The Breakdown - It's OpenSeason for Regulatory Enforcement

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.com, near NFTX, and produced and distributed by CoinDesk. What's going on, guys? It is Friday, June 3rd, and today we are talking about why it is open season for regulatory enforcement. Before we get into that, a few housekeeping notes. two ways to listen to the breakdown. You can hear it on the Coin Desk podcast network feed, which features the breakdown as well as other great Coin desk shows. That one comes out in the afternoon. Or you can listen on the breakdown only feed, which comes out in the evening of the same

Starting point is 00:00:50 day. Wherever you're listening, if you're enjoying the show, please slap a rating or review on it. It makes a huge difference and I appreciate each and every one. Finally, a disclosure as always. In addition to them being a sponsor of the show, I also work with FTX. Now, today we are talking to Hawking enforcement, and of course, if you couldn't tell from the pun in the title, we're honing in on the charges against a former OpenC executive. Let's get the overview and then let's get into the details. Nathaniel Chastain, who I will note goes by Nate, is the former head of product at OpenC. A grand jury has charged him with wire fraud and money laundering following an insider trading scandal. He was arrested on Wednesday, and each charge carries a maximum sentence of 20 years in

Starting point is 00:01:36 prison. The accusation is that Chastain used his knowledge of which NFT collections would be featured on OpenC's homepage to purchase NFTs from that collection using dozens of secret Ethereum wallets. Importantly, it wasn't just knowledge of which collections would be featured, but he was, in fact, responsible for selecting those collections. Throughout last summer, the charges go, he sold these pieces for somewhere between two and five times his purchase price. U.S. Attorney Damien Williams said NFTs might be new, but this type of criminal scheme is not. As alleged, Nathaniel Chastain betrayed OpenC by using its confidential business information to make money for himself. Today's charges demonstrate the commitment of this

Starting point is 00:02:16 office to stamping out insider trading, whether it occurs on the stock market or the blockchain. FBI assistant director Michael J. Driscoll added in a quote that the FBI will continue to aggressively pursue actors who choose to manipulate the market in this way. OpenC for their part had acknowledged this insider trading in September when it came to light. At the time, time, they wrote, as the world's leading Web3 marketplace for NFTs, trust and integrity are core to everything we do. When we learned of Nate's behavior, we initiated an investigation and ultimately asked him to leave the company. His behavior was in violation of our employee policies and in direct conflict with our core values and principles. So there are a couple of places I want to take this

Starting point is 00:02:56 conversation. First, the specifics of the charges and what's interesting about them, and then second, the community's reaction. When it comes to the charges, as you probably heard, Nate is being charged with wire fraud and money laundering. However, all the language in the public statements is around insider trading. The idea of insider trading is a nebulous one, and it's one that's got a lot of conversation. Branigan at Better Law MLA, wrote, Nate is not charged with insider trading that defrauded NFT market participants. He's charged with defrauding opency.

Starting point is 00:03:27 Pung 6-529 writes, he is not actually being charged with quote-unquote insider trading per se, but with wire fraud and money laundering for violating his duty of trust to employers. It is quite an aggressive approach in my humble opinion. Gabriel Gabe Shapiro Lexnode, who's the General Counsel at Delphi Digital, said insider trading is not an actual cause of action. It's a catch-all term for various kinds of fraud using confidential information to trade in the market. In a separate tweet, he goes on, there are different theories of why insider trading is illegal. On the misappropriation theory, it's because you misappropriated insider information,

Starting point is 00:04:01 which happened here. On the fraud on the market theory, it's because you tricked market trading. participants, which happened here. Insider trading doesn't have to be of securities. The Department of Justice has other kinds of anti-fraud authority it can use to bring a case. One of the best overviews actually came from John Wu, who is, as he readily admits, not a lawyer, but I still think it's a great sum up, so I'm going to read it here. Yesterday, Nate Chastain, former product manager at OpenC, was indicted for making around $40,000 insider trading NFTs. He's facing up to 40 years in prison. The Department of Justice is coming for your ass too. Here's what you need to know to get smart on the

Starting point is 00:04:38 surprising case and not go to jail. The facts. Nate had insider knowledge that OpenCe would feature certain NFTs on its homepage. He bought NFTs within those collections in advance of the feature and dumped them after for a modest profit. What's surprising is that this isn't classical insider trading in which an insider uses material non-public information to trade securities. Instead of securities fraud, federal prosecutors are instead pursuing a much broader wire fraud charge. Fraud in general is essentially lying to steal money from someone, that's someone being the victim. Let's put on our law school hats and ask, who is the victim in this case? You might think that the victim is the person he bought the NFTs from.

Starting point is 00:05:16 After all, that poor schlub stood to gain a penny or two from OpenC's feature event. But, using insider information, Nate purchased their NFTs first. And rather than poor schlub gaining 2 to 5x, Nate did. This is the market fairness theory. We want fair markets and Nate made it not fair. But the thing is, that's not what DOJ is claiming, and not who DOJ says the victim was. The victim in this case was, drum roll, open C. Wait, what? Here's the logic. Nate didn't owe a duty to the random schlubs who own the featured NFTs,

Starting point is 00:05:46 or even to maintaining a fair market, but he did owe a duty to his employer. And what duty was that? Put broadly, to not misappropriate confidential information. Board members of public corporations owe a duty to shareholders to not trade against them using non-public information. But in this case, there was no established fiduciary duty to NFT holders. So why is it a crime to violate a duty to your employer? Shouldn't that be a civil claim you can settle one to one with your company without involving prison? Nope, says the DOJ. If what you did, A. is fraud. And B, touches interstate wire, a.k.a. the internet, aka any financial transaction, then it's under federal purview and you will go to prison. Now here comes the fun part. If insider trading read as misappropriation of confidential

Starting point is 00:06:28 information can be and is enforced outside of the classical securities context, then there's a big open question. What exactly counts as insider trading? Say you're a Lego employee who knows that the 10261 roller coaster set is soon to be discontinued. It's well known that discontinuation typically leads to a pop and secondary market value. So knowing Lego 10-261 roller coaster is going to be discontinued, you buy a bunch of 10-261 roller coaster sets before the announcement and sell them after for a profit. Is that fraud? Yes. Some other confidential info hypotheticals. Stubhubb employee buys Duolipa ticks in advance of a homepage feature. Netflix employee buys Stranger Things merch in advance of season four. NFL employee buys

Starting point is 00:07:08 number 84 memorabilia in advance of Tom Brady's retirement. Fraud, fraud, fraud. There are many such examples where tech employees can abuse insider information, product announcements, new market entry, listings and features, all of which, if utilized to facilitate a profit-making scheme, can constitute fraud. TLDR to tech and crypto employees abusing confidential information. Do not think for a second because digital assets are not securities that you are not insider trading. Regardless of asset type and profit earned, the DOJ will send you to prison. Classical, insider trading is dead. Long live, digital asset insider trading. So John hints at a lot of things that were parts of the discussion in terms of what constitutes insider trading, how bad it has to be to get

Starting point is 00:07:51 the Department of Justice's attention, what the implications are for other types of digital assets. but I want to dig more specifically into the community's reaction. NXO lets you easily buy crypto with your bank card and earn industry leading interest rates. Earn up to 16% on crypto and up to 12% on stable coins. Nexo makes passive income easy with interest paid automatically and daily. With Nexo, you can also borrow against your crypto at 0% APR and exchange over 300 pairs. Receive a welcome bonus of up to $150 in Bitcoin until, June 30th at nexo.io. That's nexo.io. This episode is brought to you by NIR, a climate neutral,

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Starting point is 00:09:18 There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees. One of the largest exchanges in the U.S. FDXUS is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTX, you pay no gas fees. Download the FTX app today and use referral code breakdown to support the show. This case has honestly shocked me now twice in terms of how the community has responded. The first time I was shocked by how many people were coming out of the woodwork saying, hey, this is a good guy, or hey, he's learned his lesson and got fired and that's enough. Like, the ability for people to rationalize a clearly wrong behavior, where an insider used privilege information

Starting point is 00:10:01 for personal surreptitious monetary gain. That is not a good guy. At least not insofar as being a quote-unquote good guy or not is determined by your actions, not just whether you're nice to people and say GM and shit. What's more, the inability of some parts of the community to understand how unbelievably damaging for the industry as a whole this sort of behavior is.

Starting point is 00:10:23 Maybe people just had their bull market goggles on, but there are a lot of people and institutions, powerful ones who do not want us to exist. Hopefully, that's clearer now we're in a bare market and those people are feeling empowered and getting louder, but JFC guys, we are trying to usher in an era of better finance. As I said last September when the news broke, the ethics of insider trading aren't some quaint artifact of legacy finance that we should be trying to get rid of. They're a fundamental pillar of a functioning free market. And by the way, the free and free markets is about ensuring a certain level of equanimity and even playing field. Privilege information is one of those

Starting point is 00:11:05 things that can and will absolutely undermine the functioning of the market. If we really are trying to do something different, part of it should be to try to make the playing field of data and information more, not less equal. Anyway, the point was at that time, I thought that people weren't taking it seriously enough, and apparently the DOJ agreed with me. But you know what, let's consider this episode of The Breakdown, an honorary episode of Meltem and Jill's old, What Grimes My Gears? And if you get that reference, thank you, and you're old. This time around, what has been sort of unbelievable to me is how much of the conversation has been people being like, wait, there can be insider trading if a thing isn't securities? Like, what? First of all, to be clear, I'm not a lawyer. And debating

Starting point is 00:11:47 these specifics, the specifics around what does or doesn't constitute insider trading, and more importantly, the specific designations within that is super important. That's the job of law and policy, and insider trading is a complicated topic. There is a ton of gray area, and spending time determining shades of gray is immensely valuable. What's more, Nate is entitled to every defense under the law. I hope the trial is revelatory in a positive way in helping clarify these concepts in the new context of digital assets. And for all the people out there arguing that the potential sentence is massively disproportionate to the crime, I'm certainly not saying that I feel the need to nail Nate to the cross of martyrdom here. For all the people who think this was wrong, but the reaction

Starting point is 00:12:26 from the U.S. government is disproportionate, fight hard. I support you. But forgive me for being the grandson of a preacher for a minute and for fuck sake people. What this dude did was wrong, full stop. And whether it was wrong or not, wouldn't change on the basis of a legal technicality on the designation of assets. The legal case might be about him defrauding his employer, but he defrauded the entire industry. He defrauded the people who were excited and passionate about this new NFT space. He defrauded the people who every day, day in, day out, don't use this type of information for personal gain. And he defrauded everyone who has some part, some sliver of this industry that matters to them, that they are fighting against this incredible and rising

Starting point is 00:13:10 tide of people who don't want it to exist. If you're in this space at all, NFTs, Web 3, Bitcoin, This type of behavior should make you livid. It threatens to undermine something you are passionate about and perhaps even have dedicated your life to. All right, I will climb off my high horse now. I'm certainly not the only one who feels like this. Ryan Wyatt, the CEO at Polygon said weed out bad actors. It's how we progress in Web 3 and legitimize the space.

Starting point is 00:13:37 Bobby Digital said they will continue to get bad actors out of the space. Everyone should be embracing this move instead of the same bullshit narrative we don't want regulation because it will ruin things. No, thieves and crooks ruin things. Until you're rug pulled, you won't understand. Yesterday, I implored us to stop fighting stupid cosmetic battles because the real ones are coming. There are so many people out there who do not want you to be able to do what you are doing, who not only don't want you to be able to buy these digital assets you've bought, but who don't want the industry to exist at all. With that as the background, we have to be better.

Starting point is 00:14:10 Listen, I made a pun in this title, which honestly, I can't believe no one has done yet, But there's more to it than a funny headline. First of all, we've already seen some other enforcement actions in the last couple of days. The CFTC just sued Gemini for misrepresenting information around a Bitcoin ETF proposal in 2017. That one might be small, but I think is a sign of the Times. Kelly Medrich, a senior reporter at Law 360, reminds the SEC has many enforcement cases active on crypto their building, and we don't know for many what or who is involved, but they've been talking a lot about it, just a reminder. So is there anything optimistic here?

Starting point is 00:14:43 In a thread, Taylor Monaghan wrote, Nothing super remarkable about the Nate OpenC indictment except that all of it was discovered, investigated, and confirmed live in public by random NFT-faced internet sleuths way back on September 14th, 2021. Not by the FBI, not by the SEC, not by the DOJ, by motherfucking C.T. She then goes through a set of the accusations in the indictment

Starting point is 00:15:09 and the thread from people like ricefarmer.eath, again seven months ago this was coming to light based on on-chain data. So of course, the optimistic thing here is that when I say we have to be better, there are clearly some folks who are doing so and who are using on-chain data to do exactly that. Now, there is a large conversation to be had about the limits of self-policing and the challenges of it, and what type of outside support we want or is reasonable. When it comes to self-policing, we have some folks in the community that we revere. Zach XBT, whose bio on Twitter, reads, Onchane sleuth, rugpole survivor turned 2D detective, has become a community treasure for his exposés.

Starting point is 00:15:48 But I also took notice of a thread from ZeroXNGMI. He had done a long expose connecting an NFT collection founder to a slew of just unbelievably messed up discussions in the past, and, by the way, not like a random comedian saying bad stuff once type bad. And after being vindicated, he wrote a thread that said, by the way, now that I become a mini-zac, my take is that self-regulation is broken, since I spent 50 to 100 hours researching, people now hate me, massive risk if I was wrong, painted target on my back, boycott, no benefit. He then goes through and talks about each of these things. People hate him because he tanked their bags. He spent a ton of time on research that he didn't have given that he was actually trying to build a company. He exposed himself to

Starting point is 00:16:30 incredible risk if any of his allegations were wrong. And ultimately he got nothing out of it. In fact, as he says, IMO net negative, since now there's a subset of people less likely to collaborate and help me in the future. He concludes, current self-regulation in crypto relies on people being triggered enough to take kamikaze-like actions like these. In my opinion, not sustainable. We need something better. I think what better that is is a really good discussion to have, and I hope that's where we turn next. For now, I want to say thanks again to my sponsors, nexo.io, near and FtX. And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace.

Starting point is 00:17:06 Hey, Breakdown listeners, come join CoinDesk's Consensus 2022, the festival for the decentralized world this June 9th through the 12th in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web 3, and the Metaverse, and is designed for crypto newbies, investors, entrepreneurs, developers, and creators. Use code breakdown to get 15% off your pass at CoinDesk.com slash consensus 2020. 22.

The Breakdown - It's OpenSeason for Regulatory Enforcement

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