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Similarities Between UST & Early Banknotes and Insider Trading of NFTs at OpenSea (#104 - 6 June 2022)

The Future of Money with Henri Arslanian
Similarities Between UST & Early Banknotes and Insider Trading of NFTs at OpenSea (#104 - 6 June 2022)
By Henri Arslanian • Issue #96 • View online
Last month’s collapse of TerraUSD (and its sister cryptocurrency Luna) will go down in history as another failed attempt to design the future of money. 
But history shows us that there have been similar collapses and false starts over the years, with the Continental Currency, an early version of the U.S. Dollar used throughout the American colonies, a good example. 
Also, this week we learned that a former employee at NFT marketplace OpenSea has been charged with counts of wire fraud and money laundering by the U.S. Justice Department surrounding a number of illegal actions last year, turning the spotlight on the topic of insider trading in the NFT space.  
In this issue of the newsletter, I analyse what this indictment means, what the impact on the broader NFT ecosystem will be moving forward, and why this is actually a positive development for the industry.
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Here we go!

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Last month’s collapse of Luna and UST will go down in history as another failed and flawed experiment in trying to build the future of money. 
As we’ve explained in past issues of this newsletter, several civilizations throughout history have had formative impacts on the development of modern money and commercial banking, from the Lydians and the Greeks to the Crusaders and Renaissance-era Italian bankers. 
But history teaches us that many of the successful currencies we have had over history actually went through their own phases of crashes and collapses.
A good example is the U.S. Dollar, especially when it comes to the innovative effects of early paper banknotes.
It was the early American colonists who really popularised paper banknotes. As historian Jack Weatherford explains, as early as 1690, the Massachusetts Bay Colony began printing the first paper money in North America. 
The grandfather of paper money was undoubtedly Benjamin Franklin, who developed an early interest in paper money and wrote his first “pamphlet” on the topic at the age of 23.
In 1729, he published “A Modest Enquiry into the Nature and Necessity of a Paper Currency” and operated a printing press in Philadelphia, printing cash on behalf of the Pennsylvania colony (a service that often caused his newspaper, the Pennsylvania Gazette, to be late for delivery). 
To this day, Benjamin’s Franklin visage is honored on the highest denomination of the U.S. dollar, the $100 banknote. 
However, colonial authorities in London were none too pleased with such activity and outlawed the use of paper money in New England in 1751, extending the ban to the rest of the colonies in 1764.
In 1775, the U.S. Congress issued the Continental to finance the American Revolutionary War against Great Britain.
However, due to a mix of overprinting, no solid backing, and counterfeiting, it soon lost its value (thus the American expression “not worth a Continental”) and Congress stopped issuing it around 1780.
The Continental Currency; Source: U.S. Currency Educational Program
The Continental Currency; Source: U.S. Currency Educational Program
This entire experience with paper money was seen as a failure in the U.S., so much so that the U.S. printed no paper money for nearly a century afterward.
However, whilst many Americans were turned off by money, as they had lost so much of it during the war with the British, it was seen as a success by the rest of the world, who saw the Americans as having won their revolution by printing money.
The Americans adopted the decimal system in 1792 (pioneered by Russia around 1535) with the passage of the Mint Act, but the wide usage of paper banknotes needed a user-friendly system, with Thomas Jefferson later devising the idea of calling one-hundredth of a dollar a “cent” (from the Latin “centum,” meaning hundred), and a tenth of a dollar a “dime” (based on the Latin “decima” meaning one-tenth). 
Alexander Hamilton elaborated further on the country’s monetary system in “The Report on the Establishment of a Mint,” leading to the Coinage Act of 1792, making the U.S. coinage system the first wholly decimal monetary system on earth. 
Paper banknotes also played a big role in the industrial revolutions from 1760 to 1840 in both the United Kingdom and the U.S.
As explained by author Jame DiBiasio, paper banknotes outnumbered coins in Britain in 1776, with the war again acting as a revival and catalyst for paper banknotes in the U.S. 
In 1861, in order to finance the Civil War, Congress authorised the Department of the Treasury to issue non-interest-bearing Demand Notes.
These notes earned the nickname “greenbacks” because of the green ink on the back, a basic anti-counterfeiting measure used to prevent photographic copies and fakes since cameras of the time could only take pictures in black and white. 
All U.S. currency issued since 1861 remains valid and redeemable at full face value.
After the Treasury issued Demand Notes, Congress authorised a new class of currency in 1862 known as “United States Notes” or “Legal Tender Notes”, replacing Demand Notes (and continuing to circulate until 1971). 
There is another chapter to the history of the U.S. Dollar, from the confiscation of gold in 1933 to moving away from the gold standard in 1971, but that is a story for another time!
For those who cannot wait, I cover it at length in my latest book “The Book of Crypto”!
Whilst the future of money is very exciting, who said the history of money couldn’t be fun as well!
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On Wednesday, June 1, the United States Attorney’s Office of the Southern District of New York announced charges against Nathaniel Chastain, the former head of product at NFT marketplace OpenSea.
Chastain was arrested that same morning and later pleaded not guilty in a Manhattan federal court. 
OpenSea is the largest NFT platform globally, with over $30 billion in trading volumes to date. 
In his position at OpenSea, Chastain was responsible for and ultimately oversaw which NFTs would be featured on the platform’s landing page.
These NFTs were kept confidential until they appeared on the homepage, and once NFTs were visible to the public and buyers were able to purchase or bid for those NFTs, demand for those NFTs or other NFTs from that same creator would typically increase substantially. 
According to the Justice Department, from June 2021 until around September 2021, Chastain used confidential information about upcoming featured NFTs to purchase dozens of those NFTs (or NFTs from that same creator) right before those featured choices were made public. Afterward, Chastain would sell those NFTs for a healthy profit.  
For example, on August 2, 2021, Chastain purchased four NFTs from “The Brawl 2” right before the collection was set to be featured on OpenSea’s homepage.
And hours after those NFTs went live, Chastain sold his purchases at prices double what he initially paid. 
Source: OpenSea
Source: OpenSea
A week later, Chastain bought ten “Flipping and Spinning” NFTs (again, hours before they were set to be featured on the OpenSea homepage) before selling them at prices 250% to 300% higher than what he paid once the collection was visible to OpenSea buyers. 
And a month after that, on September 14, Chastain purchased the “Spectrum of a Ramification Theory” NFT, as well as three other NFTs from the same creator.
Fitting the pattern, once this creator’s collection was featured on the OpenSea homepage, Chastain sold his non-fungible tokens for quadruple what he had just paid. 
Source: OpenSea
Source: OpenSea
Now, Chastain is facing charges of wire fraud and money laundering, each of which carries a maximum sentence of 20 years in federal prison. 
Here are a couple of key takeaways from this development. 
Let’s start with the obvious. 
Is Chastain guilty? Probably so.  
After all, the beauty of digital assets is their traceability.
To the best of my knowledge, red flags and alarm bells surrounding Chastain’s actions were actually raised by amateur sleuths, who were able to spot this unusual activity and began posting about it on Twitter, something we covered in this newsletter back in September when suspicions surrounding Chastain’s activity reached a fever pitch.  
Also, the accused himself publicly admitted on Twitter to appropriating some of the NFTs in question.
And OpenSea even revealed at the time that one of their employees had committed such acts.
Now, does this fit the technical definition of “insider trading”? We can debate this for hours on end, whilst touching upon the legal status that NFTs actually hold at this point.
For example, are NFTs securities? Probably not.
This is why Chastain was charged with one count of wire fraud and one count of money laundering, as it will be easier for prosecutors to prove based on all of the available evidence. 
Wire fraud, for example, involves the use of “wire, radio, or television communication in interstate or foreign commerce” for the purposes of executing a scheme to defraud or to obtain money by false or fraudulent pretenses.
This is way easier to prove than insider trading, which involves the use of confidential, nonpublic information, in breach of a fiduciary duty or other relationship of trust, for the purposes of buying or selling a security. 
So moving forward, what will be the impact of this development? 
First of all, this should be a wake-up call to all of the various NFT traders out there.
Whilst the actual number of insider trading activities may be limited, many would argue that there are important levels of market manipulation in the NFT space done via Discord servers and Telegram groups to more organised entities like dedicated NFT funds.
If such activities are not allowed in the real world, then they are probably not allowed in the digital world either, and regulators may step in and take action.  
The big debate here will be around the legal status of NFTs. For example, many would rightly argue that such insider trading or market manipulation happens in many other industries, from art to diamonds, but that no regulator takes action as they don’t deem them to be securities. Then, the argument goes, why should NFTs be treated differently? This is a topic that will be actively debated in crypto and legal circles over the coming weeks.
The second thing to watch is the impact this might have on various NFT exchanges.
For example, OpenSea had to react quite quickly to news of insider trading originating from their team last September, launching a third-party review whilst implementing two new policies that in hindsight are quite obvious.
For example, OpenSea issued a mandate that employees should not buy or sell from any NFT collections (including any other collections from that specific creator) that the marketplace was in the active process of featuring on their home page.
The platform followed that by issuing a stark warning prohibiting their team members from using confidential information to purchase or sell NFTs, regardless of whether they were listed on the OpenSea marketplace. 
Chastain’s indictment will hopefully force all NFT exchanges to not only have proper KYC checks but also have transaction monitoring and proper internal compliance. Expect the law firms and consulting firms to make a windfall from offering these services over the coming months. 
Third, this should bring much-needed attention to some of the illicit activities taking place via NFTs. Due to their non-fungible nature and the lack of liquidity, the value of NFTs is often in the eye of the beholder, like a piece of art.
This makes them a great mechanism for laundering or creating fake sources of funds trails for anyone with crypto. One again, we’ve seen this with art in the traditional world; NFTs just make it easier for those with digital assets. 
We should expect regulators to continue paying close attention to the NFT space over the coming months.
But the reality here is that only one person has been indicted whilst there are probably several others who could have been arrested, as well. Whilst he may or may not end up doing prison time, there are many, many others out there who are equally guilty but who have just had the good fortune of not getting caught. 
It is also important to note that this is not only a problem limited to NFTs but also the broader crypto ecosystem.
For example, Coinbase had to change its new token listing rules last April after many individuals were buying those tokens before they would list and thus benefit from a price rise.
Another factor here is that OpenSea had a presence in New York, making it easier for U.S. authorities to claim jurisdiction and begin their investigation. 
And as more and more NFT marketplaces attempt to get licensed and begin running some back testing analyses to try to spot such behavior, they will probably discover that other employees were doing the same thing in the past.
Let’s not forget that many of the Silk Road players were arrested over time. This should serve as a warning to anyone trading NFTs: the same may happen here.
This is all positive for the crypto industry as it will not only increase the levels of transaction monitoring or compliance at those NFT exchanges but also the much needed governance and oversight levels.
Whilst this may cause some short terms headwinds, this is very important when it comes to creating trust and transparency in the NFT ecosystem, which will benefit the industry in the long run.
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Henri Arslanian
*Please note that this newsletter reflects Henri’s personal views and not those of any organisation he is involved with. This newsletter is for educational purposes only and none of its content should be construed as investment or financial advice of any kind. 
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Henri Arslanian

Future of Finance and Money - PwC Global Crypto Leader, Best Selling Author, Keynote Speaker, University Professor, Host of Crypto Capsule™ - Views are my own

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