Insider dealing in NFTs: regulatory challenges to come in the digital marketplace

19th November 2021

The recent admission by digital collectible market place, OpenSea, that one of its employees used inside knowledge to profit from the purchase and sale of non-Fungible tokens (NFTs) shines an interesting light on the challenges faced by established legal frameworks to keep pace with emerging technology.

NFTs are unique digital assets; they are the opposite of fungible assets, such as money or bitcoin, which can be mixed and separated. NFTs can be used to authenticate and represent real-world objects like art, fashion and music. Due to their uniqueness, they can also be an art medium in their own right. Indeed, the NFT in the OpenSea incident was essentially a piece of art.

The OpenSea employee, who was Head of Products, had inside knowledge that certain NFTs were going to be promoted on the OpenSea website – a factor that would likely increase the demand, and consequently the trading value, of the NFTs. In purchasing the NFTs before their promotion, the employee was able to profit from price hikes immediately following promotion. The illicit gains were not insignificant; one of the NFTs, called Spectrum of a Ramenfication Theory, was bought for 0.25 Ether (£650) and sold for 1.5 Ether (£3,900) just 20 minutes later, after being promoted on OpenSea’s homepage.

The volatility of the cryptoasset market makes insider trading of NFTs an extremely attractive prospect. However, unlike regulated markets which have a clear legal framework (principally policed by the Financial Conduct Authority) that criminalises such conduct, the cryptoasset market is largely unregulated and appears to fall outside the rules and oversight pertaining to insider trading.

The OpenSea incident also raises some fundamental questions about the nature of cryptoassets (and in particular NFTs). These include whether they constitute regulated securities caught within the Financial Services and Markets Act (FSMA) framework. For example, it is conceivable that in certain circumstances an NFT could be considered to be a future if it is used as a method of acquiring something (or the rights to something) that will be delivered at a later point in time.

Similarly, there are interesting questions to be considered around the effect of ‘smart contracts’ that generally underpin NFTs. For example, whether the contracts are considered as being made for investment purposes, and are consequently caught within the FSMA regime. Those involved in the cryptoasset industry should be mindful of the intersection with financial regulation and whether activities in respect of cryptoassets fall within the regulated perimeter. This should be noted, particularly given that there are criminal consequences when conducting regulated business without appropriate authorisation.

OpenSea have since committed to implementing new policies to prevent its employees from using confidential information to purchase and sell NFTs. In the absence of clear legal or regulatory deterrents it is up to organisations involved in the cryptoasset market to self-regulate and introduce policies to mitigate against the risk of insider trading.

However, the burgeoning cryptoasset industry may force regulators and legislators to address gaps in the legal and regulatory framework around cryptoassets sooner rather than later. The crypto industry is developing quickly, and it is essential for those involved to continually assess their business practices in light of regulatory regimes in both the UK and overseas.