Purchase and Sale of Assets in the Metaverse

Purchase and Sale of Assets in the Metaverse

“Reports of my death have been greatly exaggerated.” The same could be said today of the metaverse.

February 5, 2024

August 2023.

 1.  Introduction

Although the metaverse is a combination of virtual worlds that in essence are completely artificial, there are real-world consequences to interacting within that space. There can be opportunities and pitfalls for brands that use the space for making their products and services known. There can be legal implications for one’s actions; e.g. the laws of defamation and infringement still apply. Bad behaviour will not go unnoticed. Even where rules are sometimes scarce, users as a collective tribe will come together to enforce sanctions against bullying and harassment by banishing offenders from a platform. Increasingly, real-world regulators are eyeing what is happening in the metaverse; and the jurisdiction of real-world courts cannot be ousted. The metaverse is complex socially and legally because it is populated largely by idealists, nerds and early adopters; but it also is well represented by fraudsters, con artists and get-rich quick bros. Ultimately like the road to hell it is paved with good intentions, excitement and promise. Yet it can be a slippery over-hyped path where fortunes are made and lost with breathtaking speed.

People may choose to become involved in a venture involving the purchase and sale of assets in the metaverse for any number of reasons. Those reasons are not the focus here. This article chooses to focus on how an individual or entity with a considerable stake in the metaverse can mitigate their risks when buying and selling those assets. It’s all a question of degree. Certainly if the assets in question are simple and inexpensive there will not be the same measure of diligence involved for the obvious reason that it’s not worth the trouble. That said a tipping point occurs as the value of the assets increases; for example, when an entire catalogue of assets are involved or when an asset is sufficiently well known or unique that it commands a high value. Again, those details themselves are not the primary focus here. For context this discussion will explore the nature of a virtual asset that can be bought and sold in the metaverse; but it will then centre on principles that can be applied across a wide variety of situations.

2.  Types of virtual assets that typically can be purchased and sold

The first thing to get out of the way is the term NFT. Since the sharp downturn in the value of NFTs that started occurring in about the fall of 2022, that term has become somewhat off-putting, even unsavoury. NFTs are associated with speculation, greed and stupidity. Legions of gullible “investors” jumped on board the NFT train as it rose to crazy, unsustainable heights. That train was bound to crash and it did.

This tracked the same trajectory as crypto, generally, and Bitcoin in particular. Arguably there is no transformative or revolutionary purpose for a bitcoin. Bitcoin was simply the first to go to market so to speak, as an autonomous, decentralized digital currency, thanks to the visionary known as Satoshi Nakamoto, and therefore became the most famous. But it’s an inert currency in limited supply, just like cigarettes and contraband are currencies in jail. Bitcoin is not even a so-called smart cryptocurrency like Ether – which actually is not very smart – or fast – but that’s for another discussion. As a result of irrational exuberance, just like Bitcoin, the value of NFTs temporarily became stratospheric. Who knows, with time, those heights could be reached again as Bitcoin use becomes more popular for the purchase and sale of NFTs.

All of that is to say, arguably NFTs got a bum rap but they are also a misnomer. They took the heat for an early, widespread conceptual misunderstanding of how the metaverse actually works. Let me explain. An NFT is a Non-Fungible Token. It establishes a unique, trackable identity. It might have some unique features, depending upon the blockchain on which it resides, e.g. in an allegedly smart manner to automatically spin off royalties to its prior owner when it’s sold, transferred or fractionalized, but’s just a token. It’s not the piece of digital art, IRL (in real life) art or the thing or service it’s tracking. This is where so many people stumble in their understanding of digital assets in the metaverse.

NFTs have become synonymous with the often-cheesy, cheeky and/or cheerless digital art they have been heavily used with, to tokenize new, digital-only artwork. But the artwork, however good or bad, IRL or digital, is separate. This is where it gets interesting. There can be one digital Mona Lisa or a thousand. An NFT can be one digital baseball card or a collection of two thousand. It can represent title, in effect, to the underlying asset – e.g. an IRL collectible playing card. Or it can represent title to a limited-edition digital card that has been newly minted. That digital art has to be hosted somewhere on a server. The IRL baseball card actually sits in a drawer or display cabinet somewhere. As a digital asset in the metaverse, only the tokens know for sure what they actually represent. The thing to keep in mind is thatNFT means the token, not the thing(s) or service(s) it’s tokenizing. It’s up to the owners (i.e. buyers and sellers) to figure out and keep track of where the assets themselves are IRL or where they are hosted, to keep track of who is looking after them, and to keep track of whether there are extra or hidden expenses involved in maintaining them.

This brings us to one of the main promises of blockchain technology, one of the core value propositions. Anything can be tokenized.Information can be tokenized, like hospital records; blockchains are useful for supply chain management. They can keep track of the provenance of diamonds, the source for auto parts, cosmetics ingredients, etc. Artworks can be tokenized, like the cheesy art discussed above. Sound recordings can be tokenized, like WuTang Clan’s one-of-a-kind album “Once Upon a Time in Shaolin” which was sold in late 2021 for US$4 million by the US Department of Justice to a collective called Pleasr DAO to settle a fine against its prior owner the disgraced tech investor Martin Shkreli.[1] There is no limit. This is the promise. The only limit is one’s imagination for how to use a token to keep track of something, in an immutable, easily-accessed, decentralized ledger. Web3 apps and NFTs are increasingly part of a brand’s ecosystem as they gain usefulness; e.g. as tools for loyalty programs for hotels and airlines.

For the entertainment world more specifically, artists can tokenize sound recordings and videos, along with vouchers in effect for unique and/or intimate interactions with the artists themselves. These can be IRL or virtual. For gamers, tokens can allow players to own and trade their in-game assets such as avatars and skins independently of the developers who created the game so that their digital loot can be monetized, collected, bought and sold. Digital real estate is an obvious example of a virtual asset. Just like IRL real estate, it’s all about location, location, location, and having a virtual next-door neighbour like Snoop Dog doesn’t hurt either. Yet, like IRL real estate the bubble can burst, as it has done in dramatic fashion since the heights of 2021 and early 2022.

In closing on this point, it’s best to stop using the term NFT because it tends to cause cynicism and carries too many bad memories for people who got burned when they thought they might get rich overnight, and causes so much misunderstanding about how blockchains actually work. An NFT isnot by its nature an object of speculation. It’s just like the tag on a piece of luggage – like an Apple AirTag. It’s not the luggage itself, which is thereal asset it represents.

3.  Asset platforms and blockchain interoperability issues

Another thing to get straight is that there is more than one blockchain, and blockchains don’t particularly like to talk to each other, at least not without a bridge between them. And, there is no “the” blockchain. You can enjoy all the benefits of ownership of an asset on Blockchain A, but then be chagrined to discover that if you want to sell it, you can only sell it to someone else on Blockchain A.

Certainly you can duplicate an image of your asset that’s on Blockchain A then place that copy on Blockchain B, but obviously it will just be a copy. The code will indicate it still resides on Blockchain A. This is known as the interoperability problem which potentially limits the value of a digital asset because an asset is beholden to residing on the blockchain where it was originally minted, even if that blockchain is no longer that popular or cutting edge. Similarly, if the platform or game where your digital assets were created are discontinued in the future then all of your assets will disappear in a puff of digital smoke unless you can somehow archive them off chain for future use. I am sure someone is working on this right now in their basement somewhere – an automated or easy to use way to archive tokens from a platform off chain for potentially coming back to life on a new platform sometime in the future in a manner of blockchain cryogenics but to date I have not been made aware.

As mentioned above, there are bridges which address and attempt to solve the interoperability problem, however, it is important to research them before relying on them in a transaction to purchase and sell adigital asset in the metaverse because of the problem that despite being called a bridge what they essentially are doing is utilizing a smart contract to create a phantom copy of the actual digital asset so that it appears to reside on the secondary platform when in fact it does not.

 4.  Digital marketplaces for buyers and sellers

There are several metaverse platforms and marketplaces that are considered reliable for buying and selling assets. They include Blur,[2] OpenSea,[3]SuperRare,[4] Nifty Gateway,[5] Axie Infinity,[6] and Decentraland.[7] The terms and conditions on each platform vary. It is beyond the scope of this article to pick apart each one. A key factor will be to determine the blockchain that each one handles, e.g. Ethereum, Solana or Polygon, which are each so-called smart blockchains that can handle the tokenization of assets. While Bitcoin itself is not able to tokenize assets, there are bridging apps using ordinals that provide operability through an inscription process.  

It is important to note that while these platforms are considered reliable, there will still be the usual kinds of risks associated with buying and selling assets of any sort, including scams, fraud, or hacking.It is always a good idea to do your research, follow best practices for online security, and use caution when buying or selling. Ideally a buyer will want to verify the IRL identity of the seller, so that there can be recourse if the assets are somehow not as promised or not delivered in full; and a seller will want to make sure that payment actually is received in full without any holdbacks or delays.          

 5.  Involvement of brokers and other middle people

Depending on one’s appetite for risk, a downturned market can be a blessing or a curse. In a downturned market, prices are slashed and inventory is often consolidated. There are bargains galore for buyers. In this type of market, assets often are sold in bulk, at a steep discount. Buying and selling tends to be done on a batch basis. There might be more middlemen involved as aggregators and agents step in, including trustees in bankruptcy and receiver managers. This all tends to increase the exposure to risk as assets are sold cheap and fast in what might be called a fire sale.

Back in the heady days of about 2019-2022, virtual real estate brokers, mortgage lenders, leasing agents, franchisors, etc. began popping up, essentially trying to emulate IRL real estate, business and investment market players. Those were bubble times. Now that the bubble has burst, it maybe that some brokers and other middle people can still be found, but it’s unlikely, except in the largest of deals. While codes of conduct for professionals tend to follow advancements in technology rather than lead them, it is not surprising that these professionals while heavily regulated IRL are given a much wider berth in the metaverse or not specifically regulated at all. That said, most codes of conduct for professionals still contain basket clauses where professionals are required generally to conduct themselves in an ethical manner. All of that to say, if a middle person is involved it will be a good idea to determine if they are regulated by a code of conduct and if possible to determine if the code of conduct applies to the metaverse – which hopefully it will, at least by analogy.

 6.  Metaverse asset purchase agreement clauses

Realistically, on a small scale a purchase and sale will be conducted inside the platform using the platform’s standard terms of use. There won’t be much room for negotiation other than as to price. However, in a larger transaction involving more money and/or more assets – e.g. the bulk sale of an entire catalogue of assets, there will be plenty of opportunity for the transaction to be negotiated and closed off-chain, with the transfers on closing being only one of the formalities involved.

Here are some common representations and warranties, and clauses generally that may be included in a negotiated metaverse asset purchase agreement:

1.    Ownership: The seller represents and warrants that they have full ownership and control of the assets being sold, and that the assets are not subject to any liens, encumbrances or claims by third parties.

2.    Authenticity: The seller represents and warrants that the asset is authentic, original and has not been copied or replicated from another source without permission; and that the asset will not infringe the rights of any third person. Those rights might include copyrights embedded in the asset, third party trademarks that are embedded in the work that either exactly are used or are used in a manner that might cause confusion in the marketplace. The asset might also contain reference to a celebrity that is not cleared, or be defamatory of someone either by design or by accident.

3.    Quality: Depending on the circumstances, the seller might be asked to represent and warrant that the asset is in good condition, free from defects or damage, and suitable for its intended purpose. Conversely, in many agreements, these types of representations and warranties are specifically disclaimed. They may also be asked to provide additional information about the asset’s features, capabilities or performance, including where it is hosted with a copy of the hosting agreement; and the nature of any smart contracts attached to it including for example royalty obligations that will be passed along and become binding on subsequent owners.

4.    Legal compliance: The seller may be asked to represent and warrant that the sale of the asset complies with all applicable laws and regulations including those related to securities regulation, money laundering, taxation, the import or export of encryption software and cultural export requirements. Since the metaverse has fallen under increased scrutiny from securities regulators worldwide, it is important that the asset not be caught by any prohibition against the unregistered distribution of a “security”as defined by the laws of the seller’s home jurisdiction.

5.    Identification of the parties: The buyer and seller should each disclose their actual IRL identity, and their actual legal names should be used in the transaction. Ideally, this should be supported bythe exchange of copies of government issued ID. The parties should also disclose their jurisdiction of residence, in aid of determining which laws might be applicable for legal compliance.

6.    Due diligence: The buyer might consider conducting due diligence searches in the jurisdiction where the seller resides and in the jurisdiction where the assets are located. The searches would be for registered security interests that might attach to the assets being sold. The seller might also be asked to provide additional documentation or verification of authenticity, such as a digital certificate or verification from the person who created the IP contained in the asset (e.g. the video embedded in it) or the issuer of the asset. If the seller is not able to prove that they have cleared all the underlying IP, the buyer should decline the transaction. Often it is the case that developers will acquire a one-time license or a right to a partial usage of an underlying work, then either mistakenly or recklessly try to expand on those rights in the creation of a derivative work that is then offered for sale. Obviously this is not permissible.

7.    Closing and payment: There should be standard clauses regarding closing in escrow, i.e. there is no closed deal until the asset has been transferred and the payment has been received. Depending on the circumstances, closing can be done by the parties themselves, through a lawyer or through a notary or escrow agent.

Of course, when in doubt and depending on the size of the transaction, obtaining legal advice is recommended.

 7.  Conclusion

As the famous American author Samuel Clemens, whose pen name was Mark Twain is credited as having said in the late 1800’s: “Reports of my death have been greatly exaggerated.” The same could be said today of the metaverse as a place where tokenized assets are routinely used and transferred between people in surprising, innovative and useful ways. It was to be expected there would be a correction involving a sharp downturn in digital asset values and use-case expectations for metaverse-related technologies. That happened in about late 2022, and like all market corrections after a bubble was a healthy thing, albeit painful. Just as the downturn was expected, it also can be expected that new and existing cryptocurrencies, blockchains and non-fungible tokens will again flourish as the metaverse adapts and reinvents itself. Perhaps this time the growth will be fuelled by the explosive use of generative AI tools to efficiently – and hopefully ethically – find and serve the needs and desires of everyone interested in participating in such future technologies.

[1]The token was intended by the DAO to be fractionalized, and thus to game-away the non-distribution restrictions that had been established by Wu Tang Clan originally when the album was recorded (it was supposed to be a piece of art)but unfortunately due to unforeseen circumstances and perhaps securities lawconcerns the DAO never minted or fractionalized the token: https://www.nytimes.com/2021/10/20/arts/music/wu-tang-clan-once-upon-a-time-in-shaolin.html

[2] https://blur.io

[3] https://opensea.io

[4] https://superrare.com

[5] https://www.niftygateway.com

[6] https://axieinfinity.com

[7] https://decentraland.org