In the latest Weekly Wright Report:
- The Metaverse and Crypto Law
The Metaverse and Crypto Law
We have made the grand leap from green and red 3D glasses of the 1950’s to the Metaverse world of virtual reality. How does it fit within our legal system? This next generation digital technology opens doors that we could hardly imagine decades ago and creates a whole new challenge for the courts and legislators. Covid and the need for remote communication accelerated its use.
What is the Metaverse? Metaverse uses blockchain, artificial intelligence, heightened reality and virtual reality to create a real life-like reality in which people can interact, work and communicate. It can be used to store a person’s virtual assets, play games, and to assist the secure transition of funds. Crypto assets such as Non-Fungible Tokens (NFTs) and cryptocurrencies such as bitcoin are prime examples. Crypto assets are used in the world of sports, entertainment, art, music, currency, education, occupational training, commerce, financing, healthcare and an ever-growing arena. It will evolve in areas hard to conceive today. Cryptocurrencies such as bitcoin are fungible. All units are identical and transferrable. It is digital money, using blockchain as a peer-to-peer distributor that has strict rules for security and adding data. On the other hand, crypto assets such an NFTs are unique and non-transferrable. They are digital representations of real- life assets that are frequently purchased using cryptocurrencies. An NFT normally represents a fraction of the original and is stored on a blockchain that validates its uniqueness and provenance and has rules and restrictions tailored to the type of asset. It is a code residing on blockchain that contains fields such as location of the original, the unique ID and a description of the original. Art and unique recordings are examples.
The laws and regulations that will govern the metaverse are evolving with particular focus on contract, choice of law, defamation, harassment, invasion of privacy, security, finance, tax, export control and general regulation of NFTs and cryptocurrencies. Cryptocurrencies have received much publicity lately, some good and some not so good. Most of the world is familiar with the downfall of FTX.
The parties to transactions involving cryptocurrencies of other assets such as NFTs are the exchange or platform, the marketer, the creator or owner of the original and the assignee of an NFT.
Let’s focus on crypto assets. They are far more interesting and complex. Take for instance, a valuable painting by a contemporary artist. Assume that the artist owns the copyright and has a very intelligent agent. The artist can license others to make and sell prints or sell or lease the painting with or without the copyright. The license can be exclusive or non-exclusive and contain restrictions and time limits. Fractional interests in the original can be created and held as investments. Sometimes this is done by transferring the original to a limited liability company and selling units of the entity. Or the artist could sell NFTs. Ownership of the painting comes with a bundle of rights, including the right to copyright and protect intellectual property in the painting. If the artist holds the copyright, he or she can license others to make reproductions. However, the artist must be careful not to violate any license to reproduce or other rights that may be held by a third-party. In addition to copyrights protected under the Lanham Act, an artist may have recourse under the Visual Artists Rights Act of 1990. It protects moral rights even if ownership has been transferred. For instance, the artist may insist on attribution, seek correction of distortions or even prevent the new owner from destroying the work. NFTs may involve patents and trademarks as well as images of persons, generally of fame, for marketing or promotion purposes. For instance, several celebrity entertainers sued Epic Games alleging that the entertainers unique trademarked dance moves were implemented in a game. The metaverse requires development new hardware as well as the software. Patents will be required to protect rights in the hardware invented to support the software. Any agent or licensee that intends to create NFTs representing the original must research the intellectual property to protect against claims of infringement.
Tax is another issue. Are NFTs property? If sold or traded, will an income tax be accessed? Is the sale subject to sales tax or personal property tax? This is a federal as well as a state and municipality question. The Internal Revenue Services is targeting cryptocurrencies and may be looking into NFTs. The IRS has issued guidance to clarify that cryptocurrencies are property and that any profit is subject to income and capital gains taxes.
A marketer, exchange or platform promoting NFTs must be wary that security laws. If NFTs are marketed or promoted as investments, Security Exchange Commission and state Blue Sky laws may claim jurisdiction. On the other hand, if sold for strictly personal use and enjoyment, registration with the SEC and compliance with its disclosures and other requirements may not be necessary.
Users of crypto platforms should be aware of privacy protections and cyber security. The amount of personal data in the possession of the ever- increasing number of digital platforms heightens the chance of hacking and breach of confidentiality and corresponding risk of legal exposure. Metaverse creators should implement policies and restrictions.
Selling NFTs or using them as collateral for loans may be controlled by the Uniform Commercial Code – Article 2 and 9 respectively. How does a lender perfect a security interest in an NFT? Are NFTs goods? Some states have addressed this question. How do international transactions involving NFTs fit in with the United Nations Convention on Contracts for International Sale of Goods?
The federal government has been slow to enact laws and regulations to oversee the metaverse. Other countries are farther along. States, however, have been more active. Legislation coming from states has focused on, among other subjects, establishment of study groups and task forces, UCC issues, enforceability and validation of contracts secured in blockchain technology, consumer protection, security laws, custodial services of banks, validation of signatures and records, permitted government investment in cryptocurrencies and crypto assets.
What will the future bring? Billions of people will encounter the metaverse through education, work, shopping, entertainment, currency, and investment. New risks, liabilities, exposures, and regulations will quickly arise, be they regulatory, contract or tort. While a number of courts have been called upon to deal with various metaverse disputes, the application of legal concepts is still in an embryonic stage. Stay tuned.
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