OpenSea Scandal Shows Need for More NFT Regulation

There’s a lot you can do with a non-fungible token. Digital collectibles can work as passports to online communities, or ways for artists to interact with their fans. Bands have turned NFTs into backstage passes, and the writer Emily Segal used an NFT as a fundraising mechanism for an upcoming novel.

But an insider trading scandal at OpenSea, now one of the most important marketplaces for NFTs, serves as a reminder that – for all their potential – NFTs are still very much a speculative asset. In a world where everything becomes an NFT, casual collectors will need to be assured that the system isn’t rigged in favor of insiders.

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Last week, Nate Chastain, OpenSea’s head of product, resigned after being accused of front-running NFTs in the way a broker might front-run a stock.

If front-running doesn’t immediately feel like a useful rubric for understanding an NFT trade, consider what Chastain is accused of doing: in a Twitter thread, an account called @ZuwuTV explained how a group of Ethereum addresses would buy up NFTs just before they appeared on OpenSea’s homepage and then sell them once the prices went up.

Receipts from Etherscan.io – a record of transactions on Ethereum – appeared to connect these addresses to Chastain.

Collectors are constantly on the hunt for what they call “alpha” – any sort of special insight that might make them early to the next hot NFT project. And OpenSea, with a daily trading volume of around $77 million and big-name backing, is at the heart of the NFT ecosystem.

When an NFT is featured on the site’s homepage, there’s a good chance it’s about to get more valuable. Chastain, @ZuwuTV inferred, was using non-public information about the platform’s curatorial strategy to make a profit flipping NFTs. Think of these trades as capitalizing on a non-public form of “alpha,” over and over again.

After a swift “third-party review” early last week, Chastain was out at OpenSea.

It’s somewhat disingenuous to argue, as one prominent influencer did this weekend, that NFTs are a “non-speculative on-ramp to get started” in crypto. An NFT is very clearly an asset with a resale value that rises and falls. It can be many things – an artwork, a fundraising vehicle, a digital VIP pass – but more often than not, it’s something you can resell. Whatever an NFT is, it’s also a trading card. To buy one is to buy into the crypto market, which is to engage with those whiplash ups and downs.

The inherently speculative aspect of crypto is something that tends to get lost in the rhetoric surrounding digital assets. NFTs and decentralized applications built on Ethereum are always going to involve an element of risk. It’s something that’s built into the technology itself – the double-edged sword of blockchain tech, a blessing and a curse.

And as long as investments go up and down, there will be insiders trying to get ahead. The Securities and Exchange Commission requires publicly traded companies to disclose executives’ stock trades for exactly this reason.

NFTs aren’t considered securities in the U.S., and regulators aren’t nearly as aggressive toward crypto as they are toward equities (at least not yet). @ZuwuTV has said he’s against further oversight, and that Chastain’s resignation is “the best we can ask for” in an unregulated market.

Read more: Has the Biden Administration Lost the Plot on Crypto Regulation? | Opinion

OpenSea has said it now explicitly prohibits employees from “using confidential information to purchase or sell any NFTs, whether available on the OpenSea platform or not.”

Community-backed enforcement is a tricky prospect – although Twitter has become a hub for self-appointed blockchain watch dogs, things can still fall through the cracks.

Crypto purists may bristle at the idea, but the path to establishing more trust in the market may involve ceding some ground to regulators. Say Instagram suddenly turned “likes” into NFTs and the first “like” on an iconic image came with the promise of monetary value down the line. It’s not hard to see how company employees could abuse inside information to get in early on, say, the first post from a celebrity new to the platform.

How would it look for companies to fight this on their own? Would it involve dedicated enforcement teams and periodic surveillance of employee wallets?

The crypto industry has a notoriously antagonistic relationship with regulation, but if NFTs are going to take off in a more mainstream way, buyers need to know they’ve got a fair shot.

To help build that trust, oversight may be a price companies are willing to pay.