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Ifrah Law on NFTs: Blockchain Gaming and Gambling Compliance
February 9, 2022

Ifrah Law on NFTs: Blockchain Gaming and Gambling Compliance

By: Jake Gray and Jacob Grubman

In the first article of this series, we covered the basics of non-fungible tokens (“NFTs”)—unique virtual items recorded with immutable characteristics on the blockchain. We also introduced the concept of Utility NFTs, which are NFTs that serve some function beyond their value as collectibles.

Part II in our series highlights newly developing applications of Utility NFTs in the online gaming space, with a focus on potential pitfalls to avoid in implementing blockchain technology in this area. While NFTs present new opportunities for gaming companies, the rapid application of blockchain products should not come at the expense of potential liability under federal and state gambling laws.

Virtual Currency and the Real-World Economy

Video games have long since given rise to evolving virtual economies. The 1986 Nintendo game The Legend of Zelda saw protagonist Link collecting gem-like “Rupees” during the course of his adventures, which he could then use to purchase new weapons and items at “shops” throughout the game.

In the late 1990s and early 2000s, in-game economies began to reach outside the screen. As internet access proliferated, players all over the world began to play “massively multiplayer online role-playing games” (“MMORPGs”), in which users play as single characters in large, shared virtual spaces—an early precursor to modern virtual worlds like the Metaverse and Decentraland. [1] Virtual currencies and resources played an important role in each user’s experience of these MMORPGs. In the 2004 computer game World of Warcraft, for example, players needed to acquire virtual gold to purchase items and other features like mounts to advance in the game—and acquiring gold required time-consuming tasks like repetitive quests and in-game professions like farming herbs or blacksmithing. But, importantly, many of the most popular online games allowed users to trade items with one another, including gold.

This combination—the incentive to acquire gold, the time cost of acquiring it, and the ability of players to trade gold with one another—fostered a new cottage industry: “gold farming.” [2] Players with more time or economic incentive started to play for the sole purpose of acquiring gold, which they would then sell for real-world money to players who wanted to pay in money rather than time to advance in the game. It was the first meeting of in-game and real-world resources and, in effect, the first iteration of the “play-to-earn” model of gaming: By focusing on certain in-game tasks, players could effectively monetize their play.

Blockchain Gaming and NFTs

The notion of “virtual currencies” has clearly evolved since 2004, as has the relationship between the real-world economy and virtual assets. In our previous installment, we described the basics of NFTs and introduced the concept of “gamified” NFTs: To reiterate, they are virtual, non-fungible items with immutable characteristics, and they serve some function or utility in a given game.

Games involving NFTs are easily conceivable; for example, a game operator could offer NFTs as rewards for playing a game or earning some in-game accomplishment. Recently, though, operators have begun to turn to “blockchain-based games”—games which often make NFTs fundamental to the design structure of a game. In these games, NFTs can function as a ticket to play a certain game or as an in-game item, or both. But unlike previous iterations of digital resources, these NFTs are explicitly tradeable outside the game and on third-party marketplaces. Whereas companies like World of Warcraft creator Blizzard Entertainment have actively sought to combat gold farming practices and other play-to-earn tactics, blockchain-based game creators often specify that the external trading of game NFTs is not a violation of their terms of service. [3]

Integration of tradeable NFTs as a core function of blockchain-based games has led to an even more prominent play-to-earn model, as users who purchase the requisite NFT can then add to the value of their NFT by playing the game more often. Once the initial NFT purchase is made, players are able to capitalize on in-game mechanics that are designed to allow users some return on investment, whether it be through the increase in value of their NFT or the attainment of other sellable resources.

The NFT-based game Axie Infinity, a battle game structured similarly to Pokémon, popularized the model in the cryptocurrency space and illustrates the concept well. The game requires users to purchase three “Axie” pet NFTs in order to play. Players then use these pets to battle other users or breed to create more Axies. The more (and the better) users play the game, the more they can either increase the value of their purchased pet NFTs or create new pet NFTs, all of which can be traded for cryptocurrency on the Axie market or a third-party marketplace. [4]

Benefits and Pitfalls in Gamified Utility NFTs

Certain potential incentives of NFT gaming are readily apparent for businesses, as these games capitalize on emerging technology that has garnered significant attention, and they encourage players to both pay for access to games and spend more time playing the games. The revenue generated from the sale of NFTs is a large motivating factor for companies to incorporate NFTs and the play-to-earn model, but so are the additional royalty fees that the original owner (or minter) receives whenever an item is resold. As such, companies are able to keep the money in their games’ economies, and thus, also the company.

But because NFT-based games inherently involve real-world money, operators of certain play-to-earn games need to take proactive steps to avoid running afoul of federal and state gambling laws. In general, regulated gambling involves three elements: consideration, prize, and chance. Operators offering only games based predominantly on skill—an assessment that each state conducts in one of three different ways—take on less risk of liability in this area. But if a game requires a user to put up something of value to play, offers something of value for winning the game, and depends to a significant part on chance, it likely constitutes regulated gambling.

In the context of blockchain-based games, whenever in-game items can be traded outside of the game atmosphere, such as on a third-party marketplace, the items become functionally equivalent to money as a holder of value. Accordingly, when a tradeable virtual item like an NFT is tradeable for currency (crypto or otherwise), it likely constitutes “something of value” for the purposes of the gambling laws. Although players might not need to pay cash to participate, the NFT can still constitute consideration for the purposes of the gambling laws.

One practical example illustrates the difference between games often called “free” play-to-earn games and contests that are truly free. Decentral Games’s ICE Poker formally introduced its “play-to-earn” component in late 2021. [5] Under this model, players must own (or have delegated to them) an “ICE Wearable NFT” to receive a daily allocation of chips, with which they can play poker. Both the amount a user plays the game and the user’s success enable him or her to earn rewards to put toward NFT upgrades. Even further, the more wearable NFTs players have equipped on their character, the more chips they receive each day, and, accordingly, the more they are able to upgrade their NFTs to higher “levels.” However, the ultimate rewards are not limited to in-game improvements; instead, ICE NFTs are tradeable on the OpenSea NFT marketplace, and the market clearly demonstrates the way that success in the game can translate into real-world profit. For example, Level One Joker’s Baubles (one iteration of ICE NFTs) are listed on OpenSea for around 2 ETH (approximately $6,200, depending on price fluctuations). When upgraded to Level Three—which is possible only by playing ICE Poker—the same item is listed for 3.5 ETH (approximately $11,250). [6]

It is clear that ICE Poker exhibits the prize element, and most jurisdictions classify poker as a chance-based game. The final factor is consideration, and while ICE Poker does not require players to pay in cash, it does require them to purchase an NFT to begin playing (or to be delegated an NFT that another player has purchased). At this time, there is no obvious manner of playing the game that is truly free to participants.

NFT Gaming and Alternative Means of Entry

Although this common implementation of so-called “free” play-to-earn gaming raises significant compliance concerns under federal and state gambling laws, game operators have options for continuing to offer NFT-based gaming.

The gambling laws include one critical exception that can apply in the play-to-earn context: No consideration exists where a player either (1) does not need to pay anything of value to participate in a contest or (2) in addition to the paid method of entry, the game includes a free means of entry (commonly called an “alternative means of entry” or “AMOE”). An adequate “alternative means of entry” must allow users to participate in these games without making any payment, whether in cash or anything else of value. [7]

Critically, an AMOE is sufficient only if it is accompanied by the concept of “equal dignity”: non-paying users must be given the same odds of winning and have access to the same odds as paying users. Thus, for example, a game operator cannot offer more entries to paying participants than to non-paying participants or limit free entrants to a pool of lesser prizes. This presents clear challenges for NFT gaming operators, as participants in chance-based games cannot be required to purchase NFTs either to participate in games or to improve their odds of winning.

The Future of NFT-Based Gaming

With NFT-based games on the rise, reactions from large video game companies have been mixed. In November 2021, EA’s CEO Andrew Wilson, for example, claimed that NFTs and play-to-earn will be “the future of gaming.” [8] Wilson walked back his excitement in an earnings call recently, stating that collectability is an important part of the company’s offerings and “[w]hether that is part of NFT and the blockchain, well, that remains to be seen.” [9] Meanwhile, Ubisoft doubled down on its NFT embrace despite harsh feedback on the launch of its NFT platform. Ubisoft’s Strategic Innovations Lab VP Nicolas Pouard defended the company: “I think gamers don’t get what a digital secondary market can bring to them . . . . The end game is about giving players the opportunity to resell their items once they’re finished with them or they’re finished playing the game itself. So, it’s really, for them. It’s really beneficial. But they don’t get it for now.” [10] Bandai Namco announced a $130 million plan to expand its intellectual property—which includes well-known titles such as Pacman and Dark Souls—into the Metaverse. [11]

Even further, GameStop joins Ubisoft and Bandai Namco in welcoming NFTs, as the video game retailer looks to become a “major entrant” in the space with its own NFT marketplace. [12] GameStop and its partner, Immutable X, set aside a $100 million joint fund to incentivize game studios to develop on their platform.

Still, other big-name developers are staying away from NFTs. And Valve Corporation, which operates the game distribution service Steam, became the first big name gaming company to ban anything related to the blockchain (including cryptocurrencies and NFTs) in October 2021. [13] Valve provided no official explanation, but some have speculated that the decision relates to a previous gambling-related matter arising on the Steam platform: so-called “skin gambling” in the game Counter-Strike: Global Offensive. [14] Since then, Microsoft and Epic Games have enacted similar policies.

Like major game developers, governments around the world are similarly grappling with the relationship between virtual games and NFTs. South Korea recently banned the play-to-earn model, with regulators highlighting the concern that this model of gaming could fuel gambling addiction among the country’s youth. The Korean Game Rating And Administration Committee stated the following on January 28th: “If an in-game system allows users to exchange items with paid goods, there may be a chance of speculation, where the game may fall into the ‘age 18+’ classification, and not available for the youth under 18.” [15] The government’s decision reiterates a point raised earlier in this article: When an item functions as money, it can serve gambling purposes and gambling laws will apply, even in a virtual space.

Conclusion

No matter the regulations NFTs and other blockchain-based technologies may face in the future, NFTs have created new openings in digital technology markets and the iGaming space. Amidst the excitement over new opportunities, it is important to keep in mind that federal and state gambling laws still apply. Common marketing tactics, such as NFT promotional sweepstakes without a free alternative means of entry, likely violate gaming laws, for instance. NFTs evidently have value and as such they cannot be used as entry fees in games of chance or prize contests without implicating federal and state gambling laws. By being aware of these requirements, consumers can protect their digital assets and companies can comply with the gambling laws.

*Jake Gray is a graduate of Columbia University and an established technology researcher, currently working in the betting and futures space as a consultant to a variety of operators.

[1] https://electronics.howstuffworks.com/gold-farming.htm

[2] http://news.bbc.co.uk/2/hi/technology/6592335.stm

[3] https://www.polygon.com/22910677/blizzard-world-of-warcraft-boosting-banned-policy-change-explained

[4] https://whitepaper.axieinfinity.com/

[5] https://ice.decentral.games/play-to-earn

[6] https://opensea.io/collection/decentral-games-ice?search[query]=joker%20bauble&search[sortAscending]=true&search[sortBy]=PRICE

[7] Suski v. Coinbase Global, Inc., No. 3:21-cv-04539 (N.D. Cal. Jan. 11, 2022)

[8] https://coinculture.com/au/people/ea-ceo-says-nfts-play-to-earn-future-of-gaming/

[9] https://www.fastcompany.com/90718590/after-player-backlash-video-game-companies-are-quietly-scrapping-their-nft-plans

[10] https://kotaku.com/ubisoft-nft-quartz-digits-ghost-recon-assassins-creed-p-1848437476

[11] https://www.ign.com/articles/bandai-namco-metaverse-million-investment

[12] https://finance.yahoo.com/video/gamestop-nft-partner-says-video-150950315.html

[13] https://partner.steamgames.com/doc/gettingstarted/onboarding

[14] https://coinculture.com/au/business/steam-bans-crypto-games-epic-games-embraces-them/

[15] https://www.forbes.com/sites/eunicelam/2022/01/31/korean-gaming-giant-netmarble-to-launch-metaverse-and-nft-games/?sh=26b615223eee

 

Part I — Ifrah Law on NFTs: What is an NFT?

Part III — Ifrah on NFTs: New iGaming Tokens Raise Novel Securities Questions