NFT insider trading is rampant, and the son of the LVMH boss is getting involved?

Author: Jeff Kauflin

Compiled by: Vivian, Forbes China

On a Tuesday in early February, Alexandre Arnault, the 29-year-old son of the world's third-richest man (with a net worth of $170 billion), Bernard Arnault, logged onto the NFT trading platform OpenSea and placed a bid of $3,100 to purchase an NFT named Hyperbear#9021. Hyperbear is a colorful and adorable digital bear, each adorned with unique accessories such as heart-shaped sunglasses and cowboy hats, and #9021 is the rarest in this total collection of 10,000 NFTs, making it the most valuable.

On that Tuesday, buyers were bidding during what was called a presale period. In theory, no one should have known what each bear looked like or which one had the rarest features at that time. Although Alexandre Arnault is the heir to the LVMH fashion empire and an executive at Tiffany & Co., theoretically, he was blind buying like all other NFT bidders, akin to buying a lottery ticket.

However, Alexandre Arnault was determined to acquire HypeBear #9021, as his bid was 32% higher than the prices of other undisclosed HypeBears that day, allowing him to secure it easily. He also made a similar bid for HypeBear #7777, which was 58% above the market price at the time, and made similar bids on seven other digital bears. Two days later, when the identities and details of the ten thousand digital bears were revealed, Alexandre Arnault miraculously ended up with five of them, including three of the ten rarest digital bears, namely #9021 and #7777.

If his bids were made randomly without knowledge of the rarity of these digital bears, how likely is that? According to calculations by Convex Labs, a tech startup aimed at making the cryptocurrency and NFT markets more transparent, the odds are only 1 in 440,000. In comparison, the odds of a person being struck by lightning in their lifetime are about 1 in 15,000.

Among the three ultra-rare HypeBears that Alexandre Arnault purchased before their identities were revealed, #9021 is a monkey-faced bear, adorned with sparkling gold from its crown to the Crocs on its feet. Four days later, Arnault sold #9021 for $14,700, making a profit of $11,600, with a return of 377%.

Hypebear #7777, on the other hand, is dressed in a white spacesuit emblazoned with the American flag. Alexandre Arnault paid $3,900 for it and sold it for $12,900 a month later, using multiple cryptocurrency accounts that seemed to be under his control for the transactions. While Alexandre Arnault's spokesperson strongly denied that he had any insider information regarding HypeBear, they refused to answer specific questions from Forbes.

If HypeBear were a stock, then the trades of #9021, #7777, and other rare digital bears before their reveal would likely raise alarms at the Securities and Exchange Commission, prompting an investigation into what looks like insider trading—trading based on information not yet shared with the public investors. However, in the largely unregulated cryptocurrency and NFT space, trades that hint at market manipulation and insider trading are rampant and not considered outright illegal.

Convex Labs CEO Ricardo Rosales stated, "The NFT market has great potential, but there are also many bad factors. Our view is that if something can go wrong, it probably will; if someone can take advantage, they likely will."

How did Alexandre Arnault know which NFTs were the rarest before their reveal? The HypeBear project was founded by 26-year-old Ernest Siow, a part-time model and entrepreneur from Singapore. On February 10, the day HypeBear was revealed, Ernest Siow tweeted a screenshot of a video call with Arnault, captioning it, "Catching up with my brother! Now let’s see our bears." Alexandre Arnault then retweeted this, although he more commonly posts photos with numerous celebrities like Jay-Z, Roger Federer, and Warren Buffett.

Did Alexandre Arnault get a tip from Ernest Siow, similar to how Martha Stewart received a tip from the CEO of ImClone regarding her stock in 2001? We cannot be sure. So far, all evidence is circumstantial, and Ernest Siow denies leaking any information. Back then, Martha Stewart was sentenced to five months in prison for her involvement in the ImClone case, charged with making false statements and obstruction of justice. But Alexandre Arnault has no such worries, as NFTs are not currently considered securities, and their trading is largely unregulated.

Billionaire Bernard Arnault and his son Alexandre Arnault.

Unregulated NFT Insider Trading

NFT investors can easily find other examples that raise suspicions of insider trading. Earlier this month, there were rising doubts surrounding Meebit, a highly publicized NFT collection launched by Larva Labs, the creators of CryptoPunk, consisting of 20,000 digital dolls representing men, women, and other beings. In January and February of this year, Meebit’s trading volume was low, averaging only 22 trades per day on OpenSea. However, in early March, rumors of its impending acquisition surfaced, causing its trading volume to surge. On March 10, 87 Meebits changed hands. By 6 PM Eastern Time on March 11, 406 Meebits had been traded.

Soon after, significant news broke: Yuga Labs, the company behind the blue-chip NFT series "Bored Ape Yacht Club," announced that it was acquiring the intellectual property of Meebit and CryptoPunk, leading to a spike in prices for both NFT series of 70% and 11%, respectively, within hours.

An NFT watchdog account on Twitter, NFT Ethics, recently specifically named certain Meebit buyers, claiming they had non-public information. One was Justin Taylor, who describes himself on LinkedIn as Twitter's Consumer Product Marketing Director. Justin Taylor purchased 7 and 1 Meebit NFTs on March 8 and 9, respectively. Lesley Silverman, another named buyer, is the head of Web 3.0 at United Talent Agency, which claims to be a client of Larva Labs. Lesley Silverman bought one Meebit on March 5 and another on March 8. Neither responded to Forbes' request for comment.

Twitter user WhaleCrypto wrote, "This kind of crazy bulk buying of Meebits just days before the announcement shows the ongoing insider trading in this space." Another user commented, "At this point, are you really surprised?" "This is a (pyramid scheme), but that’s okay, I’ll play it to the end."

In December 2021, just two days before Nike announced its acquisition of the NFT studio Rktfkt, a Twitter user using a pseudonym seemed to know this news was coming. By December 11, this user, named Sarah1of1, had purchased five "Mint Vial" NFTs launched by Rktfkt for a total of about $81,000. On December 12, she tweeted, "Wait until tomorrow, haha, if you can, I suggest you buy now."

Sure enough, the next day Nike announced its acquisition of Rktfkt, and the prices of its NFT products skyrocketed. Within the next 24 hours, Sarah1of1 sold all five "Mint Vial" NFTs, making a profit of $85,000. "There is 100% insider trading in the CloneX series," stated a Twitter user named BitBoyJay, who owns nearly 1,000 NFTs. Sarah1of1 did not respond to Forbes' request for comment.

However, part of the issue is that few believe regulators are paying attention to this space. NFTs are not currently considered financial securities, so many NFT traders are actively seeking to profit from any advantage they can find. BitBoyJay stated, "Right now, we’re like in the Wild West. When the entire industry is unregulated, I don’t see anyone getting sued."

Strictly speaking, he is correct. Insider trading is only a criminal offense when it involves financial securities. Insider trading expert John Coffee, a professor at Columbia Law School, believes that although the SEC has recently investigated NFTs, most NFTs are unlikely to be considered securities without new legislation.

But that doesn’t mean wrongdoers won’t get into trouble. Those NFT buyers who believed in the promise of "fairness and equal opportunity" may file lawsuits for fraud, and NFT issuers may be forced to pay hefty damages.

For now, the only ones able to do this are vigilantes on Twitter, who can track transactions on public blockchains and point out bad trading behavior. Last summer, OpenSea asked its product head to resign after Twitter users discovered that a crypto wallet associated with that head appeared on OpenSea's price change homepage shortly before the head purchased NFTs— in other words, he seemed to have gotten a jump on promotional activities in his employer's market. The head did not respond to Forbes' request for comment.

Regulation is difficult, but what’s harder?

It seems that even if regulators or fraud lawsuits could tame the NFT market, it would take time. However, Silicon Valley-based Convex Labs is trying to develop tools to monitor the industry in real-time. The company was founded last year by eight Stanford graduates and students, including 29-year-old Ricardo Rosales, a former high-frequency trader at Goldman Sachs, and 31-year-old structural biology PhD Nick Bax, who has been involved in blockchain forensics research since 2017.

In July of last year, when the monthly trading volume of NFTs exceeded $300 million, Ricardo Rosales and Nick Bax realized that due to the often inadequate security or privacy controls set by NFT project teams, they could use a series of complex techniques to find the rarity data of individual items in NFT collections before their identities were revealed. They then built tools to analyze and exploit these loopholes, earning $50,000 in trading profits within five weeks.

However, they soon decided that establishing a business focused on NFT trading might be more rewarding in the long run. "Just making money by buying and selling NFTs isn’t very satisfying," Bax said. "The first few times were indeed fun. But clearly, I don’t want to do this for the rest of my life. Solving this problem feels more interesting." Thus, the two released tools to detect unfair trading practices and shifted their business focus to making the NFT market more transparent.

One way they achieve this is by providing fairness audit services for NFTs, which can help issuers ensure that their NFTs are fairly distributed and signal to investors through Convex Labs that external experts have reviewed the project. Rosales and Bax say this is a time-consuming job, with fees ranging from $10,000 to $100,000.

Today, they are building an NFT label system called "Honest Protocol," which can publicly identify the attributes of an NFT collection, such as whether rare items are fairly randomly distributed. "Many people in the retail NFT space have been scammed," said C.K. Umachi, co-founder of Convex Labs. "So that’s our mission: How do we educate these people? And how do we protect them?"

There is an urgent need for this type of transparency tool, especially since many NFT collections are launched by artists and software developers lacking relevant experience. For example, the Superlative Secret Society from Indonesia raised $2.7 million in September 2021 with a set of abstract art NFTs. However, when Convex Labs investigated it, they found a significant flaw: 75% of the 50 rarest tokens were minted during the presale phase, when only a selected group of investors could purchase these digital artworks before they were sold to the public. In other words, the most valuable NFTs in that collection were mostly bought by insiders and early investors.

Recent research by blockchain data platform Chainalysis shows that even in fair NFT launches, insiders capture the largest share of profits, at least in the short term. Collectors who were on the presale list and later resold the NFTs had a 76% chance of making a profit because they bought at a discount, while those who were not on the presale list had only a 21% chance of profiting.

Luqman Santosa, the community manager of the Superlative Secret Society, acknowledged the flaw regarding rarity and attributed it simply to their software developer's lack of experience. According to him, the developer known as The Bot had no prior blockchain programming experience before developing these NFTs, so he didn’t know how to randomly distribute rarity among the 11,110 collection items.

Worse still, this person named The Bot is hard to find, as Luqman Santosa said he lives in a "virtually off-the-grid" area of Indonesia, where internet access is slow and unstable. Luqman Santosa claimed this was not due to any ulterior motive, as The Bot himself has never owned any NFTs issued by the Superlative Secret Society, and now each NFT in that collection is priced at about $250, roughly the same as the initial purchase price during the presale.

Another NFT project plagued by controversy is MekaVerse, which is based on Japanese robots, a type of art often depicting giant robots controlled by humans. MekaVerse raised $6 million at its launch in October last year, but accusations of insider trading have been rampant. Before the collection was revealed, a major developer seemingly purchased a rare MekaVerse item. However, this chaos may have been caused by a misunderstanding, as data from the NFT rarity ranking platform rarity.tools shows that the NFT bought by the developer was not particularly rare, ranking 1,424 out of 10,000 items.

Mathieu Le Berre is one of the two co-creators of MekaVerse. He stated that the real issue was that he and his partner Matthieu Braccini were overwhelmed by the operational demands of running a popular NFT collection, which is akin to running a startup.

"We made some mistakes," Mathieu Le Berre said. NFT collectors have raised significant doubts about the fairness of their issuance, and because he and Matthieu Braccini did not use publicly verifiable blockchain tools to manage the rarity distribution of those NFTs, they could not convince others that it was fair. Today, Mathieu Le Berre deeply regrets this decision: the average price of MekaVerse NFTs has dropped from $8,000 at launch to below $1,400.

Was it just luck?

While there are many suspicious trading behaviors in the NFT market, Alexandre Arnault's HypeBear trading case is particularly intriguing.

Ernest Siow said he first met Alexandre Arnault in January this year when the latter messaged him on Twitter to learn more about HypeBear.

"He wanted to build a nice portfolio for himself—a nice collection, a profitable collection," Ernest Siow stated. Now, his relationship with Alexandre Arnault has progressed beyond HypeBear. "We’ve been investing together… whatever I’m playing with, I share what I know with him." Over the past year, Ernest Siow has been trading cryptocurrencies and NFTs, claiming to have made over $1 million in profits.

While Alexandre Arnault is reluctant to answer specific questions about his relationship with Ernest Siow, the latter denies giving the former any insider information. However, Alexandre Arnault's spokesperson pointed out, "He (Arnault) has always been an active investor in NFTs and an art collector—given this, he has been in contact with many artists, creators, and other collectors."

Ernest Siow stated that he has conducted investigations and is confident that no insider information regarding HypeBear rarity was leaked to Alexandre Arnault, but in fact, he has a significant motive to please the LVMH executive as well: the potential collaboration between Tiffany and HypeBear, similar to Gucci's deal with the "Superplastic" NFT series. When asked about the status of this collaboration, Ernest Siow said, "It’s not finalized yet, but we’re discussing various possibilities."

When asked to explain why Alexandre Arnault had this incredible ability to identify some of the rarest HypeBears before they were revealed, Ernest Siow replied, "Maybe he was just lucky."