Will NFTs push regulators to regulate the metaverse? | Barnea Jaffa Lande & Co.
A few years ago, NFTs were only the topic of interest to tech geeks and the cryptocurrency community. However, nowadays it seems that NFTs are almost everywhere. For those who don’t yet know, NFTs (non-fungible tokens) are digital objects that use a similar type of blockchain technology to secure cryptocurrencies. This technology makes it possible to create a unique and one-of-a-kind digital token that embodies a virtual or physical asset. The process of creating an NFT is known as “coinage”. NFT can be digital art, a video clip, or even a virtual figure in a video game. In some cases, it can even be a physical asset connected to such a token. This connection enables new forms of ownership and transferability. The uniqueness of each NFT sets them apart from other cryptocurrencies such as Bitcoin, Ether, and many other virtual tokens.
But make no mistake about it. NFTs are valuable and increasingly important assets in the market. They will be important in future marketing and investment decisions. Since late 2017, hundreds of millions of dollars have been spent on NFT. Their use has exploded over the past year, and that number will increase.
Impact of NFTs on the physical world
One important thing to remember is that because NFTs are secured using blockchain, it creates a singularly secure way to transfer ownership of those NFTs and indirectly to transfer ownership of any asset (virtual or physical) that they have. they represent. It has the potential to revolutionize commerce as we know it. The immediate and direct impact is on electronic commerce of virtual assets, which exist in the virtual world (rapidly transforming into “metaverse“), but there are growing indications that NFTs will also have an impact on trading in physical assets.
An interesting example of this impact is the formation of a new type of asset, the one which is “hybrid”. Parts of the “hybrid” asset are in the physical world and parts in the virtual world. For example, in the summer of 2021, world-renowned artist Damien Hirst sold “hybrid” works of art that consisted of genuine real-life paintings that each had corresponding NFTs. Another interesting example is the announcement made by Nike in December 2021 regarding the purchase of a virtual shoe designer and manufacturer by the name of RTFKT Studios. This transaction will allow Nike to begin operating in the metaverse by selling shoes and clothing (marked as NFT) for the use of virtual avatars (which may well be represented by NFTs).
New types of ownership
The next step in the evolution of NFTs is the “tokenization” of physical assets and then the use of those NFTs to prove ownership and enable the transfer of those physical assets. For example, a DFT may reflect ownership of a physical work of art. Provided custody and custody by a trusted third party exists, it can revolutionize the buying and selling of works of art. Potentially, any physical asset can be “tokenized” and blockchain technology can be used as a trusted global registry of ownership and a platform for the liquidity of those tokens.
In other words, NFTs influence our daily lives according to several vectors: NFTs allow the creation of new types of assets; NFTs stimulate the development of the metaverse, where people can own virtual assets and use their avatars to create value; and, at the same time, NFTs become a bridge connecting the physical world to the metaverse.
Where regulation comes into play
Given their dramatic disruptive impact, we shouldn’t view NFTs as relevant anecdotes only for die-hard blockchain supporters. They are changing our world and therefore governments and regulators need to pay close attention to their impact. Financial regulators, for example, focus on the stability of financial institutions, the integrity of capital markets, and consumer protection. NFTs impact all of this, and along with their promises and benefits, they create risks that we need to consider. But make no mistake, governments and regulators should not and cannot try to ban the trade in NFTs or attempt to restrict the use of blockchain technology. Stopping technological innovation is impossible and foolish, especially given the many benefits that this technology brings with it. It is imperative to harness these advantages for the benefit of consumers and commerce.
Currently, most regulators and governments are on the fence. They are waiting to see what other jurisdictions are doing or how the market develops. In some cases, governments and regulators are trying to tackle this problem more actively, but with very different results. For example, federal regulators in the United States are applying legal principles developed decades before anyone even dreams of cellphones, let alone the Internet, to classify different types of digital tokens such as securities, utilities, or coins. types of products. China has banned crypto-related services altogether, while El Salvador has adopted Bitcoin as legal tender. It is clear that this is an extremely uncertain area where the law is still evolving and which differs significantly from one jurisdiction to another.
To do or not
And when the law is uncertain, lawyers find themselves in a difficult position. On the one hand, companies that develop NFT-based products want to do business. In many cases, these products and technologies have real value. Examples include NFTs that can protect artists against counterfeiting and counterfeiting of their works, NFTs that distribute royalties to creators immediately and continuously without resorting to third-party intermediaries, or NFTs that allow talented individuals make a living by controlling their virtual avatar in the metaverse.
On the other hand, when the law is unclear, the easiest and safest advice a lawyer can give to a client is “don’t do it”. This is where lawyers face the challenge. They need to find the right balance between protecting their customers and growing their business. This requires a thorough understanding of the regulatory principles that governments and regulators will apply and the risks that affect them. It also requires working with customers to proactively develop products that adequately address these concerns. One example is NFT platforms that reduce the risks of money laundering and improve consumer protection mechanisms.
Evolving is necessary
Ultimately, governments will evolve and develop laws and regulations that address these challenges while providing regulatory certainty for these technologies to thrive. The world is changing and our reality exists in two dimensions, physical and virtual. This means that consumers must benefit from protection in both dimensions and that measures taken in one of these dimensions must not jeopardize economic systems. Fraud and theft, for example, also exist in the metaverse, and governments must develop the capacity to deal with them adequately. NFTs related to physical assets exist in both dimensions, and governments must provide the legal infrastructure for rights and obligations to exist in both dimensions.
Regulators must also change. Some aspects of these regulations can be addressed by harnessing the technological advantages that NFTs and blockchain provide. For example, the use of technology capable of detecting suspicious sources of funds can mitigate some of the risks of money laundering. Smart contracts can resolve potential conflicts of interest between financial institutions and consumers. Decentralized Finance (DeFi) can change conventional thinking about conflicts of interest in the financial world because, in some cases, there will no longer be a need for central third-party intermediaries. These examples do not mean that we will no longer need regulators. It just means that regulators will need to develop an in-depth understanding of these technologies and their risks.
Indeed, these are significant challenges. But our governments and regulators will rise to the challenge. They will learn to function in this new and complex reality in two distinct but connected dimensions. Until that happens, lawyers will have to work harder and become more sophisticated in their technological understanding, in order to provide their clients with sound and effective advice.