Cap Hill Crypto

Week of June 3, 2022

Good morning, and thank you for subscribing. With a quiet week on the Hill, we examine what may be the first insider trading case involving digital assets.

Top Points

  • DOJ charged an ex-OpenSea employee with wire fraud and money laundering for allegedly exploiting and profiting from his advanced knowledge of what NFTs OpenSea would feature on their homepage.

  • A group of 26 computer scientists and engineers sent a letter to certain members of Congress, urging them to "resist pressure from digital asset industry financiers, lobbyists, and boosters to create a regulatory safe haven for these risky, flawed, and unproven digital financial instruments."

Wire Fraud and Money Laundering Charges Filed Against ex-OpenSea Employee Based on Alleged Insider Trading

​On Wednesday, the DOJ unsealed an indictment charging a former OpenSea employee with wire fraud and money laundering for allegedly trading on inside information about what NFTs OpenSea would feature on their homepage. The charges are brought in the Southern District of New York (Second Circuit). Here is the text of the indictment.

Importantly, the DOJ charges the defendant under a Title 18 wire fraud statute (18 U.S.C. § 1343), not under federal criminal securities fraud statutes (15 U.S.C. 78j(b); 17 CFR § 240.10b-5). Criminal liability for securities fraud stems from a violation of Section 10(b) of the Securities Exchange Act and Rule 10b-5, which generally prohibit any "device, scheme, or artifice to defraud...in connection with the purchase or sale of any security." (See 17 CFR § 240.10b-5) (emphasis added).

By bringing charges under Title 18 wire fraud, the DOJ avoids the legal question of whether an NFT is a security.

A Brief Summary of the Indictment

Facts

Nathaniel Chastain ("Defendant"), a former product manager at OpenSea, had advanced knowledge as to when OpenSea would feature certain NFTs on their homepage. From around May 2021 to around September 2021, Defendant allegedly used his advanced knowledge to purchase NFTs just prior to them being featured on the homepage. He then allegedly sold the NFTs at profit shortly after they went live on the homepage, at 2-5 times the purchase price.

Defendant allegedly purchased and sold the NFTs using anonymous digital currency wallets and anonymous accounts on OpenSea.

Charges

Wire Fraud - 18 U.S.C. § 1343

To convict a defendant of wire fraud under 18 U.S.C. § 1343, the prosecution must prove (each element) beyond a reasonable that:

  • (1) defendant voluntarily and intentionally devised or participated in a scheme to defraud another out of money

  • (2) the defendant did so with the intent to defraud;

  • (3) that it was reasonably foreseeable that interstate wire communications would be used; and

  • (4) that interstate wire communications were used. See 18 U.S.C. 1343; See also DOJ Criminal Resources.

Here, DOJ alleges that the Defendant knowingly and intentionally devised a scheme to defraud and obtain money through fraudulent means by misappropriating OpenSea's confidential business information, in violation of the duties he owed to OpenSea. Specifically, the indictment alleges that Defendant was responsible for selecting the NFTs that would be featured on the OpenSea's homepage. Because of this role, Defendant knew what NFTs would be featured before the public, and that the price of a given NFT was likely to appreciate once featured on the OpenSea homepage. Moreover, the Defendant allegedly signed a written agreement in which he acknowledged his obligation to refrain from using confidential business information except for the benefit of OpenSea or as necessary to perform his job. Thus, Defendant allegedly violated his duty to OpenSea and committed fraud by profiting from the purchase and resale of NFTs featured on OpenSea's homepage, based on his access to inside information.

The indictment further alleges that, in executing the fraud, Defendant used "wire, radio, and television communication in interstate and foreign commerce...for the purpose of executing such scheme and artifice." In other words, Defendant used the internet, thus satisfying elements three and four.

Money Laundering - 18 U.S.C. § 1956(a)(1)(B)(i)

To convict a defendant of money laundering, the prosecution must prove (each element) beyond a reasonable doubt that:

  • (1) defendant conducted or attempted to conduct a financial transaction;

  • (2) knowing that the property involved in the financial transaction represents the proceeds of some unlawful activity;

  • (3) with funds derived from a specified unlawful activity;

  • (4) with one of the following four specific intents:

    • (i) intent to promote the carrying on of specified unlawful activity;

    • (ii) intent to engage in tax evasion or tax fraud;

    • (iii) knowledge that the transaction was designed to conceal or disguise the nature, location, source, ownership or control of proceeds of the specified unlawful activity (alleged here); or

    • (iv) knowledge that the transaction was designed to avoid a transaction reporting requirement under State or Federal law. See 18 U.S.C. § 1956; see also DOJ archives.

Here, the DOJ alleges that the Defendant knew that the proceeds he received from selling the NFTs shortly after being featured on the OpenSea's homepage were from unlawful activity. Further, the indictment alleges that Defendant conducted financial transactions (i.e., using anonymous digital wallets and OpenSea accounts), knowing that the transactions were designed in whole and in part to conceal the nature, location, source, ownership, and control of the unlawful proceeds.

So What?

First, as a quick reminder, the information contained in the indictment are mere allegations yet to be proven in court. All defendants are presumed innocent until proven guilty beyond a reasonable doubt.

The lawsuit shows that DOJ is not waiting for additional clarity or legislation from Congress to pursue alleged bad actors in the crypto space. Instead, DOJ will utilize already existing and broadly written criminal anti-fraud and money laundering statutes and apply them to digital assets. As U.S. Attorney Damian Williams stated in the press release accompanying the indictment release: “NFTs might be new, but this type of criminal scheme is not."

The lawsuit also shows that DOJ has the means to track down financial transactions on the blockchain, even when multiple, anonymous digital wallets are used. This is important because a common concern raised by crypto-skeptic members of Congress is the extent to which blockchain technology might enable bad actors to evade law enforcement.

Finally, the allegations in the indictment may stir up calls for stricter insider trading laws. For more background on insider trading, including bills proposed in recent Congresses, check out the CRS report here.

"Tech Experts" Send Letter to Congress Warning Members About Crypto

On Wednesday, a group of 26 computer scientists, software engineers, and technologists sent a letter to Congressional Leadership and the Chairmen and Ranking Members of the Senate Agriculture, Senate Banking, Senate Finance, and House Financial Services Committees.

Specifically the letter is addressed to:

  • Majority Leader Chuck Schumer (D-NY), Minority Leader Mitch McConnell (R-KY), Speaker Nancy Pelosi (D-CA), Minority Leader Kevin McCarthy (R-CA), Chairwoman Debbie Stabenow (D-MI), Ranking Member John Boozman (R-AR), Chairman Sherrod Brown (D-OH), Ranking Member Patrick Toomey (R-PA), Chairman Ron Wyden (D-OR), Ranking Member Mike Crapo (R-ID), Chairwoman Maxine Waters (D-CA), and Ranking Member Patrick McHenry (R-NC).

Key Points

The thrust of the letter is that blockchain utility is drastically overblown and Congress should resist crypto industry insider attempts to convince them otherwise.

Specifically, the letter claims that blockchain utility is "at best still-ambiguous and at worst non-existent." See pg. 3.

Further, the letter asserts, blockchains and underlying crypto-assets pose:

  • "threats to national security through money laundering and ransomware attacks, financial stability risks from high price volatility, speculation and susceptibility to run risk, massive climate emissions from the proof-of-work technology utilized by some of the most widely traded crypto-assets, and investor risk from large scale scams and other criminal financial activity."

The drafters urge Congress to resist "digital asset industry financiers, lobbyists, and boosters" attempts to "create a regulatory safe haven for these risky, flawed, and unproven digital financial instruments." See pg. 2.

Notably, the letter lacks any specific policy suggestions, other than for Congress to "take an approach that protects the public interest and ensures technology is deployed in genuine service to the needs of ordinary citizens." See pg. 2.

​Here is a copy of the letter.

So What?

The letter is unlikely to move the needle amongst members of Congress. You could easily find, at the very least, 26 "experts" to write a letter supporting the benefits of blockchain technology. Nonetheless, media outlets widely reported on the letter, feeding a narrative that crypto and blockchain technology may be nothing more than speculative investment assets. Moreover, members who are already skeptical of crypto may use the letter as ammunition for any anti-crypto policy proposals going forward.

Look Ahead

  • On Tuesday, June 7, at 10am ET, the Senate Homeland Security and Government Affairs Committee will hold a hearing "to examine ransomware attacks and ransom payments enabled by cryptocurrency, focusing on rising threats."

  • June 7th is when we expect to see Sen. Lummis and Sen. Gillibrand's draft comprehensive crypto legislation.

  • The first report under President Biden's Executive Order on digital assets, covering how to strengthen international law enforcement cooperation for detecting, investigating, and prosecuting criminal activity related to digital assets, is also due on June 7th.

Worth the Read

Trivia

Last Week's A: Bangui is the capital of the Central African Republic. Bonus A: The CFA Franc shares legal tender status alongside Bitcoin.

This Week's Q: In 2014, this rapper became the first major musical artist to accept Bitcoin as payment for his album. Bonus points if you can guess the name of the album.

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Thank you for reading, and please enjoy your weekend.

Sincerely,

GSL