Cryptocurrency conjures images of both the Wild West and the Wolf of Wall Street. Crypto advocates, of course, dispute this characterization, but the recent implosion of FTX—one of crypto’s biggest exchanges—isn’t helping their case, especially given the allegations of wild mismanagement and possible (if not likely) fraud.

The fallout from this event has been continuous and vast. Some, such as Sen. Elizabeth Warren, have repeated their calls for intensive crypto regulation, while others have pushed back, saying that fraud is fraud whether it happens in the crypto space, traditional finance, or elsewhere.

While crypto is relatively new—bursting onto the scene with the introduction of Bitcoin in 2009—it’s been around long enough to attract the attention of both criminals and law enforcement. In fact, many were introduced to Bitcoin and cryptocurrency through Ross Ulbricht’s case. He founded Silk Road, the dark web’s version of eBay, where people could buy and sell illicit drugs, using Bitcoin to facilitate their transactions.

Of course, crypto has come a long way since those early days. And there’s even a compelling argument that today, law enforcement can more easily trace illicit crypto transactions than traditional cash-based transactions. The Justice Department has established its own cryptocurrency-focused task force and recently recovered over $3 billion worth of Bitcoin that had been stolen from Silk Road users about 10 years earlier.

But for an ecosystem that’s supposed to be based on a number of trustless decentralized actors, crypto has become surprisingly dependent on centralized actors—e.g., exchanges like FTX—to facilitate transactions. So what happens when individuals working at these centralized organizations, or elsewhere, use material, non-public information to benefit themselves? Isn’t that insider trading—a crime? Can’t the Justice Department prosecute these individuals? Yes, but even though these prosecutions are styled as ones involving “insider trading,” they’re not in the usual sense and have unique features. As a result, they can’t currently be prosecuted like typical insider trading cases—though that could change in the future.

This is because there’s uncertainty about whether certain cryptocurrencies qualify as “securities.” Even federal regulators seem to be divided on whether some qualify as securities, commodities, or something else. For example, in a CNBC interview, former Securities and Exchange Commission chairman Jay Clayton explicitly said that Bitcoin does not meet the standards to be a security under the judicially-created Howey Test. Current SEC Chairman, and former Commodities Futures Trading Commission Chairman, Gary Gensler, seems to agree. But what about other cryptocurrencies? Ethereum, the second largest cryptocurrency by market capitalization, has faced a lot of uncertainty. The SEC has previously said it’s a commodity, not a security. But Gensler may have a different view. The current CFTC chairman claimed it could be a commodity—before backtracking. All of this to say that whether certain cryptocurrencies qualify as securities is very uncertain, which poses unique challenges for cases being billed as crypto insider trading prosecutions.

U.S. law currently does not statutorily define insider trading. But it’s understood to take place when someone with a fiduciary duty executes trades on the basis of material, non-public information. Those who engage in insider trading most frequently face civil penalties pursued by the SEC and/or criminal prosecution by the Justice Department. Section 10(b) of the Securities Exchange Act of 1934 and the SEC-promulgated Rule 10b-5 provide the basis for most enforcement actions and prosecutions of insider trading. But these require that a “security” be involved. And there’s the rub: Are certain cryptocurrencies securities?

Given this uncertainty, how can two recent crypto insider trading cases brought by the U.S. Attorney’s Office for the Southern District of New York be explained? The Justice Department billed one as the “first ever digital asset insider trading scheme” prosecution and the other as the “first ever cryptocurrency insider trading tipping scheme” prosecution. Of course, prosecutors must prove any charges they bring beyond a reasonable doubt. So will these cases resolve whether the cryptocurrencies involved are securities? No, not by a country mile. Here’s why: While insider trading cases today typically involve a securities fraud allegation, they don’t necessarily have to. One white-shoe law firm notes, “there is precedent for the stand-alone use of the wire and/or mail fraud statute to prosecute insider trading.” And in some ways, removing the securities fraud component makes the government’s case easier to prove.

The “first ever digital asset insider trading scheme” case involves Nathaniel Chastain, who worked as a product manager at the online NFT marketplace OpenSea. Non-fungible tokens are different from, but related to, cryptocurrencies. Broadly speaking, unlike fungible (or interchangeable) cryptocurrencies (a Bitcoin is a Bitcoin—it doesn’t necessarily matter which one you hold if you plan to use it like a currency), these non-fungible tokens are unique. Today, the most widely traded NFTs involve digital art. OpenSea bills itself as “the largest NFT marketplace,” and while he worked there, Chastain selected which NFTs would be featured on OpenSea’s homepage. This innocuous-sounding task came with a lot of power. When OpenSea featured NFTs on its homepage, the price of those NFTs often spiked. According to the Justice Department, Chastain used his material, non-public knowledge about which NFTs would be featured and purchased many of them before OpenSea placed them on its homepage. After their placement, he quickly sold them for a profit.

         The “first ever cryptocurrency insider trading tipping scheme” case involves former Coinbase product manager Ishan Wahi, his brother Nikhil Wahi, and their friend Sameer Ramani. Ishan worked as a product manager at cryptocurrency exchange Coinbase and participated in the highly confidential process of determining which cryptocurrencies Coinbase would list on its exchange. When a major exchange like Coinbase lists a cryptocurrency, the price of that asset often soars. According to the Justice Department, Ishan possessed “detailed and advanced knowledge” not only of which assets would be listed but also of the timing of those listings. Ishan used his knowledge of this material, non-public information to tip off his brother, Nikhil, and/or his friend, Sameer, to purchase the cryptocurrencies shortly before Coinbase listed them, which they would then sell for a profit after the listing.

Both of these cases involve individuals trading on material, non-public information. But the Justice Department didn’t charge anyone involved in either case with securities fraud or conspiracy to commit securities fraud—the hallmarks of traditional insider trading prosecutions. Instead, it charged them with combinations of wire fraud and conspiracy to commit wire fraud, and also threw in a count of money laundering against Chastain. In both cases, the defendants argue that’s not enough. Chastain, in particular, argued that the wire fraud count against him should be dismissed because an “insider trading wire fraud charge” requires “the existence of trading in securities or commodities.”

In strongly rejecting this argument, the federal judge overseeing his case said his argument was “wholly without merit.” The judge said that Chastain seized “on two references in the Indictment and statements made by the Government (in a press release and at the initial conference in this case) to assert that he is charged with ‘insider trading.’” The judge said, though, that “he is not charged with insider trading, at least in the classic sense of the term . . . .” He said that to “accept Chastain’s argument would be to read an additional element into the wire fraud statute, which the Court may not do.” The judge said that at most, “Chastain’s argument suggests that the phrase ‘insider trading’ may be misleading.” He said if that’s the case, the appropriate remedy would be to strike it from the indictment and prevent the government from using it at trial. But he declined to rule on whether that would be necessary.

In the Coinbase-related case, the SEC brought a parallel civil enforcement action against the three individuals being prosecuted. The SEC alleges that at least nine of the cryptocurrencies involved in that scheme were securities—a necessity for the SEC’s jurisdiction and ability to bring the enforcement action. These allegations were notably absent from the Justice Department’s criminal indictment of these individuals. Coinbase responded to the SEC’s civil suit by saying that “Coinbase does not list securities. End of story.”


But it’s not. With the recent downfall of FTX and the fallout from it, all eyes are on the future of cryptocurrency regulation and holding bad actors accountable. No one wants cryptocurrency to be a place where the Wolf of Wall Street can run amok with no accountability and no recourse like the Wild West of yesteryear.

Note from the Editor: The Federalist Society takes no positions on particular legal and public policy matters. Any expressions of opinion are those of the author. We welcome responses to the views presented here. To join the debate, please email us at [email protected].