US court provides clarity on crypto rules with OpenSea verdict

Hello and welcome to the latest edition of the FT Cryptofinance newsletter. This week we’re taking a look at the world’s first NFT insider trading case.

“We need regulatory clarity” is fast becoming the rallying cry for crypto companies frustrated with the US crackdown on digital assets.

In fairness to the complaints, the US oversees the industry through a patchwork of existing federal securities, banking and derivatives laws. Congress does not yet have a legislative package on the same level as the EU’s recently passed Mica regulation. No one regulator has full remit over the space at the federal level — not even Gary Gensler, the hard-charging chair of the Securities and Exchange Commission.

But this week the US courts spoke loud and clear on the application of existing rules in one area, inside information and NFTs. They’re the non-fungible tokens that are bought and sold on the blockchain that briefly enlivened the art world last year.

Nate Chastain, former product manager at OpenSea, the world’s largest NFT marketplace, was on Wednesday found guilty of fraud and money laundering after purchasing NFTs that, owing to his position, he expected would become popular once displayed on OpenSea’s website. Chastain, who will be sentenced at a later date, is facing a maximum of 40 years in prison.

Prosecutors alleged that Chastain bought 45 tokens over roughly a five-month period before they appeared on OpenSea, only to sell them soon after display for between two and five times the price he paid.

Assistant US attorney Allison Nichols referred to messages from Chastain that showed he had a “fear of missing out”. “He saw a way to make some extra money, to capture some upside,” she said in closing arguments this week.

Chastain’s defence argued that he had no training or guidance at OpenSea that would have taught him to avoid buying the NFTs in question, adding that the marketplace had “no policies” in place before he bought his tokens.

But a chunk of his defence also rested on one of the crypto market’s biggest gripes: insider trading charges apply to securities or commodities, and that NFTs (like a lot of other crypto tokens) have not been legally designated as either.

Notably though, the court verdict sidestepped this thorny issue.

“If it looks like a duck . . . in the case of Mr Chastain, the facts as laid out by the government had classic markings of insider trading and why it’s prohibited to begin with,” BakerHostetler litigation partner Joanna Wasick told me this week.

“A white-collar, presumably well-resourced individual is in the privileged position to access key non-public information. The person takes that information and does with it what the Average Joe cannot — exploits the confidential data to make even more money,” she added.

This clearly has implications for the rest of the crypto market; insider trading is insider trading, regardless of whether it involves securities, commodities, or digital pictures of apes lacking enthusiasm for life.

In fact, the case serves as the perfect microcosm of the wide disconnect between the crypto industry and American lawmakers. People such as Coinbase’s chief executive Brian Armstrong argue that the US “needs to update its finance system”.

Perhaps, but no matter when the laws emerge and in what form they take, they’re unlikely to undercut existing federal laws.

“Nothing in the government’s case turns on classifying the NFTs at issue as securities, or any other regulated instrument,” Peter Fox, partner at law firm Scoolidge, Peters, Russotti & Fox, told me over email.

What are your thoughts on Chastain’s case? As always, email me at scott.chipolina@ft.com.

Join me and FT colleagues at the FT’s Crypto and Digital Assets Summit on May 9-10 as we discuss where the digital assets market is heading. Also appearing at the event are the UK’s economic secretary to the Treasury Andrew Griffith and Hester Peirce of the US Securities and Exchange Commission. Register for your pass here.

Weekly highlights

Coinbase has reported a narrower loss than expected in its first-quarter results. The Nasdaq-listed exchange reported a loss of 34 cents a share on more than $772mn in revenues, above the estimated $653mn. Shares in the company rose 7 per cent in after-hours trading yesterday.
The White House released a report proposing that firms engaged in crypto mining practices face a 30 per cent tax for the cost of the electricity they use. The policy would mark yet another recognition of the immense energy costs involved in mining cryptocurrencies such as bitcoin. According to Cambridge university, bitcoin’s electricity consumption levels are at present roughly equivalent to the entire nation of Ukraine.
Another word on bitcoin: while the flagship cryptocurrency has enjoyed its longest winning streak for more than two years, there are plenty of signs investors are still reluctant to buy into crypto. Read my piece on how crypto’s recent rally has been built on an increasingly thinly traded market.
One year on from the infamous collapse of Terraform Labs, South Korea is tightening its grip on digital asset trading. At the heart of the country’s crypto reckoning is wemix — a token issued by a local game developer that quickly surged in popularity among gamers flocking to “play-to-earn” video games.
The UK’s Financial Conduct Authority continues its hawk-eyed clampdown on illegally operated crypto ATMs. In a joint operation with law enforcement agencies the regulator “inspected” sites in Exeter, Nottingham and Sheffield. They had previously gone after sites in east London and West Yorkshire. Big league stuff.

Soundbite of the week: Coinbase loves the US

Coinbase’s Brian Armstrong has been vague on whether the exchange would consider leaving the US should regulatory pressure — which he perceives as unjustified — continues.

“Anything is on the table,” he said during a visit to London last month.

On an analysts’ call following last night’s results, the Coinbase chief was much more straightforward.

“So let me be clear, we’re 100% committed to the US. I founded this company in the United States because I saw that rule of law prevails here. That’s really important, and I’m actually really optimistic on the US getting this right.”

Data mining: Digital asset investment products on the rise

Crypto prices rallied, and then crypto prices fell flat. But despite the market’s many challenges (again, read my latest here) at least investors feel slightly less poor now.

Assets under management for digital asset investment products, offered by companies such as Grayscale, rose to $33.5bn by the end of last month, data from provider CCData has found. That’s the fifth consecutive month of growth and a 70 per cent return year to date. Still not as high as last summer’s, but it’s a start.