What is insider trading?

By  Artem Khomenko 420 1 Feb 2023
Photo - What is insider trading?

Insider trading is a way to profit using confidential information about an asset.

Some news have a positive effect on the asset. This can be a listing on a major cryptocurrency exchange (if the coin has not been traded before), a big brand partnership, internal non-public updates, and other events.

Some traders get access to confidential information before others, so they open the appropriate positions to reap a profit, betting that the market will play this event in a certain way.

Who is involved in insider trading?

Since the main value in an insider transaction is information, usually two or three subjects take part in the event:

● The company or asset that is the subject of insider trading;
● An insider who owns confidential information and uses it for his own purposes;
● An insider who passes on confidential information to a third party.

For example, you work in a large cryptocurrency exchange. According to some closed statistical information, your platform plans to delist a token. Often this provokes investors' disappointment and a fall in the coin's value. Knowing the likely impact of delisting on the asset, you open a short position and, with a high probability, profit from this deal.

Is insider trading legal?

In most cases, insider trading is illegal for several reasons:

■ Lack of healthy competition;
■ Benefits for major players – market makers, institutional representatives, exchanges;
■ The result of insider trading is a deterioration in the asset's liquidity and destabilization of the market.

It is evident that many people work in the field of cryptocurrencies, stock markets, and other assets, and many have access to sensitive information. In this case, employees sign an NDA (Non-disclosure agreement).

Insider trading causes significant damage to the company and the people involved in it. Responsibility for such actions is punishable either administratively (huge fines, up to millions of dollars) or even criminally.

Legal insider trading

In the cryptocurrency world, there is a way to find out confidential information quite legally. Most often, this is an analysis of on-chain activity: large transfers, purchases of tokens on DEXs, massive cryptocurrency loans – all this can be used to reap a profit. Sometimes, due to the above reasons, the asset's price may differ on different trading platforms. At this point, the possibility of arbitrage arises.

People who use insider information often do not move the earned funds for a long time but use the same address to leave fewer digital footprints. In this case, some market participants duplicate insider trades, even without understanding what will happen next.

Examples of insider trading

■ Binance recently listed Rocket Pool (RPL) coins. 10 minutes before the announcement of the listing, someone bought a low-liquid token on the 1Inch decentralized exchange for $200,000. After the listing announcement, the RPL token pumped by 25%, and the user sold the asset for $250,000, earning $50,000;

■ Alameda Research bought tokens before they were listed on FTX. Both platforms were owned by the same person who freely used insider information for his financial gain. At the moment, it was possible to track purchases of coins for $60 million, while the potential profit is many times greater;

■ Former product manager of Coinbase crypto exchange provided insider information to his brother Nikhil Wahi. He earned $1.5 million from 25 tokens transactions. After confessing in court, Nikhil was sentenced to 10 months in prison;

■ Former OpenSea manager Nathaniel Chastain traded NFTs before their official release on the platform. Nathaniel pledged not guilty, citing that cryptocurrencies are not subject to the "securities law," and the case cannot be charged in this vein. But the SEC thinks otherwise. At the moment, the proceedings are ongoing.

Every year there are more and more such examples. Obviously, this negatively affects both the reputation of cryptocurrencies and the overall liquidity of the crypto market.