You Asked, We Answered: NFTs and Virtual Currency in Games: Compliance Issues and Legal Risks

5 min

Game developers and platform providers are increasingly integrating non-fungible tokens (NFTs), virtual currencies, and digital marketplaces into their games and platforms, creating seamless, novel, and interactive experiences. While the industry has moved ahead quickly, federal and state regulators are taking a much closer look at how these technologies fit within existing legal frameworks.

In a recent webinar, partner Ellen Berge and associate Chris Boone of Venable's Advertising Law and Payments groups explored the latest regulatory developments and addressed how to spot and avoid compliance and regulatory risks associated with NFTs, virtual currencies, and other platform-based monetization mechanics. We received insightful questions from members of the audience, which our lawyers answer below.

Q. Would you compare an NFT to a numbered art print? Are there other comparisons that would help us understand why someone would pay a lot of money for a string of digits?

A. A numbered art print is a good comparison. An NFT is secured by a blockchain using cryptography and a network of computers that update a common shared ledger. This technology makes it virtually impossible to counterfeit or double-spend, and it proves the authenticity of the NFT. There is no clear answer for why some people will pay millions for a particular NFT. Scarcity, novelty, the idea of owning a bit of history, a need to collect, and human psychology all likely play role.

Q. New projects like Bored Ape Yacht Club and Cool Cats are gaining traction on NFT marketplaces like OpenSea. How are regulators approaching these developments?

A. Regulators are still trying to understand the technology and landscape surrounding NFTs, and they may hold workshops in the future, much like the FTC's 2019 workshop on loot boxes. For NFT platforms dealing primarily in NFTs of original artwork, the FTC will likely focus on consumer protection issues like unfair and deceptive acts or practices. The NFT ecosystem is so new that we do not know exactly what types of issues will arise, but they could include claims that the NFTs will increase in value or regulators could raise concerns over the security of digital assets held by the platform on behalf of consumers. To the extent these platforms host giveaways, sweepstakes, and other promotions, regulators will apply traditional regulatory principles to those applications. Money transmission and securities regulators may step in to regulate edge-use cases where the NFTs begin to look more like investment contracts or operate like a substitute for currency. Regulators are still trying to figure out how their analytic principles will apply to these assets in practice.

Q. It sounds like NFTs can be a token for a digital artform or luxury product. How can NFTs be regulated in a market that hasn't had much regulation in the "real" market?

A. Regulators are interested in learning more about these concepts and how their enforcement powers intersect with the use of NFTs. We expect consumer protection issues to be at the forefront and exchanges/marketplaces to be the most obvious subjects of regulation. While some NFTs make the news for being hugely expensive, most are not. How these assets are marketed will be a consumer protection touchpoint. In addition, government agencies may decide to regulate instances where NFTs resemble investment contracts or a substitute for currency.

Q. What are some concerns and/or considerations for including an NFT as a prize in a sweepstakes, contest, or tournament?

A. Sweepstakes are heavily regulated, and those same principles apply if the prize is an NFT. The promoter will need to include a free alternative method of entry (AMOE) and ensure clear and conspicuous disclosure of the AMOE. We have seen at least one recent class action targeting a cryptocurrency exchange for failure to clearly disclose the AMOE in a sweepstakes promotion with cryptocurrency as its prize. There is a whole body of law on this and related sweepstakes topics. Sweepstakes promoters must be careful not to misstate the prize or how the winner can claim or use it. For example, a regulator could find it a deceptive practice if a promoter suggested the prize would be an NFT worth a significant amount, but in reality the NFT was worthless.

If the NFT is simply a representation of digital artwork, securities concerns appear to be minimal. The more complex the NFT becomes, the more likely it is that a regulator could find a regulatory hook. For example, if an NFT entitles the holder to interest or payouts in cryptocurrency, that could raise concerns under an investment contract analysis.

It is unclear how the Financial Crimes Enforcement Network (FinCEN) views NFTs in terms of whether they act as a substitute for currency. The more fungible the NFT is, the more likely it is that it could be considered a substitute for currency, and its transmission regulated as money transmission. This risk is heightened if the NFT can be melted or transformed into an underlying cryptocurrency, such as Enjin coin. Enjin offers a flexible platform to create, integrate, and scale tokenized gaming assets. You can mint an NFT using the Enjin coin, so each NFT has the cryptocurrency built into it. Conversely, you can "melt" the NFT back down to its component cryptocurrency.

There are a lot of open questions, so all eyes are on the regulators to see how they will approach these complex topics.

Q. Has Venable received any direction from the payment brands regarding appropriate Merchant Category Code (MCC) classification for NFTs?

A. Visa and Mastercard have not published definitive guidance on how they classify NFTs. Card brands might view such digital assets as digital goods under MCC 5816 in some cases but might not in others. Card brands' views on NFTs are also developing, and their current approach may change as their understanding and the NFT ecosystem evolve. It's important to note that under Visa's rules, merchants that sell cryptocurrency in a card-absent environment are classified as a High-Brand Risk Merchant, which carries important implications. It's not entirely clear how Visa defines cryptocurrency in this context, but a key factor may be the asset's ability to be used outside of a game platform as a replacement for fiat currency.

Laws surrounding cryptocurrency and NFTs are evolving rapidly, and our lawyers can help address your unique concerns in this area. Click here to learn more about our Advertising Law Practice Group and here to learn about our Payment Processing and Merchant Services Practice Group. Click here to watch the full webinar.