Matt Stankiewicz, Partner at Volkov Law Group, joins us for an article on the recent scandal of OpenSea, the cryptocurrency industry’s leading NFT marketplace.
The crypto industry is in turmoil with a recent scandal involving OpenSea, the industry’s largest NFT marketplace (for those who don’t know, NFT stands for non-fungible token, and the most common use case in this moment is to represent digitized works of art on the blockchain). OpenSea platform users recently discovered that Nate Chastain, OpenSea’s product manager, used inside information to gain profit at the expense of platform users. On its home page, OpenSea displays a “featured” section that highlights an NFT project. As a rule, with the additional advertising, the demand for this project increases – which inevitably leads to an increase in prices. Users discovered that Chastain, using a handful of wallet addresses, “got the upper hand” on these opportunities by buying NFTs in these projects just before they were presented, then selling them as prices rose. after adding them to the home page.
How was this discovered? That’s the interesting part, and it highlights a very promising benefit of blockchain technology. At the end of the day, transactions on the blockchain are incredibly transparent. You can see all. If you know a person’s wallet address, you can connect them to a block explorer and see a wide range of information about that wallet. You can see all transactions made, whether sent or received, along with dates and timestamps. In the NFT world, you can also see all the unique NFTs that a user may have in that wallet. And that’s how it all came to be. After a few months, users started to notice only a handful of accounts were consistently at the forefront of these promotional opportunities. A few minutes before an art project was featured on the OpenSea home page, those same accounts purchased multiple NFTs from the collection. The price of these coins would inevitably increase as the promotion boosted demand, and the accounts would then quickly sell their NFTs at a profit. Users could then see that these wallets were sending their Ethereum profits to a single wallet address.
Now the wallet address is pseudonym. Identifying the person who owns this wallet is not always easy, usually nothing really connects the two publicly. However, in the NFT world there are many NFTs that are unique and you are just trying to identify who owns that particular coin. The wallet address in question had a Cryptopunk, one of the most sought after NFTs. There you go, Chastain had the same Cryptopunk set as his Twitter profile picture. To further seal it, the wallet address was also the holder of the natec.eth ENS domain, which Chastain also listed in his Twitter bio. With a little crypto-sleuthing, the identity had been discovered.
To say that OpenSea is experiencing explosive growth does not correctly describe the rise of the market. In July, OpenSea raised funds that valued the company at $ 1.5 billion. That same month, OpenSea processed $ 325 million in transaction volume. The following month, OpenSea’s August volume increased more than 10 times, to $ 3.4 billion in transaction volume (As a perspective, Etsy processed about $ 3 billion in transaction volume over the entire second quarter). With the rapid rise of the NFT industry, OpenSea is firmly seated on the tip of this rocket as THE place to buy and sell DTVs. Assuming the company can continue down this path, we will likely see the company go public in the years to come. With that, many business owners, officers, and employees will walk away with an important payday. As a product manager, Chastain held a prominent position and almost certainly envisioned a payment that would change his life. From his leading efforts, Chastain left with less than 20 Eth, or approximately $ 60,000. While not an insignificant amount, it is probably paltry compared to what could have been in front of him playing a central role in the business.
I lay this foundation to discuss the motivations of people who commit these kinds of wrongdoing. Sometimes the rewards don’t need to outweigh the risks from an objective standpoint. Too often, these bad actors rationalize their behavior and convince themselves that their actions are justified, not really problematic, or some other excuse, and move on regardless. Other times, they just dip their toes into the misconduct pool before moving on to something bigger. For compliance professionals, it’s important to recognize this and investigate any credible allegations that come to your desk. I have been involved in internal investigations as an outside lawyer where senior management comes and goes on the pursuit of a thorough investigation, believing that there was no way their best employee could commit a serious offense without much to gain (apparently). However, once the investigation began, we were able to quickly substantiate the allegations and determine that this was only the tip of the iceberg. The point is not to dismiss an allegation just because the accused did not have âenough to gainâ – it may not be necessary.
With these events, OpenSea is facing a crisis. Chastain damaged the company’s reputation and questioned the integrity of OpenSea. These types of problems unfortunately arise all too often in businesses – Coinbase had similar issues a few years ago – and this is part of the difficulties of growing a business. The differentiator is How? ‘Or’ What the company responds. OpenSea now has the ability to restore its integrity and restore trust with its users if it can identify the problem, take appropriate corrective action, and be transparent with all of these efforts. After all, reputation is arguably a company’s most valuable asset.
To OpenSea’s credit, it looks like they’re doing the right thing. They already have issued a statement regarding the incident, underscoring the company’s position on the misuse of inside information, and pledged to investigate the allegations and commit to “regaining the trust of the community.” Since then, the company has hired a third party to conduct an investigation. An update to OpenSea’s original post on the matter indicates that they have substantiated the allegations and requested and accepted the resignation of the offending employee (without specifically naming him, at this time). Chastain, meanwhile, updated his Twitter profile to note that he is no longer with OpenSea. OpenSea has also indicated that it will seek to strengthen its own internal controls to ensure this does not happen again in the future.
With the cryptocurrency industry currently in the spotlight of regulators, I fear this may not even be ground to call for restrictive regulations. Instead, regulators should see the good sides of this incident. The reason this was even revealed in the first place, as I explained, is due to the transparency inherent in blockchain. This level of transparency is unprecedented in traditional, very opaque financial markets. Regulators should welcome this type of public oversight of the stock markets. If only the public could see the financial transactions of their representatives in real time, for example, this could prevent some from trading on sensitive information. This type of technology could also be a godsend in the stock markets to eliminate real insider trading among companies and executives. While full financial transparency has many drawbacks, the fact is that this situation at OpenSea was highly unlikely to be revealed in the absence of blockchain transparency.