present, the investigators’ methods include scanning the market for illegal activity around important events, like earnings reports, as well as tips and complaints. Whistleblowers can even collect a monetary award of up to 30%, provided that the enforcement action results in at least $1 million worth of penalties.

If crypto ever comes under insider trading scrutiny, those methods will have to be reviewed. Not only will investigators have to monitor on-chain activity, but also crypto Twitter. They will need to keep track of new crypto ideas, platforms and protocols, understand smart contracts, and more. How would they investigate insider trading cases in GameFi? Would they play to earn?

Community oversight

For now, insider trading remains in the hands of the community, regulated by tech-savvy volunteers who catch suspicious activity on-chain and expose it on social media.

One of the biggest crypto exchanges, Coinbase, is tackling the issue by letting the public know which coins and tokens they consider listing, instead of withholding all information until the final decisions have been made.

This approach is not bulletproof, though. A day before Coinbase announced a list of 50 assets under consideration for listing in the second quarter of 2022, a pseudonymous crypto influencer Cobie tracked down an ETH address that amassed over $350,000 worth of some of the less popular altcoins from the list.

When Nate Chastain, OpenSea’s head of product, was found to have purchased NFTs that he knew would later land on the front page, he was forced to resign.

In other words, insider trading in crypto is regulated by the community’s outrage, and in some cases ostracism, but there is no prosecution and little to no consequences.

Now that the Biden administration is preparing a sweeping effort to assess the risks and benefits of digital assets, insider trading could soon enter the crypto dictionary for good.