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Phemex Crypto Blog: Learn the latest news, updates, and industry insights on bitcoin futures, bitcoin trading, crypto derivatives exchange, and related blockchain technology.

What is Insider Trading: Non-public Crypto Information

In the past, whenever there were problematic transactions and bugs within a network, the crypto space used the forking mechanism to resolve them. However, a new dimension is forming amongst other market manipulation and fraud within the crypto space – insider trading.

insider trading

What Is Insider Trading?

Insider trading is when a key employee or executive knowingly uses non-public information to trade in the company’s stocks or securities. In the early days of cryptocurrency, insider trading law and crypto assets did not fit together because the crypto assets are supported by open-source software. Therefore, material non-public information does not exist. However, this has changed recently as the crypto world evolved into something more than just open-source digital currency.

What Are the Forms of Insider Trading Within Crypto?

In the United States, there are three types of insider trading within crypto, namely classic liability, tipper liability and tippee liability.

  • Classic liability: This classical type of insider trading occurs when an employee or director trades on material, non-public information from the company they work at. For example, an employee of a publicly-traded company knew that an announcement would be published in the near future that would boost the price of shares, so they bought more company shares in advance. As a result, the employee would have committed the most classical type of insider trading.
  • Tipper liability: This type of insider trading involves a company insider that communicates confidential non-public information to a trader. For example, an employee told their friends to purchase a particular stock today because there would be an announcement about greater than expected earnings tomorrow. The employee here would be the tipper that committed insider trading.
  • Tippee liability: This type of insider trading is different compared to the tipper liability. In this type of insider trading, a trader actively seeks and trades on material, non-public information from a source with confidential duty. For example, one who trades on a hot tip would be accountable for tippee liability.

Is Insider Trading Illegal?

Not all trading that stems from the material, non-public information violates security laws. There is a certain distinction depending on the person’s awareness before conducting a particular trade. For example, one can trade with information overheard from a conversation about an impending transaction between two corporations in a public setting. The listener has no duty to keep the information confidential. In contrast, if one is aware that the information violates the duty of confidentiality but went ahead to trade with the confidential information, they may be liable for insider trading.

When insider trading occurs, the Securities and Exchange Commission (SEC) can pursue legal action against the act of insider trading conducted on cryptocurrencies that it considers a security. On the other hand, the Commodity Futures Trading Commission (CFTC) is the authority that will pursue insider trading affairs regarding cryptocurrencies that are considered a commodity.

Some Cases of Cryptocurrency Insider Trading

It was recently discovered that a top executive (now resigned) of OpenSea, a non-fungible token (NFT) marketplace, committed insider trading. Since transaction records are public on the Ethereum (ETH) blockchain, a crypto user noticed that an anonymous trader was purchasing items just before they were advertised on the site’s front page, where demands are usually high. After crypto traders had identified the wallet where profit had ultimately gone, they found out that the anonymous trader was Nate Chastain, the head of product for OpenSea. Many crypto traders responded to the incident and called it insider trading. However, NFTs have very few regulations to restrict participants’ behavior. In addition, the SEC has not determined the definition of NFTs as a security. Hence, no law-enforcement authority has accused the “insider” of any wrongdoings yet. Now, the company is introducing policies to prevent employees from buying and selling artworks before they are being promoted on the site’s front page.

Besides, US officials are also scrutinizing possible insider trading at Binance. The exchange has become a target for not registering and following anti-money laundering standards across multiple countries. As a result, some countries have banned its service over concerns of money laundering in crypto. Recently, the CFTC has also launched an investigation by contacting the possible witnesses for insider trading. Although the exchange has yet to be accused of any wrongdoings, they have announced a restructure for better transparency to improve relations with regulators.

How to Prevent Insider Trading?

Many laws related to cryptocurrency law are complex and have yet to be tested and defined. In the circumstances where regulators believe there is possible insider trading, the investigation process can be excessive and invasive for the accused. Regardless of genuine transactions, insider trading remains a possible risk for traders inattentive of the ever-changing rules. Therefore, here are some suggestions to help traders avoid behaviors that may alert the authorities.

  • For a company insider, one can seek legal advice if intending to use their own coin offerings to trade. This can help them avoid the possible classical insider trading violation. Even though seeking counsel may be expensive, it is less burdening than defending themselves in a lawsuit from violating insider trading laws.
  • Traders should be wary about trading tips from possible insiders. The information may contain a duty of confidentiality, which may attract regulatory attention if traded on.
  • Coin developers should avoid sharing information about the coin to close friends since their friends would potentially trade with the information given.
  • Traders should avoid buying or selling in groups to manipulate market prices. Even though insider information may or may not exist, regulators are still watchful.
  • Traders should also keep in mind that anonymity will not cover insider trading acts since the coin used would be tied to a wallet address. In some instances, traders may deal with additional criminal penalties.
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What is The Current Insider Trading Regulation in Crypto?

Right now, relevant authorities such as the SEC are attempting to play their part by imposing existing regulations. However, most crypto assets are too vaguely defined for actual enforcement to take place.

Regulation in the USA

Major cryptocurrency like Bitcoin (BTC) is labelled as a commodity by the CFTC. When a cryptocurrency functions as a currency, it is under commodity regulations where insider trading regulations would apply accordingly. Nonetheless, most cryptocurrencies would be perceived as securities if conforming to the Howey Test. Therefore, most initial coin offerings (ICOs) held are collectively deemed as securities by the SEC. Moreover, the authorities’ latest discussion also showed that they intend to consider crypto coins with unclear designation as securities.

announcement from FATF
Recent announcement from FATF (Source: Decrypt)

Under the securities law, the insider trading violation includes crypto trading based on material, non-public information for either public or private companies. Recently, the CFTC revealed plans for the comprehensive regulation of crypto within four years.

Regulation in the European Union

For the European Union (EU), a regulatory framework called “Markets in Crypto-assets” (MiCA) which has been in development since 2018, was proposed to introduce rules against insider trading and market manipulation on crypto trading platforms. Moreover, the Financial Action Task Force’s (FATF) Travel Rule was proposed to make crypto transactions traceable to prevent money laundering by requiring wallets and exchanges to disclose users’ private information. Under the EU’s anti-money laundering rules, unidentified crypto wallets will not be permitted. Furthermore, MiCA is likely to take some years before becoming law as the final decision is based on the European Parliament. Therefore, regulations for crypto exchanges will take some time before insider trading can be considered illegal in the crypto world.

Outlook for Regulations in the Crypto Space

Increasingly, US regulators see the need to impose basic regulation in the crypto space. The recent “insider trading” incident on OpenSea would be another accelerating factor for the development of regulation that is taking place within the crypto space. Recently, the US administration proposed tighter regulations and tax reporting requirements for cryptocurrency. However, critics are saying tax reporting could compel cryptocurrency developers to collect information from their users, which is deemed impossible owing to the design of a decentralized financial system.

Moreover, the chairman of the SEC stated that the unsupervised crypto space is rampant with fraudulent activities, and thus, he is seeking more authority and funding to regulate the market. When insider trading happens, a negative impact is that people will become distrustful of crypto markets. As a result, regulators are motivated to make crypto markets safer. Moreover, authorities worry that without regulation, the taxpayers may have to carry the burden if similar large-scale insider trading affects the economy of the country or government. Therefore, despite the vision of blockchain application, regulation in this context seems beneficial so that common investors can trade with basic confidence.

As of now, there are no official regulations that prohibit crypto insider trading. Despite this, industry watchers suspect that there are frequent occurrences of insider trading within the crypto space. Nonetheless, analysts have acknowledged that it would be hard to prove that insiders knowingly use confidential information for trade. In the past, a few crypto traders have accused several major exchanges of “insider trading.” However, many have defined the occurrence as price manipulation instead of insider trading.

In addition, reducing insider trading in crypto can be complicated, but the phenomenon might reduce naturally because the market usually focuses more on established cryptocurrencies than new coins. An example of a highly regulated exchange includes Börse Stuttgart, where insider trading would be unfeasible. Although regulation and market maturation may help diminish insider trading, traders are encouraged to take an active approach by hedging against surprises from insider trading and price manipulations. On the other hand, commentators have argued that crypto fraud and market manipulation requires higher priority than issues like insider trading.

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Conclusion

As the crypto space develops, traders and exchanges will have to perform their due diligence to avoid violating laws and be more suspicious about insider trading. The three forms of insider trading identified for the crypto space include classic liability, tipper liability and tippee liability. Even though regulations in crypto are not very developed to prove insider trading activities as illegal, multiple proposals are already in place that will potentially become law in the future. For insider trading, there are difficulties in proving such activities because the public records within the blockchain makes these activities unsuspecting. Although market maturity may reduce insider trading in crypto, traders may also hedge against losses as a form of insurance against insider trading. Regardless, the future innovation of cryptocurrency in the US is likely to be impacted if Congress decides to give the SEC more power to regulate the crypto market. This may even cause ripple effects throughout the crypto space worldwide.


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