What is insider trading? Meaning, examples and penalties

What is insider trading?

As a seasoned observer of the ever-evolving world of finance, I must say that the cases of insider trading in the crypto markets have left me both intrigued and dismayed. The tales of individuals like Ishan Wahi, who used their privileged positions to amass fortunes, only to face the wrath of justice, serve as a stark reminder of the perils that come with unchecked power and access to confidential information.

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 numerous nations, specific types of insider trading within stock exchanges are considered unlawful because they’re perceived as giving undue advantages over fellow 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. 

One straightforward rephrasing could be: Instances of illegal insider trading encompass situations where a CEO purchases company shares or employees invest in the corporation they are employed by.

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. 

Here’s one way to rephrase that:

Lately, the Securities and Exchange Commission (SEC) has classified some digital currencies, such as Ripple (XRP), Cardano (ADA), and Solana (SOL), as securities. This classification implies that they are subject to regulations concerning insider trading, much like traditional stocks or bonds.

A significant, over-100% increase in the value of Sui (SUI) tokens within a month sparked accusations among cryptocurrency investors regarding alleged insider trading. By 10:13 am UTC on Oct. 14, SUI had reached $2.25. In response to these allegations, Sui issued a statement through the X platform on Oct. 14, denying any involvement in insider trading, as demonstrated by 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?

In the past, the realm of cryptocurrencies resembled the lawless frontier of the Old West. It lacked substantial regulations and oversight, which facilitated questionable activities such as secretive dealings and biased insider trades.

If you’re familiar with the world of cryptocurrency trading, you might have come across instances where insider trading seems to be an issue.

• 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.

Have you heard? It appears that there’s a pattern of illegal insider trading within the crypto market. This involves individuals leveraging confidential information to purchase coins prior to exchange listing announcements. A research conducted by the University of Technology Sydney (UTS) suggests that this practice occurs in 27% to 48% of all cryptocurrency listings, despite growing regulatory oversight.

Penalties for illegal insider trading

The penalties for engaging in insider trading can be severe, ranging from imprisonment to significant financial penalties.

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.

Fun fact! When it comes to breaking the rules in the crypto world, there are two types of penalties: criminal and civil. Criminal penalties are imposed after a conviction for serious offenses that might lead to jail time or probation. On the other hand, civil penalties are financial consequences for regulatory or non-criminal violations, where no imprisonment is involved, but damages or restitution must be paid instead. In crypto regulation, civil fines are often used to tackle market infractions, whereas criminal fines may be imposed for fraudulent or unlawful activities.

Real-world examples of insider trading in crypto

Multiple significant instances of insider trading scandals involving prominent figures in the cryptocurrency sector, such as Coinbase and OpenSea, have come to light.

Coinbase insider trading scandal

2022 saw the Securities and Exchange Commission (SEC) accuse a former Coinbase product manager, along with his brother and a friend, of engaging in insider trading involving crypto assets. The SEC claims that while employed at Coinbase, Ishan Wahi was involved in a team deciding which cryptocurrencies and tokens would be made available for trading on the platform. In other words, they are being charged with using this inside information to their advantage before the general public had access to it.

Ishan frequently alerted his sibling and companion about impending crypto announcements, which they leveraged to purchase at least 25 different cryptocurrencies, nine of which were securities. Their investments yielded profits exceeding $1.1 million. As a result, Ishan was convicted and sentenced to two years in prison, while his brother received a sentence of ten months. The friend was mandated to pay a fine exceeding $1.6 million.

Long Blockchain Corp.

2017 saw an unusual move by Long Island Ice Tea, the beverage company, who decided to change their name to Long Blockchain Corp. They explained that they were shifting their focus from drink production towards blockchain technology. This decision was made during a period of high interest in cryptocurrencies, and the rebranding led to an impressive 380% increase in share prices.

As a crypto investor, I’ve learned that my investment in Long Blockchain didn’t yield any blockchain technology as promised. It turns out that three individuals, who had access to insider information and made share purchases before the announcement, were indicted for insider trading. Among them, Oliver-Barret Lindsay and Gannon Giguire were convicted and ordered to pay a combined penalty of $400,000 as a result of their insider trading activities.

OpenSea

2021 saw Nate Chastain, who led product development at OpenSea, face charges for insider trading. This incident caused a stir within the NFT marketplace community as Chastain exploited his inside information to purchase NFT collections he knew would be showcased on the platform’s homepage. He then resold these NFTs when their trading volume and value increased, pocketing approximately $57,000 in the process. Convicted of this offense, Chastain was sentenced to three months in prison and fined $50,000.

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 Securities and Exchange Commission (SEC) is determined to advance its efforts in regulating insider trading and overseeing the cryptocurrency sector. With an increasing number of cryptocurrencies and blockchain assets being labeled as securities, any unlawful trading activities fall under their scrutiny.

As a crypto investor, I can’t help but echo the words of Gary Gensler, SEC chair, who consistently emphasizes the insider trading definition set by the SEC: “When someone is fundraising by selling a token and the buyer expects profits due to the efforts of that group to promote the seller, this aligns with something that’s classified as a security.

As a crypto investor myself, it’s crucial to remember that while blockchain technology may seem anonymous, its public nature can make it easier for insider trading to be traced. Therefore, anyone with access to confidential, non-public information in the industry should exercise extreme caution before engaging in coin and token trading, as this activity could potentially be monitored, tracked, and prevented.

For quite some time, there has been a significant amount of illicit insider trading taking place within the cryptocurrency market. However, regulatory bodies are increasingly taking action against such activities, particularly in the wake of the Initial Coin Offering (ICO) surge in 2017. This isn’t unexpected, given that approximately 56% of ICO token listings display signs of insider trading, as reported by Solidus Labs.

Crypto platforms and businesses are implementing stricter self-regulation to prevent instances of insider trading and uphold market honesty. In numerous advanced economies, centralized exchange systems must carry out customer identification (KYC) and anti-money laundering (AML) screenings to spot illicit trades. Nevertheless, less regulated and decentralized exchanges (DEX) continue to pose challenges in identifying insider trading actions.

In a progressing field, there’s an increasing need for even distributed systems to strengthen their protective measures, fostering ethical conduct and investor security.