What is insider trading?
Insider trading is the process of buying or selling a company’s stock or security based on private, nonpublic information or owning at least 10% of a public company stock.
In many countries, certain forms of insider trading in stock markets are illegal as they are viewed as unfair advantages to other investors.
Not all forms of insider trading are illegal, and regulatory bodies have very strict rules about what is and isn’t allowed. In the United States, the Securities and Exchange Commission (SEC) governs the insider trading law. They allow insiders to buy and sell shares of a company legally, but they must be correctly registered in advance with the SEC.
Examples of legal insider trading include a CEO buying back shares in their company or employers buying stock in the company they work for.
When you think of insider trading, it invokes a darker image - the illegal kind where people have secret information they use to their advantage. Illegal insider trading doesn’t just apply to company executives and staff. Relatives, friends and people on the street can partake in insider trading if the information is not publicly available.
For instance, a barber could overhear a confidential phone call while cutting a CEO’s hair. He learns private information about the company’s annual earnings and decides to buy the stock. That’s illegal insider trading, and he could be prosecuted by the SEC. The SEC uses sophisticated insider trading detection methods, including monitoring of trading volumes, particularly any spikes when there is no news released about a particular company.
In recent years, the SEC has declared certain cryptocurrencies as securities, including Ripple (XRP), Cardano (ADA) and Solana (SOL). That means insider trading rules are being applied to these assets and others.
For example, a sharp, triple-digit surge in the Sui token led to allegations of insider selling among crypto investors. Sui (SUI) climbed more than 120% over the past month, reaching $2.25 as of 10:13 am UTC on Oct. 14. In an Oct. 14 statement shared on the X platform, Sui addressed and denied insider trading allegations, as shown in the image below.
Did you know? In 1909, the US Supreme Court ruled that a company director buying the company’s stock with undisclosed inside information leading to a price increase was committing fraud. How does insider trading work in crypto?
For a long time, the crypto world was the digital Wild West. The market was largely unregulated and unmonitored, making it fertile ground for shady practices and unfair insider trading.
If you’ve spent time trading cryptocurrency, you’ve probably noticed that insider trading is a problem.
You’ll often see big owners of cryptocurrency (specifically whales), often project founders and developers, manipulating the market by buying or selling large quantities of a coin. Pump and dumps are common, with cryptocurrencies being driven up in price with excessive buying and fake promotional news while a group of insiders collude to sell at a predetermined time.
Prior knowledge about a coin being listed on a major exchange is also used to profit from insider information. Usually, these individuals work on a crypto project or exchange and start trading the asset ahead of its launch on a leading trading platform.
Information about upcoming technical updates for a project, like forks, can also be used to gain a trading advantage. Still, the decentralized design of many cryptocurrencies does help to keep most information in this area transparent and public.
Did you know? Evidence shows systematic insider trading in the crypto markets, where people use confidential information to buy coins before exchange listing announcements. A study from the University of Technology Sydney (UTS) estimates that “insider trading occurs in 27% - 48% of cryptocurrency listings” despite increasing regulatory scrutiny.
Penalties for illegal insider trading
Insider trading legal consequences for violations can be harsh, including prison sentences and hefty fines.
In the US, insider trading penalties include:
Prison sentences of up to 20 years per violation are possible. The amount of profit gained and the history of offenses determine whether a prison sentence is handed out and its length.
Criminal fines for individuals can reach $5 million, depending on the severity of crimes, while corporations face up to $25 million per violation.
Civil fines can be up to three times the profit (or loss) avoided.
Individuals can be disbarred, meaning they aren't allowed to be a public company director or serve as a company officer.
Public announcements are also often made that can destroy an individual’s or company’s reputation.
Disgorgement can be ordered, forcing guilty traders to return the money they receive and repossess the stock.
Did you know? Criminal fines are penalties imposed after a conviction for breaking the law that may also involve jail time or probation. Civil fines are usually financial penalties for regulatory or non-criminal violations, where the offender isn’t imprisoned but must pay damages or restitution. In cryptocurrency regulation, civil fines are commonly used to address market violations, while criminal fines may be applied for fraudulent or illegal activities.
Real-world examples of insider trading in crypto
There have been several major crypto high-profile insider trading cases that have involved some of the industry’s biggest operators, including Coinbase and OpenSea.
Coinbase insider trading scandal
In 2022, the SEC charged a former Coinbase product manager, along with his brother and a friend, with crypto asset insider trading. The SEC alleged that during his employment at Coinbase, Ishan Wahi was part of a team coordinating the announcements of what cryptocurrencies and tokens were going to be added to the trading platform.
Ishan was found to have regularly tipped his brother and friend about upcoming announcements. They used the information to buy at least 25 cryptos, nine of which were securities, to generate profits of more than $1.1 million. Ishan was found guilty and sentenced to two years in prison and his brother was sentenced to 10 months. The friend was ordered to pay a penalty of over $1.6 million
Long Blockchain Corp.
In 2017, drink manufacturer Long Island Ice Tea made a bizarre announcement, rebranding its name to Long Blockchain Corp. The company said it was transitioning from drink manufacturing to focus on blockchain technology. It was a time of “crypto mania,” and the rebrand sparked shares to soar 380%.
Long Blockchain never actually began producing blockchain technology. Three people who were involved in sharing information and purchasing shares before the announcement were charged with insider trading. Two of the defendants, Oliver-Barret Lindsay and Gannon Giguire, were found guilty and ordered to pay penalties for insider trading totaling $400,000.
OpenSea
In 2021, head of product at OpenSea, Nate Chastain, was charged with insider trading. It was a major scandal for the NFT marketplace as Chastain used his insider knowledge to buy NFT collections he knew would be featured on the platform’s homepage. He would sell the NFTs as their trading volume and value spiked. He made $57,000 in the process, was convicted, and received a three-month custodial sentence and a $50,000 fine.
Did you know? Binance is offering up to a $5 million reward for tip-offs about insider trading on the exchange. This came after a crypto whale bought 314 million BOME tokens before their listing on Binance. Post listing, the trade was identified and flagged, sparking discussions in the community. Some thought it was a lucky trade, while others alleged it was insider trading.
Future outlook of insider trading in crypto markets
The SEC is resolute on pressing forward in its insider trading regulation and motoring of the cryptocurrency industry. A growing number of cryptocurrencies and blockchain assets are being classed as securities, which puts any illicit trading in the agency’s cross hairs.
Gary Gensler, SEC chair, continues to reiterate the insider trading SEC definition: “If somebody is raising money selling a token and the buyer is anticipating profits based on the efforts of that group to sponsor the seller, that fits into something that's a security”.
So, anybody privy to confidential, non-public information in the industry needs to be careful before trading coins and tokens. Blockchain technology is not as anonymous as often believed; its public transparency can actually be used to monitor, track and prevent insider trading.
Insider trading in the cryptocurrency world has been rife for years, but authorities are cracking down on the behavior, especially since the ICO boom in 2017. It’s not surprising, since 56% of ICO token listings show evidence of insider trading, according to Solidus Labs.
Crypto exchanges and companies are adopting tougher self-regulation measures to protect against insider trading court cases and maintain market integrity. In many developed countries, centralized exchanges are required to perform know-your-customer (KYC) and anti-money-laundering (AML) checks to help pinpoint illegal trading. However, lesser regulated and decentralized exchanges (DEX) still make it hard to identify insider trading activity.
As the industry matures, there is growing pressure for even decentralized platforms to implement more robust safeguards to ensure fair practices and protect investors.
