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DOJ NFT’s First Insider Trading Charges Mark New Era of Enforcement

The Department of Justice is stepping up its enforcement efforts regarding the non-fungible token (NFT) market and recently filed the first indictment against a person for an alleged insider trading scheme on digital assets.

Even with this increased application, the DOJ will need to rely on the NFT community and recognized market experts to monitor the development of the sector.

For example, the charges in the DOJ’s May 31 indictment against Nathaniel Chastain, a former employee of OpenSea, the world’s largest NFT marketplace, were brought to the government’s attention by members of the NFT community.

The government alleges that Chastain, who was responsible for selecting the NFTs to feature on OpenSea’s website, purchased the NFTs before they were auctioned. He is charged with wire fraud and money laundering.

The money laundering charge alleges that Chastain used anonymous accounts in the market to conceal his identity and transferred NFTs through hot wallets (cryptocurrency wallets always connected to the internet) to avoid getting caught. Chastain’s alleged activity was first detected by the NFT community who were able to trace the transfer of NFTs and funds to his public account.

Meanwhile, the wire fraud accusation has sparked interest because the word “securities” is missing from the allegations. The case could bring clarity to the NFT industry as to which transactions involving NFTs should be categorized as securities under the Howey test, which is used to determine when a transaction is subject to US securities laws.

The DOJ alleges that Chastain invested money in NFT projects in hopes of selling the NFTs for a profit. The allegations, if true, could expand the class of NFTs considered titles, a far cry from the popular misconception that NFTs are just digital images.

Evolution of NFTs

Over the past few years, NFTs have evolved from primarily collectible digital images to blockchain representations of property rights. NFTs are now more commonly used as a fractional interest of a market that may or may not be tied to a collection of physical or digital items. The value of these NFTs is often determined by the liquidity of the markets and the promotional know-how of the project and marketplace managers – third parties – rather than as a simple asset.

As NFTs continue to expand beyond art and digital collectibles, marketplaces will continue to be created to accommodate the different types of NFTs entering the blockchain. Additionally, existing marketplaces are expanding their capabilities to accommodate new varieties of NFTs. While many NFT trading platforms have policies and procedures in place that govern when their employees can buy or sell NFTs featured on their marketplaces, their ability to enforce these policies is often limited due to the potential employees to create hot wallets.

The DOJ, Securities Exchange Commission, Commodity Futures Trading Commission (CFTC), and other insider trading agencies are in a better position to investigate individuals who use their respective positions for profit given their expertise and their resources. As noted above, however, the NFT community is an invaluable resource for businesses and researchers.

Current status of the application

The DOJ is well aware of the potential for fraud in the NFT space and has already exercised its enforcement power over the NFT industry. Two months ago, the DOJ charged two people with conspiracy to commit wire fraud and conspiracy to commit money laundering stemming from an NFT scheme. The organizers are said to have misappropriated the funds received by the wallets under their control and abandoned the project before providing the advertised incentives. The same people reportedly planned to launch a second NFT project with the same intent, but the DOJ indictment stopped them before the second project was released.

To address the rapid expansion of cryptocurrencies and NFTs, the DOJ created the National Cryptocurrency Enforcement Team (NCET) in February. Eun Young Choi, a seasoned prosecutor with nearly a decade of experience, was named its first manager. Choi was instrumental in the prosecution of Silk Road founder Ross Ulbricht, which resulted in his life sentence. The Silk Road was a dark web marketplace that existed from 2011 to 2013 that allowed users to purchase illegal items such as drugs, guns, and even exotic animals anonymously by paying in bitcoins.

In addition to Choi’s expertise and leadership, the NCET has openly announced that it will rely on the private sector to assist in its oversight of the NFT industry. Notably, there are already countless social media accounts dedicated to verifying NFT projects and tracking suspicious activity. Many of these industry experts (and perhaps some self-proclaimed experts) have hundreds of thousands of followers, allowing for wide dissemination of information. By working with these authors and resource aggregators, the DOJ hopes to provide oversight to a larger portion of the market.

An overwhelming majority of the NFT community believe government oversight is necessary. Thousands of scams occur every day with little recourse for those whose digital assets are stolen. Information disparities remain endemic. The DOJ and other government agencies have recently stepped up their efforts by creating cryptocurrency-focused units, but these efforts need to be expanded.

Just as with this first NFT indictment for insider trading, the DOJ will need to rely, at least in part, on the NFT community to alert it to suspicious activity in order to ensure justice as the usefulness of NFTs is growing.

This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Author Information

John Cahill is a partner in Wilson Elser’s office in White Plains, NY. His practice focuses on cryptocurrencies, NFTs in particular, and he researches current trends to ensure clients comply with all current and developing legal restrictions.

Jana S. Farmer is a partner of the Wilson Elser offices in the New York subway. She chairs the firm’s art law practice and is a member of the firm’s intellectual property and technology practice. It focuses on the development, acquisition, licensing and exploitation of intellectual property, including in transactions involving NFTs.

William H. Behr is a partner in the New York office of Wilson Elser. He focuses on mergers and acquisitions, corporate and secure financial transactions, art law, commercial transactions and corporate governance.

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