Insider NFT trading — was that wrong?

In a famous episode of Seinfeld, George Constanza was confronted by his boss who said he had been informed that George had sex with the cleaning woman on the desk in his office. George replies: “Was that wrong? Should I have not have done that? I tell ya, I got to plead ignorance.”

This week, the NFT world faced a similar situation. It didn’t involve something as salacious as sex in the office, but instead, the apparent “insider trading” by OpenSea’s Head of Products Nate Chastain, who resigned after reportedly buying several NFTs at a lower price before they were featured by OpenSea and then selling them at higher prices. From the available public information, the value of profit from the sales appeared to be only several thousand dollars. For our prior summary of the incident, click here.

OpenSea opened a third-party investigation of the insider trading and announced “we have also implemented the following policies” against such practice:

  • OpenSea team members may not buy or sell from collections or creators while we are featuring or promoting them (e.g. on our home page); and 
  • OpenSea team members are prohibited from using confidential information to purchase or sell any NFTs, whether available on the OpenSea platform or not.

The reported purchases by Chastain would have violated these two company policies. But it’s unclear from OpenSea’s Sept. 15, 2001 blog post whether the policies were in place before Chastain’s reported purchases or in response to them. Artnews interprets the blog post as creating new policies for OpenSea in response to the sales. That seems to be the more natural reading.

So, assuming OpenSea’s policies are new and the company had no specific policies on the kind of “insider trading” reportedly engaged in by Chastain, why should he resign? To borrow George Constanza’s response, “Was that wrong?” Even further: “If anyone had said anything to me to me at all when I first started here that that sort of thing was frowned upon,” then maybe the transactions wouldn’t have ever happened.

This is not to disagree with OpenSea’s new policies, which are necessary and sensible to ensure fairness to consumers. But the ethical rules (much less, legal rules) regarding sales of NFTs by platform employees are unclear. The NFT marketplace is still in its infancy. Federal securities laws do not apply to it. Even the concept of “insider trading” from federal securities laws is a bit off. Here, the transactions did not involve the purchase or sale of stock or other securities of a public company. OpenSea is a platform for third-parties to sell their NFTs. True, the company does earn a commission of 2.5% on each sale. But an auction house is probably a closer analogy to what OpenSea does. (Sotheby’s and Christie’s have also been selling NFTs for big money!) To our knowledge, no federal law prohibits auction house employees from bidding on art sold in an auction, even if to drive up the price! Whether it’s unethical or not is a different story. (For more on the practice of house bidding for online auctions, check out this story.)

It’s important to recognize that federal securities insider trading laws are not a perfect fit. Assuming Chastain was an insider of the company, he wasn’t using inside information to buy stock of the company before the price went up. From the press accounts, he did apparently turn a small profit from the quick resale of NFTs he reportedly purchased. But it’s also important to recognize that the third-party creator of the NFTs also benefited from the sales to Chastain (and possibly to others through the resale royalty option on OpenSea), a fact that makes it somewhat different from the sale of stocks by an insider of a company. Anil Dash (@anildash) is one of the few people we’ve found who is staunchly defending the practice of employees buying NFTs if it helps the creators. He likens it to some employee of Etsy buying a featured product on Etsy, to the benefit of the artist.

Dash does have a point, but he misses the quick resale of NFTs reportedly made for a profit by Chastain. It’s one thing to support creators. It’s another thing to profit by buying low and selling high based on insider information from the company that ordinary consumers lack. Should employees of NFT platforms be allowed to do that?

We think not. First, such insider NFT trading can easily devolve into artificial price manipulation and speculation by an NFT company. Company employees can just buy every NFT before it is prominently featured by the company and then sell it at higher prices when the company features it. Other buyers might not realize the company’s own employees are the ones actually selling the NFTs on the featured page–and might view the offer for sale much differently if they did know. Second, this kind of NFT insider trading creates really bad incentives for employees to engage in self-dealing to profit from sales of NFTs promoted by the company. The ordinary consumer loses out.

To return to Chastain, was a resignation the proper fate? Impossible to say without all the relevant facts. The reported use of secret or pseudonymous accounts suggests at least some sneakiness by Chastain. But, if this was a first offense and if the company’s policy at the time was unclear, we think perhaps a lesser penalty might suffice (e.g., disgorgement of the profits or offer of refunds to the buyers).