New Kind of Crypto Insider Trading? SEC Might Take a Look at These Trades, Experts Say

Crypto
derivatives
trading
platform
Hegic
recently
made
millions
of
dollars
by
placing
a
trade
of
its
own,
loading
up
on
tokens
issued
by
an
affiliated
project.
The
strategy
paid
off
in
days,
when
Hegic
shut
the
smaller
business
down.

It
might
not
just
be
a
savvy
trade,
but
a
perilous
one
as
well.
Experts
interviewed
by
CoinDesk
warn
that
the
chain
of
events
could
render
Hegic
vulnerable
to
what
would
be
a
first-of-its-kind
insider
trading
investigation
by
the
U.S.
Securities
and
Exchange
Commission.

Hegic,
a
platform
for
trading
crypto
options
on
the
Ethereum
blockchain,
could
reap
$17
million
because
of
a
highly
profitable
trading
strategy
executed
by
its
pseudonymous
developer,
Molly
Wintermute.
She’s
the
sole
developer
for
Hegic
and
its
less
popular
platform,
Whiteheart.

Late
last
month,
Molly
gave
up
on
developing
Whiteheart.
In
a
message
on
the
Discord
server
that
Hegic
and
Whiteheart
share,
Molly
said
Whiteheart
would
return
its
$28
million
treasury
to
investors
and
shut
down.

The
redemption
news
caused
Whiteheart’s
token
to
rally
sixfold
to
$3,500
under
heavy
buying
pressure
from
arbitrageurs
eager
for
a
piece
of
the
treasury
liquidation,
a
process
Hegic
is
facilitating.

But
no
one
is
profiting
more
than
Hegic.
That
protocol’s
treasury,
which
is
separate
from
Whiteheart’s,
bought
nearly
a
third
of
WHITE’s
token
supply
three
days
before
the
shutdown
announcement,
according
to
blockchain
data.
Between
that
purchase
and
another
in
September,
it
can
lay
claim
to
almost
half
of
Whiteheart’s
treasury:
$17
million
of
ether

(ETH).

Securities
experts
who
reviewed
the
situation
told
CoinDesk
the
case
speaks
to
the
“grey
area”
that
decentralized
finance
protocols
such
as
Hegic
and
Whiteheart
purport
to
exist
in
and
profit
from.
Their
proponents
have
argued
the
old
rules
shouldn’t
(or
can’t)
apply
to
new
financial
innovations
built
on
blockchains.

When
executives
at
publicly
traded
companies
know
their
business
is
about
to
do
something
potentially
market-moving,
they’re
barred
from
trading
on
that
information
until
it’s
revealed
to
the
public.
If
they
do
trade,
that’s
insider
trading
–
and
it’s
illegal.

Hegic
and
Whiteheart
are
not
organized
as
conventional
corporations
and
WHITE
isn’t
a
stock,
so
the
same
rules
don’t
apply.
But
as
the
SEC
ventures
into
regulation
of
cryptocurrencies,
that
could
change.
What
happened
here
could
newly
be
considered
illegal,
the
experts
said.
SEC
Chair
Gary
Gensler
has
stated
that
the
vast
majority
of
cryptocurrencies
are
unregistered
securities
that
ought
to
be
subject
to
the
same
rules
as
stocks
and
bonds.

“I
think
he
would
think
it
was
a
security
and
maybe
an
enforcement
case
would
be
appropriate,”
James
Park,
a
law
professor
at
UCLA
who
studies
securities
regulation,
said
of
the
WHITE
situation.

Molly
Wintermute
did
not
respond
to
a
request
for
comment.

When
examined
through
the
securities
law
angle,
the
Whiteheart
trading
could
raise
questions
about
fiduciary
duty,
shareholder
rights
and
information
asymmetries
on
unruly
crypto
markets
that
would
rather
not
be
subject
to
such
questions.

According
to
Park,
the
U.S.
prohibition
on
corporate
executives
trading
using
valuable
secret
information
is
part
of
their
fiduciary
responsibility.
They
can’t,
for
instance,
just
frontrun
earnings
announcements.

Things
get
tricky
when
one
tries
to
graft
this
standard
onto
DeFi.
Project
founders
–
the
likeliest
stand-in
for
an
executive
–
could
say
they
don’t
control
their
creations,
and
thus
don’t
have
a
fiduciary
responsibility
to
tokenholders.

Even
so,
Whiteheart
and
Hegic’s
relationship
with
Molly
undercut
this
argument,
according
to
Park.
She
created
them,
wrote
their
white
papers,
conducted
their
token
sales
and
controlled
their
treasuries
as
their
“solo
core
developer.”
She
also
announced
the
decision
to
close
Whiteheart
on
Nov.
30.

Molly’s
activity
“shows
that
they
are
not
some
random
person
who
is
trading,
but
some
person
who
tokenholders
entrusted
to
develop
this
project
in
a
way
that
would
help
them
increase
their
profits,”
Park
said.

Some
projects
seek
to
bolster
their
decentralization
by
letting
tokenholders
vote
on
key
business
decisions.
Whiteheart
was
not
one
of
them.
The
only
thing
holders
of
WHITE
were
entitled
to
was
30%
of
the
revenue
generated
by
the
protocol.
If
anything,
that
makes
WHITE
look
more
like
a
security,
two
lawyers
said.

Still,
Whiteheart
and
Hegic
exist
in
a
world
of
legal
uncertainty,
and
it’s
far
from
clear
that
securities
laws
should
apply
to
them
or
their
tokens,
said
Nejat
Seyhun,
a
professor
of
finance
at
the
University
of
Michigan’s
Ross
School
of
Business.

Despite
that,
“it
seems
like
there’s
smoke
here,
and
it
may
be
worth
an
investigation
to
see
if
there’s
a
fire,”
he
said.

WHITE
spent
most
of
2023
in
the
forgotten
corner
of
the
crypto
market.
Three
years
after
its
founder


raised

13,667
ETH
(then
worth
over
$8
million)
to
fund
Whiteheart’s
novel
hedging
contracts,
it
had
devolved
into,
at
best,
an
afterthought
to
Hegic.

“Molly
delivered
on
the
promise
(protocol
was
up
and
running
like
it
should)
but
the
idea
did
not
get
as
much
traction
as
people
thought.
Even
today,
options
in
DeFi
are
the
lowest
used
derivative,
people
don’t
trade
them
nearly
as
close
to
as
much
as
perps/futures,”
said
a
longtime
user
of
Hegic
and
Whiteheart,
who
goes
by
the
screen
name
Parad0xPrince.

Traders
stopped
trading
WHITE,
too.
In
the
first
three
weeks
of
September
2023,
Uniswap
processed
14
total
trades
worth
less
than
$9,000
total.
It
was
priced
at
$78
–
87%
below
its
value
during
the
December
2020
sale.

Then
Molly
started
bidding.
In
10
minutes
of
trading
on
Sept.
21,
her
wallet
bought
$158,000
worth
of
WHITE
–
over
16%
of
all
the
tokens.

She
paid
for
this
trade
using
100

ETH
from
Hegic’s
treasury.
Two
months
later,
she

sent
its
WHITE
proceeds
to
Hegic’s
current
treasury
wallet.

This
wallet
traded
WHITE
again
on
Nov.
27.
In
a
single
trade,
the
Hegic
treasury
bought
2,900
WHITE
tokens,
paying
$2.3
million
worth
of
ETH.
Again,
the
price
of
WHITE
ballooned:
from
$193
to
$2,000,
before
settling
down
near
$500
three
days
later.

Seven
hours
after
roiling
WHITE’s
Uniwap
market,
the
Hegic
Discord
account
promised
“further
announcements”
about
Whiteheart’s
future
and
advised
holders
against
“hasty
action.”

The
news
came
three
days
later.
Whiteheart
would
shut
down
and
“refund”
all
WHITE
holders
at
the
price
original
investors
paid
in
2020:
1.7
ETH.

There
is
evidence
of
“frontrunning”
throughout
crypto.

According
to
market
surveillance
firm
Solidus
Labs,
more
than
half
of
Ethereum-based
tokens
“experienced
insider
trading
activity”
right
before
their
debuts
on
centralized
exchanges,
in
the
period
between
January
2021
and
June
2023.

Decentralized
exchanges
such
as
Uniswap
are
“a
game
changer
for
insider
traders,”
said
Chen
Arad,
chief
external
affairs
officer
of
Soludius.
They
lack
the
monitors
and
regulations
to
stop
such
activity
and
make
it
easy
for
manipulators
to
strike,
he
said.

But
they’re
also
a
boon
for
those
trying
to
catch
them
because
every
transaction
is
recorded
publicly
on
the
blockchain,
creating
a
digital
trail
of
breadcrumbs
that
regulators
can
follow,
he
added.
That
is
“a
point
we
emphasize
in
discussions
with
regulators,”
he
said.

Federal
prosecutors
have
taken
action.
In
a
pair
of
cases
against
insiders
at

OpenSea
and

Coinbase,
the
U.S.
Department
of
Justice
cracked
down
on
frontrunning
as
a
form
of
“wire
fraud.”
The
distinction
highlights
how
the
government
can
allege
illegal
activity
even
if
securities
law
–
and
the
SEC
–
don’t
come
into
play.

There
hasn’t
yet
been
a
case
against
insider
trading
in
the
DeFi
markets.
Arad
expects
that
to
change.

“Many
regulators
are
considering
insider
trading
prevention
as
a
key
element
of
applying
market
abuse
regulation
to
crypto
and
DeFi,”
he
said.

Regardless
of
its
status
under
securities
law,
the
Whiteheart
redemption
plan
gives
investors
in
WHITE
an
uncommonly
happy
ending.

Most
crypto
projects
fall
into
obscurity
only
after
their
treasuries
have
gone
to
zero,
leaving
nothing
for
the
tokenholders.
A
cottage
industry
of
activist
investors
has
developed
around
forcing
struggling
decentralized
autonomous
organizations,
or
DAOs,
to
buy
out
their
investors
before
they
run
out
of
money.

But
Whiteheart
never
ran
out
of
money.
Molly
and
Hegic
have
set
up
a

market
on
Uniswap
that
will
buy
every
single
WHITE
token
at
1.7
ETH
apiece.
That’s
the
same
ETH-denominated
price
WHITE’s
original
investors
paid
three
years
ago.

“I
never
saw
a
founder
return
money
to
ICO
investors
1:1
even
though
he
delivered
on
what
he
should,”
said
Parad0xPrince,
using
the
acronym
for
initial
coin
offerings.

The
biggest
winner
is
undoubtedly
Hegic
protocol
itself.
Molly’s
trades
netted
a
nearly
600%
return
on
investment.
Whiteheart
may
be
dead,
but
nearly
half
of
its
riches
will
live
on
in
Hegic.

And
the
market
approves.
On
Nov.
30,
when
the
shutdown
announcement
went
live
and
WHITE
pumped
to
$3500,
Hegic’s
token
price
climbed
alongside
its
swelling
treasury.

The
market
drove
the
HEGIC
token
60%
higher
in
a
single
day.