US court provides clarity on cryptographic rules with OpenSea verdict

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

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

In fairness to the complaints, the US controls 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 approved Mica regulation. No regulator has a full mandate on space at the federal level, not even Gary Gensler, the chairman of the Securities and Exchange Commission.

But this week US courts ruled loud and clear on the application of existing rules in an area, insider information and NFTs. It’s 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 of OpenSea, the world’s largest NFT marketplace, was on Wednesday found guilty of fraud and money laundering after purchasing NFTs which, due to its location, it expected would become popular once displayed on the OpenSea website. Chastain, who will be sentenced at a later date, faces a maximum of 40 years in prison.

Prosecutors said Chastain bought 45 tokens over a period of about five months before they appeared on OpenSea, only to sell them soon after they appeared for between two and five times the price he paid.

Assistant U.S. Attorney Allison Nichols referred to messages from Chastain that showed she was “afraid of missing something.” “He saw a way to make some extra cash, to capture some upside,” she said in closing discussions this week.

Chastain’s defense 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 market had “no policies” in place before it bought its tokens.

But part of his defense was also based on one of the cryptocurrency market’s biggest complaints: insider trading fees apply to stocks or commodities, and that NFTs (like many other crypto tokens) have not been legally designated as any of the two.

Notably, however, the court’s verdict sidestepped this thorny issue.

“If it looks like a duck . . . in Mr. Chastain’s case, the facts exposed by the government had the classic signs of insider trading and why it’s prohibited in the first place,” BakerHostetler’s litigation partner Joanna Wasick told me this week.

“An employee, presumably well-resourced, is in a unique position to access key non-public information. The person takes that information and does with it what the average Joe can’t: he leverages the confidential data to make even more money,” he added.

This clearly has implications for the rest of the cryptocurrency market; insider trading is insider trading, whether it’s in stocks, commodities, or digital images of monkeys with no zest for life.

Indeed, the case serves as a perfect microcosm of the vast disconnect between the cryptocurrency industry and American lawmakers. People like Coinbase CEO Brian Armstrong argue that the US “needs to upgrade its financial system”.

Perhaps, but no matter when laws emerge and in what form they take, they are unlikely to undermine existing federal laws.

“Nothing in the government’s case involves classifying the NFTs in question as securities or any other regulated instrument,” Peter Fox, a partner at law firm Scolidge, Peters, Russotti & Fox, told me by email.

What do you think of the Chastain case? As always, write me at scott.chipolina@ft.com.

Join me and FT colleagues at the FT Crypto and Digital Assets Summit May 9-10 as we discuss where the digital assets market is heading. Also in attendance at the event are UK 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 reported a smaller-than-expected loss in Q1 results. The Nasdaq-listed exchange reported a loss of 34 cents a share on more than $772 million in revenue, higher than an estimated $653 million. Shares of the company rose 7% in after-hours trading yesterday.

• The White House released a report proposing that companies engage in cryptocurrency mining practices face a 30 percent tax for the cost of the electricity they use. The policy would mark yet another acknowledgment of the immense energy costs involved in mining cryptocurrencies such as bitcoin. According to the University of Cambridge, bitcoin electricity consumption levels are currently roughly equivalent to the the whole Ukrainian nation.

• Another word on bitcoin: While the flagship cryptocurrency has enjoyed its longest winning streak for more than two years, there are plenty of signs that investors are still reluctant to buy cryptocurrencies. Read my piece on how the recent cryptocurrency rally was built on a less and less traded market.

• One year after the infamous collapse of Terraform Labs, South Korea is tightening his grip on trading digital assets. Central to the country’s crypto showdown is wemix, a token issued by a local game developer that has rapidly grown in popularity among gamers flocking to “play to earn” video games.

• The UK’s Financial Conduct Authority continues its hawk-eyed crackdown 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 searched for sites in East London and West Yorkshire. Big league stuff.

Bite of the week: Coinbase loves the US

Coinbase’s Brian Armstrong has been vague about whether the exchange would consider leaving the United States if regulatory pressure – which he perceives as unwarranted – continues.

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

During an analyst call following last night’s results, the Coinbase boss was much more direct.

“So let me be clear, we are 100% committed to the United States. I founded this company in the United States because I saw that the rule of law prevails here. This is really important, and I’m actually very optimistic that the United States gets it right.

Data mining: digital asset investment products on the rise

Cryptocurrency prices went up and then cryptocurrency prices went down. But despite the numerous market challenges (again, read my latest here) at least now investors feel a little less poor.

Assets under management for digital asset investment products, offered by companies like Grayscale, soared to $33.5 billion by the end of last month, according to data from provider CCData. This is the fifth consecutive month of growth and a 70% return so far this year. Still not as high as last summer, but it’s a start.

Cryptofinance is edited by Philip Stafford. Please send any thoughts and feedback to cryptofinance@ft.com.