Despite the minimal regulatory actions against blockchain gaming companies and NFT issuers, it is NOT time to get complacent about regulatory issues. As noted below, many US agencies are increasing their focus on regulatory enforcement in the crypto space, and NFTs are no exception. In 2022, we saw US regulators increase staffing for more enforcement. All of this happened before the FTX debacle. Things are only going to intensify in 2023 as a result of FTX. Some of the areas to focus on include the following.
- insider trading- lawsuits were filed against Nathaniel Chastain (formerly of Open Sea) for insider trading allegations related to NFTs, despite the fact that the NFTs were not even alleged to be securities. See here and here for more information on these actions. Similar charges were brought against another person. We still recommend that companies adopt an NFT policy for insider trading. One reason for this is that the SEC is investigating the lack of such guidelines for NFT/crypto exchanges.
- Sanctions – OFAC sanctioned an exchange and designated 57 cryptocurrency addresses (associated with digital wallets) as Specially Designated Nationals (SDNs). These designations appear to be the first time NFTs have been publicly affected as “blocked property,” as one of the designated cryptocurrency addresses owns non-fungible tokens (NFTs). Because U.S. persons are essentially prohibited from trading with individuals and entities associated with the specified cryptocurrency addresses, trading in these NFTs is also prohibited for U.S. persons. See here for more. OFAC is likely to be more vigilant with crypto and NFT enforcement in 2023.
- Money laundering – The Ministry of Finance published a study on the facilitation of money laundering and terrorist financing through the art trade. Among other things, the report discussed the risk of financial crime associated with high-value art, including NFTs (see our previous blogs on NFTs here and here). The study found that the high-value art market has certain inherent qualities that make it potentially vulnerable to a range of financial crimes. NFT buyers, marketplaces, issuers and other intermediaries in NFT transactions should be aware of the Treasury Department’s interest in regulation and the potential for abuse through NFT transactions. As the study continues, expect enforcement to follow. For more see here.
- taxes- The IRS continues to increase its efforts to force taxpayers to report digital asset activity on their tax returns and apparently continues to force information from exchanges to target users who do not. For more see here. To date, their efforts have had only minimal effect. Look forward to stricter enforcement in 2023.
- Securities- despite written requests, the SEC has not provided specific guidance on the applicability of securities laws to NFTs. In the meantime, the general guidance in the framework for “investment contract” analysis of digital assets should be considered to assess whether an NFT offering implicates securities laws, particularly where NFTs are used in lieu of traditional fundraising. Some of the scenarios where this can occur include fractionation, pre-selling of NFTs where a game has not yet been built and attaching certain revenue rights to ownership of NFTs. However, the decision in each individual case will be very fact-specific. The SEC has reportedly issued subpoenas related to the investigation into NFTs and is particularly interested in information about fractional NFTs. For more on that see here. The SEC has announced a nearly doubling of staff to focus on enforcement of cryptoassets including NFTs, with an emphasis also on cryptoasset lending, staking and defi platforms. For more see here. A pending securities class action lawsuit against Dapper Labs alleges that NFTs sold on Dapper’s platform constituted unregistered securities in violation of federal securities laws. Many in the industry are looking at this matter. Friel v. Dapper Labs, Inc., et al., No. 1:21-cv-05837-VM. The SEC is reportedly investigating Yuga Labs for potential violations of federal securities laws in connection with the sale of Bored Ape NFTs and its subsequent issuance of ApeCoins as governance and utility tokens. As the Bored Ape Yacht Club is one of the most successful NFT projects, any enforcement action against it would have potentially significant implications for the industry. Keep an eye out for this one in 2023.
- intellectual property- The IP issues with NFTs continue to be somewhat unclear. The US Patent and Trademark Office and the US Copyright Office are conducting a joint study to assess intellectual property and policy issues related to NFTs. The results of this study may lead to new policy directives and potential regulatory changes in IP issues with NFTs. I am working with the American Bar Association (ABA) and the American Intellectual Property Law Association (AIPLA) to provide input to this study. If anyone is interested in commenting, comments are now 3 February 2023. Feel free to get in touch for more info or to discuss. As part of this study, the two offices will conduct a series of three virtual public roundtables focusing on IP considerations as they relate to NFTs. They will take place on the following dates:
- Roundtable 1: Trademarks and NFTs (January 24, 2023)
- Roundtable 2: Patents and NFTs (January 26, 2023)
- Roundtable 3: Copyright and NFTs (31 January 2023)
The number of lawsuits related to misuse of IP and other IP issues in connection with NFTs is also increasing. While two high-profile NFT-related IP lawsuits were settled in 2022 (Roc-A-Fella Records, Inc. v. Damon Dash and Miramax, LLC v. Quentin Tarantino et al), a number of major cases are pending on these issues , including :
- Nike v. StockX- whether StockX NFTs are just a digital certificate of authenticity or a separate product
- Herms v. Rothschild- whether NFTs of Herms’ iconic Birkin handbags advertised and marketed as “MetaBirkins” are infringing works or expressive works of art protected under the First Amendment under Rogers v. Grimaldi
- Yuga Labs v. Ryder Ripps- whether Ryder Ripps is infringing Yuga’s IP and whether Yuga actually has any copyright protection due to the fact that the monkey images allegedly “were generated by an automated computer algorithm in which no human was involved in deciding which of the 10,000 BAYC images were selected.” Yuga Labs, Inc. v. Ryder Ripps, et al.
- Consumer Protection- The FTC has taken a greater interest in the way NFTs are described and marketed to avoid misleading consumers. This can occur, for example, when an NFT is advertised in a way that includes false advertising or misinformation. This often leads to NFT buyers not understanding what they are buying. As a common example, NFTs are often advertised as providing “ownership” of a “unique” digital asset, but in reality the buyer may only receive a limited license and/or the asset is not unique (e.g. NFTs are offered too many copies of the digital asset).
The Uniform Law Commission adopted amendments (including a new Chapter 12) to the Uniform Commercial Code (UCC) to govern the transfer of digital assets, including cryptocurrency, digital tokens, and non-fungible tokens (NFTs). The changes span nearly every article of the UCC and add a new Article 12 that addresses certain types of digital assets defined as “Controllable Electronic Records” (CER). The changes provide new standard rules to govern transactions involving these new technologies. Several states have adopted or are in the process of adopting the changes, and others plan to do so.
- Recommendations from celebrities – Many high-profile NFT projects have used celebrities to support their projects. These endorsements may fall under the jurisdiction of the FTC and SEC. The FTC Endorsement Guidelines apply to celebrity endorsements of NFTs. However, the SEC has even stricter disclosure requirements for celebrity endorsements of crypto-assets that are securities. The FTC’s endorsement guidelines require disclosure of a “material connection” between the endorser and the company or product. In contrast, the SEC mandates disclosure of the “nature, scope and amount of compensation” related to the approval.
- The SEC reached a $1.26 million settlement with Kim Kardashian for her role in supporting, via social media accounts, a crypto asset that was offered and sold as a security. Kardashian did not fully disclose her compensation for her role. The SEC found that Kardashian’s failure to disclose this compensation violated Section 17(b) of the Securities Act, which makes it illegal for any person to promote a security without fully disclosing the receipt and amount of such consideration from an issuer.
- A recent class action lawsuit against 37 defendants alleges that stakeholders in Yuga Labs, the company that issued Bored Ape Yacht Club NFTs and its other digital products, engaged in a celebrity conspiracy to defraud potential investors. The complaint alleges that BAYC’s digital collectibles were “misleadingly promoted” by using celebrities to lure investors without disclosing the nature, source and amount of compensation paid, directly or indirectly, to the celebrities. Adonis Real, et al. v. Yuga Labs Inc. This will also be closely watched in 2023.
- Fraud- fraudulent practices will continue to be prosecuted. This occurred before FTX and is likely to accelerate as a result of FTX. For example, in March 2022, two fraudsters who engineered an NFT “rug-pull” were criminally charged with conspiracy to commit wire fraud and conspiracy to commit money laundering. The million-dollar scheme to defraud buyers of NFTs was based on how they advertised “Frosties.” Instead of providing the advertised benefits to Frostie’s NFT buyers, the defendants channeled the proceeds from the sale to various crypto wallets under their control and shut down their NFT website.
One of the great things about NFTs and blockchain games is that they are just getting started. As more companies adopt NFTs and more game studios enter the space, more competition will result. This will undoubtedly drive continued experimentation and new development. As these offerings evolve, new legal issues will continue to emerge. Regulators are falling behind in terms of enforcement based on current technology. As the pace of NFT and blockchain gaming innovation increases, it will become more and more difficult for regulators to develop clear guidelines. This lack of clarity will continue to cause challenges for companies wishing to comply with the regulations. This will increase the need for such companies to seek advice from lawyers who truly understand the NFT and blockchain gaming space and can help advise on issues where there is a lack of regulatory clarity.
