Metaverse Series (1): The compliance risks of investing in Metaverse real estate should not be forgotten


Recently, The sandbox, one of the two Metaverse platform giants, announced a new partnership with HSBC. HSBC has become the first global financial service provider to enter The sandbox and will purchase virtual land in the Metaverse of The sandbox. , marking that the Metaverse platform is trying to intervene in financial services and integrate with traditional financial institutions. Since the second half of 2021, Metaverse has begun to enter the public eye, and a large number of players and investors have flocked to the Metaverse to engage in “enclosure movement”, triggering a wave of virtual real estate rush buying and hype. The real estate company “Metaverse Group”, which focuses on the Metaverse economy, purchased a virtual real estate transaction with a price of US$2.4 million in “Decentraland”, and the internationally renowned accounting firm PwC also entered the Metaverse real estate speculation , famous singer JJ Lin spent $750,000 to buy land in Decentraland. Behind the pursuit, we can’t help but have such doubts:

Where does the value of “land” in the Metaverse come from? Why is it possible to fry such a high “sky price”? What is the support behind it? Next, we trace the legal attributes of the Metaverse, analyze the legal risks of the land and platforms, investor relations and speculation in the Metaverse, and explore the issues that should be paid attention to in terms of investment compliance in the Metaverse.

1. Legal Attributes and Economic Effects of Metaverse Land

The Metaverse is a superimposed combination of time and space in the online virtual world. Different from the traditional Internet, Metaverse provides rich scenarios of diversified interactions. Users buy land, build houses, and buy and sell commodities in the Metaverse, and connect with the real economy through Tokens. The land in the Metaverse is the basic element that constitutes the ground space of the Metaverse. Taking “Decentraland” as an example, its standard plot area is 16m*16m and the height is 20m. Each piece of land is a non-fungible token (NFT) representing a unique digital asset, which is not a mapping of physical objects (such as artworks and digital collections), but virtual assets independent of the real world, Provide users with a virtual space-time that can be customized and freely defined. Virtual properties can be bought and sold as primary and secondary sales on marketplaces such as OpenSea and Rarible. The virtual real estate in the form of NFT is recorded on the decentralized blockchain, and its acquisition, transfer, registration and publicity and other procedures are completed on the blockchain, which is not as cumbersome as traditional contract transfer.

What are the legal attributes of virtual real estate ? From the perspective of criminal law that is relatively stable and needs to maintain dynamic evolution, Professor Zhang Mingkai proposed that property as a criminal object and an object of legal interest must meet three criteria: management possibility, transfer possibility and value. The possibility of management means that the property must be able to be controlled by the subject, and in the case of virtual real estate, it is manifested as the exercise of the right of possession through account wallets, private keys, NFTs and the fact of management. The possibility of transfer means that virtual real estate can have the ability and liquidity to transfer, and can be traded in the primary and secondary markets. Value means that it can bring economic benefits, and it is the indiscriminate human labor condensed in commodities, which is manifested as consensus and recognition based on technologies such as distributed ledgers and cryptography. It can be embodied in different meanings such as economic price, meaning to people, and importance. As Professor Si Xiao said, the value of the native digital assets of the blockchain is endowed by the blockchain system and also depends on the social contract of the participants, but its value changes with the changes in the economic and political environment. From the point of view of civil law, virtual real estate exists outside the human body, has the characteristics of being controlled and can meet the needs of human production and life, although it is an intangible object, it can break through the traditional requirements for the form of objects and bring more economic benefits. Intangible objects with economic value are included in the category of property rights. Therefore, we believe that virtual real estate has the property of real right, and the holder has the right to possess, use, benefit and dispose of.

The title of virtual real estate has become a digital status symbol for early investors, while offering innovative business models. Improve channels, products and services with higher transparency and higher efficiency by changing the traditional offline location selection, store opening, distribution and promotion methods. By opening virtual retail experience stores on virtual real estate, merchants can achieve 24-hour global sales. Virtual real estate forms an agglomeration effect around one or several brands, forming a business circle, which in turn generates functional differentiation and realizes the integration of physical life and digital life. This may be the prototype of the future virtual city.

2. Relationship between Metaverse Platform, Development Team and Investors

The Metaverse Platform is the main body that creates the Metaverse virtual space, and most of them are the main company behind it. Although virtual real estates such as land and houses are developed on public chains such as Ethereum, the specific data may be stored in the server of the Metaverse platform (company), and the platform is responsible for maintaining these on-chain data. Although the ownership of the land belongs to the purchaser, from a technical point of view, the trading activities of commodities such as houses built on the land and the purchase of materials currently require the support of the services provided by the platform. If the platform stops operating or stops providing services, the value of the land will be reduced. After a sharp fall, the relationship between land and platform is inseparable. From this relationship, in the current situation where the virtual worlds of the Metaverse have not yet been connected, the Metaverse platform is more like an auxiliary manager of virtual real estate, similar to the role of property management, and constitutes a hidden relationship with the virtual real estate holder. Sexual consumer service contracts.There is no shortage of voices of doubt about this. For example, some people think that “purchasing virtual land is just to obtain a license in the virtual space. In fact, you are purchasing the services provided by the platform. Once there is a problem with the operation of the platform, the money invested will be wasted.”

The development team is the person and team responsible for the R&D and design of the underlying technology of the Metaverse, smart contracts, economic models and virtual characters. In the early development stage of the Metaverse, the development team is in a very important position, playing a key role in the adjustment of code and smart contracts, and the cultivation of the community. Development teams typically hold large amounts of land in the Metaverse in the treasury to prop up the value of land assets in ways such as encouraging development and slow sales of new land. In this mode, the development team also acts as a “player behind the scenes”, and its improper behavior may harm the interests of ordinary players. Therefore, it is necessary to restrict developers, such as including developers in governance organizations to participate in voting, and supervising the treasury such as financial audit and information disclosure.

How to choose virtual real estate investment? The preservation and appreciation of virtual real estate is inseparable from the following elements:

(1) Scarcity

The amount of land in the Metaverse is limited, for example, there are only 90,000 pieces of land in the “Decentraland” Metaverse, and the platform promises not to increase the amount of land arbitrarily in the short term, and the existence of “economic scarcity” helps to preserve the value of land.

(2) The value of the content

The platform’s branding and content scenarios, such as unique gameplay, high-quality and promising partnerships, foster diverse communities and player groups. The Sandbox and Decentraland platforms are more in-depth in model design, partner ecology, infrastructure construction and management services, and have won more users’ recognition for their content value, with high user stickiness. This is why the number of plots in The Sandbox is only 62% of all the land in the Metaverse, but the full year 2021 The Sandbox land sales will account for at least 73.5% of the total;

(3) Consensus

Metaverse Decentraland and The Sandbox jointly maintain the governance of the community by issuing governance tokens MANA and SAND, and users vote for decision-making management. In the future, as the scale of the Metaverse becomes larger and the scene gradually improves, a good community governance consensus will not only promote the rise of token prices, but also promote the preservation and appreciation of real estate.

3. Legal risks and compliance paths of virtual real estate speculation

Virtual real estate was originally designed to provide users with a customized work-life experience . In terms of its value as a commodity, the current price of virtual real estate deviates greatly from its value, and speculation and speculation are prevalent, especially by raising prices in the secondary market to “beat drums and pass flowers” to find investors to take over. The trend of over-hype and “financialization” of virtual real estate will breed many legal risks.

(1) Financial regulatory risks

Governance tokens and NFTs issued by Metaverse may involve ICO financing activities, and are likely to be considered securities under U.S. law and then be regulated by the U.S. Securities and Exchange Commission (SEC). If the governance tokens issued by the Metaverse platform meet the four requirements of monetary investment, common cause, income expectations and the efforts of a third party, it constitutes the standard of the “investment contract” in the Howe test and can be regarded as securities. At the same time, some NFT tokens, such as divisible virtual real estate NFTs, also have the possibility of becoming securities due to their homogeneous properties.

(2) Criminal risk

The ways and means of money laundering in the field of blockchain finance have gradually spread from centralized exchanges and decentralized finance (DeFi) to the field of NFT and the Metaverse, and the means of money laundering crimes are more hidden and complicated. The perpetrator uses the stolen money to buy land and then converts it into virtual currency or other types of NFT, which can effectively evade the current mainstream anti-money laundering legal framework and law enforcement methods. In addition, the production of software tools rushed by scientists to purchase virtual real estate NFTs may also involve criminal risks such as the crime of illegal business operations and the crime of providing tools for intrusion into computer information systems.

(3) Civil risk

Once the Metaverse platform is poorly managed or a new “disruptor” emerges, virtual real estate will no longer have sufficient scarcity, and the devaluation of real estate will bring property losses to investors. Can virtual property holders claim losses to the Metaverse platform? In addition, the construction, rental and transaction circulation of houses on virtual real estate also need the improvement of legal rules to fill the gap. If the Metaverse platform leaks users’ data information due to poor management and collects and uses player information in violation of the principles of informed consent and minimum necessity, it will involve civil risks such as data security and personal privacy information infringement, and in serious cases, administrative and criminal penalties will be incurred.

In this regard, Metaverse Virtual Real Estate needs to introduce diversified compliance governance. First , the basic principles of “housing, not speculating,” de-financing, and “deleveraging” in the real economy are also applicable to virtual real estate. Virtual real estate should pay more attention to user experience, enrich related infrastructure and brand ecology of affiliated partners ; secondly , Do a good job in user identification (KYC) and anti-money laundering review, including compliance review of user wallet accounts, real estate NFT funds and cryptocurrency travel process, and consider the Metaverse platform as a virtual asset service provider (VASP) to be included in anti- money laundering. Money laundering regulatory framework; furthermore , strengthen the exploration of compliance technology for decentralization of virtual space. By modularizing and contracting third-party services such as law and auditing on the chain, a decentralized compliance system of the Metaverse will be created. For example , Astra Protocol has created a decentralized legal network  (DLN), Metaverse users can obtain non-transferable  NFTs after certification , and can participate in Metaverse activities that require permission, including buying and selling virtual real estate.

Author: Attorney Liu Lei, Master of Laws, head of the “Digital Economy and Fintech Legal Service Team” of Beijing Yingke (Shanghai) Law Firm. Won the honorary titles of “Top Ten Future Stars” of Yingke Headquarters; “New Decade · Ten Youths” representative of Yingke (Shanghai) and other honorary titles.

Author: Zhang Xiaming, a doctoral student in financial law at Central University of Finance and Economics, and a researcher in the team of lawyer Liu Lei of Beijing Yingke (Shanghai) Law Firm. Worked in the research institute of leading Internet technology institutions. He has long focused on the fields of financial technology, blockchain finance and digital currency, published the book “Digital Finance”, and participated in the writing of several industry-related books and research reports.

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