Justice Department Indicts OpenSea's Nathaniel Chastain

The Justice Department announced Wednesday its first indictment of an American in history for fraud related to non-fungible token (NFT) trading.

Nathaniel Chastain, 31, worked for NFT exchange OpenSea selecting which NFTs to feature on the site’s homepage. In an indictment unsealed Wednesday morning, the Justice Department alleged that Chastain took advantage of his position by purchasing NFTs before they were featured, and subsequently selling them at a profit.

“From at least in or about June 2021 to at least in or about September 2021,” the department said, Chastain “misappropriated OpenSea’s confidential business information about what NFTs were going to be featured on its homepage and used that information to secretly purchase dozens of NFTs shortly before they were featured. Chastain then sold the NFTs he had purchased at a profit shortly after the NFTs were featured.”

The feds said Chastain flipped “approximately 45 NFTs on approximately 11 separate occasions,” selling them for 200-500 percent in profit each time. In particular, the feds said, Chastain purchased four NFTs from The Brawl 2 collection, 10 from Flipping and Spinning, and one from Spectrum of a Ramenfication Theory, in addition to three more from the same creator.

The indictment also claimed Chastain used “anonymous digital currency wallets” to facilitate the transactions, but failed to say which ones. And the indictment later implied that it may have used the word “anonymous” as a synonym for “new wallets,” saying he “transferred funds through multiple anonymous Ethereum accounts.”

As crypto enthusiasts know, “anonymous Ethereum accounts” do not exist — making it likely the feds intended to say he transferred the funds between multiple wallets.

“NFTs might be new, but this type of criminal scheme is not,” U.S. Attorney Damian Williams in a statement. “As alleged, Chastain betrayed OpenSea by using its confidential business information to make money for himself.”

Chastain is facing one count of wire fraud and one count of money laundering, which each carry a maximum sentence of 20 years in prison.

Broader Implications for NFTs and GameFi

The case could have implications for NFT collections beyond OpenSea, and particularly for NFTs related to crypto gaming. DeFi gaming, which was popularized last year by industry leaders Axie Infinity and DeFi Kingdoms (DFK), is powered by NFTs. Unlike traditional video games, you cannot “own” items in a DeFi game — unless they are NFTs. Examples include:

Characters
Equipment
Pets
Land
Money

Put simply, every action you take in the game is powered by NFTs. And as a consequence, every change the developers make affect the real-world monetary value of your in-game possessions. As an example, let’s consider DeFi Kingdoms. If it were a traditional company, the game’s native JEWEL token would represent shares of the company — and its only regulated security.

Wednesday’s indictment by the Justice Department casts a different light on the situation. It indicates that federal prosecutors view every item in the game as a security. That could be a problem for game developers, who tweak — or manipulate — the in-game economy to such a degree that it would make a Third-World Marxist dictator blush. They are incentivized to do so mostly by the fact that they are themselves compensated in the form of JEWEL that users voluntarily spend to participate in the game.

The token, valued at 46 cents as of Wednesday after peaking at a price slightly above $22 in January, is the engine that motivates activity in the game. The cost of creating (“summoning”) a new character, for instance, is generally between 32 and 60 JEWEL. Once spent, the JEWEL is shimmied away to a developers’ fund, which is used to pay staff salaries. (For perspective, the price to create a new hero began at about $14 as of Wednesday, down from $650 in January. Those new heroes were valued between $13 and $250 as of Wednesday, down form $700 to $11,000 as of January.)

A few examples of what game developers have done over the last several months to pull the strings governing the in-game economy:

Offered raffle tickets to users who summoned new heroes. This caused the value of existing heroes — which, remember are securities, according to the DOJ — to plummet.
Offered raffle tickets to users who performed the most quests using “stamina potions.” This required them to purchase gold, the in-game currency, which caused the price of gold-producing heroes (“miners”) to rise.
Subsequently made ALL heroes capable of producing gold, putting miners on track to plummet from an an approximate starting price of $1,000 to roughly $20 as of Wednesday.
Abruptly increased the distribution of “eggs,” which create pets, causing the value of eggs to plummet. (They were valued at roughly $14 as of Wednesday, down from a high of $5,000.
Promised raffle tickets and other in-game items (remember, securities) to users who held JEWEL during a specified time frame in January, as the price crashed. (After the event ended, they clarified that users who held less than an average of $10,000 in JEWEL would not qualify for any prizes. After widespread outcry, they amended the offering to distribute low-value items — like eggs — to several hundred additional users.)

It’s worth reiterating that the aforementioned raffle prizes were NFTs — which, again, are securities. Going forward, regulators and law enforcement officials in the U.S. are very likely to pursue cases against developers who have sold NFTs for the purpose of raising capital unless they registered them as initial public offerings (IPOs) according to securities law. DeFi Kingdoms might have circumvented that law on several occasions by using their new NFTs — or IPOs — to pump the price of JEWEL, rather than by requiring investors to pay for them directly. (Even so, there is a strong case to be made that holding an unregistered raffle violates state and federal gambling laws — particularly if entrants are not permitted to enter free of charge.)

In fairness, the game’s team has been forthright in disclosing that they pay staffers in the form of JEWEL. Players are aware that those staffers have the right to dump it on the market at undisclosed times, and through their ongoing participation, have signaled acceptance of the practice. And DeFi Kingdoms isn’t the only NFT-based play-to-earn project in the “GameFi” sector to engage in such practices, with its native token representing a mere $40 million — or half a percent — of the sector’s $8.3 billion market capitalization.

Nonetheless, these question have become more salient in the face of the sector’s growing connection to real-world finance. DFK in particular has paved the way among its competitors in that arena, introducing a method earlier this year for players to purchase in-game assets directly using just their credit cards. Yet, despite the swirling legal and regulatory questions, proponents of GameFi have been quick to dismiss the possibility that federal officials might be on the cusp of a a heavy-handed crackdown that could affect their favorite projects.

The Justice Department’s unspoken disclosure that the feds have NFTs in their crosshairs, made through Wednesday’s indictment, may give enthusiasts a reason to engage in a little self-doubt, and to grill their favorite developers on any measures they’re taking to pass regulatory muster.