56% of Crypto Token Listings Show Evidence of Insider Trading
56% of crypto token listings since 2021 exhibit evidence of insider trading, reported Blockchain Security company Solidus Labs.
A significant contrast to the already excessively high figures for stock-based insider trading: 5% for earnings announcements and 20% for mergers and acquisitions, as reported by researchers at the University of Technology Sydney.
A fraught reality for web3 retail investors that had SEC Chair Gary Gensler promised in November 2023 that the U.S. Securities and Exchange Commission would go after fraud in the cryptocurrency industry “with the same fervor the agency has investigated insider trading in its regulated community.”
Insider trading in CryptoFi is both similar to and different from that occurring in TradFi.
Here’s why.
To understand how insider trading takes shape in the crypto industry, let’s begin by what defines insider trading.
According to the SEC’s Insider Trading Policy,
SEC Rule 10b-5 prohibits corporate officers and directors or other insider employees from using confidential corporate information to reap a profit (or avoid a loss) by trading in the Company’s stock. This rule also prohibits “tipping” of confidential corporate information to third parties. […]
An “insider” is an officer, director, 10% stockholder and anyone who possesses inside information because of his or her relationship with the Company or with an officer, director or principal stockholder of the Company. Rule 10b-5’s application goes considerably beyond just officers, directors and principal stockholders.
This rule also covers any employee who has obtained material non-public corporate information, as well as any person who has received a “tip” from an Insider of the Company concerning information about the Company that is material and nonpublic, and trades (i.e. purchase or sells) the Company’s stock or other securities.
This policy also applies to your family members who reside with you, anyone else who lives in your household, and family members who do not live in your household but whose securities transactions are directed by you or are subject to your influence or control, as well as trusts or other entities for which you make investment decisions.
To grossly summarize, if you gain access to information that few possess through a talkative insider, or if you are the insider and choose to trade based on that information to make a profit, you are guilty of insider trading.
Now, Solidus reported to have detected evidence of insider trading through decentralized exchanges (DEXs) connected to 56% of all ERC-20 token listing announcements on a number of major crypto exchanges since January 2021.
A staggering number fueled by what Solidus Labs called “serial insiders.”
51 entities total were spotted, among which three insiders who have traded ahead of no less than 25 listings apiece.
Solidus further revealed that one such a “serial insider” traded ahead of 14 listings using DEXs and 22 using centralized exchanges (CEXs), using $2.7 million to buy tokens before their listings for a profit of over $300,000.
None of this could have been possible without the first key piece in any insider trading case, the “insider!”
So who are they in the cryptocurrency industry?
Crypto Insiders Profiles
The name of the game is to have access to “material non-public corporate information”, also knows as MNPI, as stated in the SEC’s Insider Trading Policy.
People who have access to MNPI in the crypto industry are many as well as few.
For Solidus Labs there are four entities through witch MNPI can be acquired:
- Token Issuers — A no-brainer.
- Crypto Trading Platforms — In January 2023, Coinbase director openly accused Binance of insider trading. Ironically, it was Coinbase that saw a former insider sentenced in first ever cryptocurrency insider trading case in May 2023. Binance has also been continuously embroiled in insider trading rumors and being investigated by the CFTC.
- Market Makers (working on behalf of token issuers) — It needs to be noted that there are at least three incentives for Market Makers to glide into insider trading themselves:
- Profit Motive: The most common motivation for insider trading is financial gain. If market makers possess non-public information that could influence the price of a cryptocurrency, they might be tempted to use that information for personal profit.
- Competitive Advantage: Insider trading can provide a significant competitive advantage. By acting on privileged information before it becomes public, market makers may position themselves to capitalize on market movements more effectively than other participants.
- Risk Mitigation: In a highly volatile market, market makers may see insider trading as a way to mitigate their own risks. By making informed trades based on undisclosed information, they might attempt to avoid potential losses.
- Investment Firms providing capital to token issuers
This being said, the insider could be anyone!
A low-ranking employee, a corporate officer or even a CEO.
How to Insider Trading
Now that we know who, let’s understand how.
Solidus Labs underlines in its report that, compared to TradFi, in the cryptocurrency landscape, fraudsters are blessed with two more blockchain-specific modus operandi when it comes to insider trading:
“1. Buying a digital asset on a centralized exchange (CEX) on which it is already listed, on the knowledge that it will soon be listed on another CEX
2. Buying a digital asset on a DEX using a pseudonymous cryptocurrency wallet.”
For non-crypto savvy readers, usually a digital asset will see a pump once it is listed in huge CEXs.
Being listed on Binance for example, that touts its tough screening process when it comes to listing cryptocurrencies, can make the value of a cryptocurrency jump from 20 to 200%.
This phenomenom has even been dubbed the “Binance Effect.”
A January 2023 study led by Ren & Heinrich revealed that, on average, newly listed tokens on Binance would see their price spike of 41%.
With even more bountiful cases, like in December 2023, when meme coin Satoshi saw a 140% price surge within hours of Binance announcing it would list the token.
With pumps as high as that, promising immense returns, it’s no wonder the space has become the place-to-be for insider trading.
Not only the rewards are high, but the methods used to do so are quite simple.
Solidus Labs identified three main strategies favored by fraudsters:
Modus Operandi #1 —
The insider or complicit of the insider will buy the token on a DEX hours or days before its listing on a major CEX platform, like Binance. After the listing, and following token’s price surge, the token is sold at a profit on a DEX.
Modus Operandi #2 —
The insider or complicit of the insider will use a DEX in one of the two step. Either they buy the token on a DEX hours or they sold it at a profit on a DEX.
Modus Operandi #3 —
The insider or complicit of the insider bypasses the use of DEX. Instead, they would most likely transfer the token from one CEX to another.
The choice to pick a MO over another is possibly motivated by either reducing transaction cost, optimize profits, or circumvent the detection models for insider trading employed by CEXs, notes Solidus Labs.
Insider trading in digital assets is a common practice in 2023.
It’s easy, almost undetecteable unless you go looking for it like Solidus Labs did, and the regulatory environment is such as it seems most if not almost all fraudsters guilty of insider trading will get away with it.
The fact that the first ever cryptocurrency insider trading case only happened in May 2023 when it’s such a widespread issue and it has been so for years, says a lot about the inefficiency of authorities to stiffle this issue.
It creates a climate of absolute impunity that explains away the frequency of insider trading in the space.
Crypto retail investors, the most vulnerable users in the space, are the true victims of this story as they are being used over and over as exit liquidity.
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