Category: business law

Stablecoins 101: What Are They, How Are They Taxed, and Can I Use Them In My Business?

Cryptocurrency has significant business utility, especially in international transactions. Companies can exchange funds directly, without wiring fees or banking delays, and easily convert their native currencies into crypto and vice-versa using a mobile phone. However, traditional cryptocurrencies like Bitcoin and Ethereum are extremely volatile and their exchange values can easily fluctuate 10-20% or more in a matter of days or even hours. Market supply and demand forces determine the prices of these most popular cryptocurrencies and their value is particularly sensitive to various external factors. Events like China’s crypto clampdown, significant buys or sells by capital investors, or even Elon Musk’s tweets can crash the market or send the price of crypto soaring. Obviously, price volatility makes businesses and consumers reluctant to adopt these cryptocurrencies for day-to-day transactions. Price volatility translates into purchasing power uncertainty, which in turn devalues the currency.

Stablecoins are cryptocurrencies that try to solve the volatility problem. They do so by pegging their price to the price of another asset (such as the U.S. Dollar or an ounce of gold). For example, the USD Coin (USDC) can be acquired and sold for U.S. Dollars on a 1 to 1 ratio. USDC is actually backed by existing dollar reserves, meaning that each USDC has a real-world dollar counterpart held by regulated financial institutions. USDC reserves are also periodically verified by a third party (but not audited).

There are other stablecoins as well, for example Tether, Binance USD, TrueUSD, DAI, and more. Like USDC, some are tied 1 to 1 to U.S. Dollar reserves. Others are backed by commodities like gold, silver, or oil. The price of a commodity-backed stablecoin is tied to the market price of a commodity unit, like an ounce of gold. There are also stablecoins that attempt stability through overcollateralization using other cryptocurrencies. Finally, there are algorithmic stablecoins that automatically adjust the cryptcurrency’s supply to keep its market price within certain parameters.

Stablecoins are however still cryptocurrency. Even if the stablecoin has a pegged 1 to 1 exchange ratio with the U.S. Dollar, it is not the same as cash. For tax and regulatory purposes, the IRS treats all cryptocurrency as intangible property subject to capital gains tax. They may be subject to separate state-level regulation as well.

Paying for goods and services in stablecoin is a taxable event because the IRS treats it like a sale or exchange of an asset, which is subject to capital gains tax. Technically, if the stablecoin is pegged to the dollar at a 1 to 1 ratio, the capital gain is 0 and there is no tax owed. But the transaction must still be recorded and reported, just like if you were buying and selling a stock at zero net gain/loss. Otherwise, you risk attracting an IRS audit to determine whether you underreprted taxable income. Buying stablecoin for cash and holding it is a non-taxable event.

Receiving stablecoin in exchange for goods and services is a taxable event. It is not much different than receiving payment in fiat currency, which is income subject to tax. The fair market value of the cryptocurrency as of the date of receipt determines its value for income reporting purposes. With stablecoin, it is easy to calculate because of the 1 to 1 ratio. Receiving 500 USDC is the equivalent of receiving $500 cash. However, spending the 500 USDC is not the same as spending $500 cash – rather, the transaction is considered a liquidation of property (subject to capital gains). Again, if the value of the stablecoin is pegged to the dollar, you are not going to have capital gains. But you must still keep records and record the transaction. If you are using a stablecoin that is pegged to an asset like gold, its price will fluctuate and you may record a capital gain or loss.

Converting other cryptocurrencies into stablecoin and vice-versa is also a taxable event. The sale of the crypto is an asset disposition that is subject to capital gains tax even if the transaction is an exchange of one currency to another. Similarly, using stablecoin to purchase other cryptocurrencies is a sale of the stablecoin that must be reported as income, even if the the capital gain is $0.

Stablecoins are still risky and unregulated. Not all stablecoins are created equal and it is a mistake to think that “stablecoin” means there is no risk involved. The LUNA/TERRA debacle is a good example because TERRA was supposedly a “stablecoin” pegged 1 to 1 to the U.S. dollar, yet it was pegged algorithmically (meaning artificially without any actual assets or fiat currencies backing it). An algorithm that no one really understands is not the same backing as fiat in a vault or money market securities or corporate bonds or commodities portfolios. The bottom line is that without a uniform definition of “stablecoin,” users should at a minimum know what “stabilizes” the value of the purported “stablecoin.”

There are other hurdles to using stablecoins in day-to-day business operations. As cryptocurrency, they are still subject to government regulation. For instance, it is illegal under federal labor law to pay workers in anything other than U.S. Dollars. On the international scene, China recently tightened anti-crypto regulations, prohibiting financial institutions from providing crypto exchange services, which presumably includes stablecoins. At the same time, China is rolling out its “digital yuan,” which is a sovereign-backed virtual currency. United States regulators have also expressed interest in the “digital dollar,” in part to improve financial services access to unbanked or underbanked communities. Additionally, all cryptocurrency transactions are still subject to exchange fees imposed by the intermediaries, and there may be delays or additional processing costs associated with converting stablecoin into fiat currency. Widespread adoption by merchants and the public is a must for stablecoins to develop practical utility – but right now, holding a wallet full of stablecoin is not the most practical or liquid solution for most businesses. Nor does a 1 to 1 dollar stablecoin provide any investment upside and in fact periodically loses value due to inflation.

Finally, there are at least 36 different stablecoins available for purchase via most popular exchanges. It is unknown which stablecoin (if any) will enjoy widespread adoption and popularity sufficient to result in real utility for businesses. Further, stablecoins are not truly decentralized because a central entity is holding the collateral, which in turn must be audited or otherwise verified. If a holding entity starts issuing stablecoins that are not actually collateralized, this would cause hyperinflation and essentially render the stablecoin worthless.

Stablecoin certainly holds a lot of promise for business use, but only solves the problem of volatility. Reduced volatility comes at a cost of a centralized authority and reintroduces trust into the cryptocurrency equation. At the same time, sovereign-issued digital currencies are on the horizon and may very well dispel the need for and demand for stablecoin.

Want to know more? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

Ask the Crypto Tax Lawyer: Is Staking Income Taxable?

Yes, staking income – just like most other types of income – is taxable. However, the question is when? When you receive the staking reward? Or only when you sell or exchange the newly- obtained tokens? Under the first, more conservative approach, the token is actually taxed twice – once as ordinary income at the time of receipt and the second time at the capital gains tax rate when it is sold or exchanged. Under the second, more aggressive approach, the token is not taxed upon receipt and not subject to tax until it is sold or exchanged. The second approach also allows token holders to take advantage of more favorable long-term capital gains tax rates by holding the staking rewards longer than a year.

How is Staking Different From Interest?

What is staking? It is an arrangement to “lock up” or “stake” a portion of an owner’s crypto tokens in a staking pool in return for additional cryptocurrency over time. The return is often expressed as a percentage. This makes staking seem very similar to an interest rate paid on a certificate of deposit or savings account. Indeed, on Coinbase, staking rewards are expressed in terms of an APY (annual percentage yield) and the term “interest earned” is used synonymously with staking. Unlike proof-of-work mining, which validates new transactions through solving complex algorithms, staking is more energy efficient and environmentally-friendly. Staking allows network participants to nominate their coins to be used as validators and to guarantee the legitimacy of new transactions on the blockchain. In return for validating a new block, the owner receives new tokens; if the transactions validated are later found to be illegitimate, the validator may lose tokens through a process called “slashing.”

Although it may seem like interest income, staking income may not be taxed the same way. The IRS has not taken a definitive position on this question even as the deadline to file 2021 taxes approaches. One of the reasons may be because of pending litigation in Jarrett v. IRS. In 2019, Josh and Jessica Jarrett sued the IRS for a refund on taxes paid on staking income, arguing that cryptocurrency received for staking should not be. Recently, the IRS appeared to concede that staking income is not taxable at inception and agreed to issue the Jarretts a refund. However, the taxpayers rejected the IRS’s offer – instead, opting to push the Tax Court to make a definitive ruling on the issue and create binding precedent. In response, the IRS has asked the Tax Court to dismiss the case in light of the plaintiffs having obtained full relief and the absence of a “case or controversy” for the Tax Court to decide.

The Conservative Approach – Staking Rewards Are Taxed Twice

Intuitively, it may seem that income from staking should be treated the same as interest/dividend income from a savings account, which is incurred when the bank pays it out. In the crypto context, the IRS has taken a position since 2014 that with mining, the fair market value of the virtual currency as of the date of receipt is includible in gross income. Arguably, staking income is sufficiently similar to interest earned or mining to be treated the same. Depending on the terms of the staking arrangement or agreement, the cryptocurrency or token contributed is restricted much in the same way that cash in a certificate of deposit is locked in until maturity.

The Aggressive Approach – Staking Rewards Are Only Taxed When Sold or Exchanged

However, the counter-argument (and the taxpayer’s position in the Jarrett case) is that the tokens received as a staking reward have no value until they are sold or exchanged. In that sense, they are like manufactured product that may have value when created, but is not taxed until it is sold. The product has a market value when created, but the IRS does not impose a tax on it at the time of creation.

Further, fiat currency has tangible value when received – an interest payment of $25 has worth and buying power at the time of receipt. It does not need to be sold or exchanged to have value. Conversely, 100 Tezos tokens (at issue in the Jarrett case) have no buying power or value until and unless they are exchanged into fiat, traded for another currency, or used to pay for services. Yes, if you pay for services with cryptocurrency, you are taxed on any difference between the basis and the fair market value of services received. According to the IRS, if you buy 100 Tezos for $1 (a basis of $100) and then exchange those same 100 Tezos for $300 worth of legal services, you just realized a $200 taxable gain. Proponents of the more aggressive Jarrett approach argue that cryptocurrency or tokens received as staking rewards are more analogous to a manufactured product than fiat currency interest or dividends.

The Issue Remains Unsettled

To complicate the issue further, the IRS’s offer to refund the Jarretts’ tax and settle the litigation seems like a tacit endorsement of the second, more aggressive approach. Arguably, the IRS is conceding the issue and admitting staking income is only subject to income tax when sold or exchanged. However, this position is directly at odds with the IRS’s guidance on tokens received from mining. The IRS’s Notice 2014-21 on virtual currency taxation states that “when a taxpayer successfully “mines” virtual currency, the fair market value of the virtual currency as of the date of receipt is includible in gross income.”

While the issue remains unresolved, taxpayers should consult with their legal and financial advisors on the correct approach for them. The conservative approach risks including too much in your gross income. The aggressive approach risks underpayment penalties in the future if the IRS does issue guidance and takes the same position on staking as it has on mining. But in any case, keep an eye on the Jarrett case, as the Tax Court may rule on this very question in the near future.


Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2022 Artaev at Law PLLC. All rights reserved.

Categories
trademarks

Do I need a Metaverse Trademark?

Luxury goods company Gucci recently bought a plot of LAND in the Sandbox Game, an Ethereum-based play-to-earn game. This LAND is a virtual real estate plot (in the form of an NFT or non-fungible token) where Gucci plans to sell in-game clothing and collectibles. As futuristic as this seems, Gucci is not the only major company looking to get into the Web3.0 space. Walmart, McDonalds, Panera, Victoria’s Secret, Nike, and L’Oréal are just a few of the big players that recently filed trademarks specifically to protect their intellectual property in the Metaverse.

Nike has become particularly active. The company created a Nikeland experience in the popular Roblox game world (along with companies like Vans, Chipotle, and Hyundai, which also have staked out territory on Roblox). Nike also recently acquired RTFKT, a studio that specializes in NFT development and in January 2022, Nike announced the formation of Nike Digital Studios to create and deliver Metaverse and blockchain-based user experiences. Additionally, Nike has filed for dozens of trademarks to protect its virtual brand, including the use of its name and logo in online art, virtual goods, video games, and avatars. With a multi-billion dollar company like Nike trademarking dozens of its NFTs, many game developers, NFT collectors, traders, crypto bros, and others wonder whether they, too, should file for trademark protection within the Metaverse for their brand.

Do Gaming Developers Need Trademark Protection?

Absolutely. Games, gaming, and software in general are highly-competitive industries. Unfortunately, there is not much stopping a third party from copying your design and profiting off of it. This can create – not only marketplace confusion – but irreparable damage and dilution of your valuable brand. This can happen to companies big and small. Additionally, if you fail to trademark your game, brand, logo, catchphrase, etc., your competitor can come in, copy your brand, and then accuse you of violating their rights. While it is possible to file for retroactive trademark protection and win eventually, the easiest (and cheapest) protection is filing a trademark right away.

Do I Need to Trademark my NFT?

Yes. It is essential for you to trademark your NFT in order to protect it from copycats. The United States is a first-to-use country, which means your NFT will already have some automatic protections after minting. However, it would be very tough protecting your unregistered “common law” trademark in the worldwide NFT marketplace. Additionally, it would be very difficult to defend an unregistered NFT trademark in any sort of legal dispute should a third party copy your idea. Filing a trademark with the USPTO ensures validity and protection within all fifty states.

Trademarking your NFT creates a brand identity that is uniquely yours. Trademarking a unique slogan, logo, or design can be a valuable marketing tool for you going forward and add tremendous value to your project. After all, intellectual property rights are what you actually own when it comes to non-physical property like NFTs (and software or computer code in general).

Copyright is another important intellectual property right for NFT owners, users, buyers, and sellers. For example, it is critical to ask what rights you are actually buying when purchasing an NFT? Is there an agreement to transfer the copyright? A license? Nothing at all? Lack of clarity in the NFT transfer process can and will lead to litigation, more so as NFTs become more and more widespread.

How Do I Protect my NFT Internationally?

You can protect your NFT internationally, provided that you also apply for international registration during your initial trademark filing. Under the Madrid Protocol (which is an international treaty for the uniform protection and registration of trademarks), a registration through the USPTO can also be registered in other countries with a single application.

What is a benefit of international registration? International registration allows you to use a foreign country’s laws and judicial resources to enforce your mark in that country. A USPTO registration still allows enforcement through a U.S. based court, even if the infringer is in a foreign country. However, even if you prevail, you might not be able to enforce the U.S. court’s judgment abroad. An international trademark registration opens up a number of other enforcement options. If you are interested in international trademark registration, this is something to discuss at your initial consultation.

What Types of Things Should I Trademark?

Here is a non-exhaustive list of items that could potentially qualify for trademark protection:

  • Avatars
  • Logos
  • Game Name or Gaming Development Company’s Name
  • NFTs
  • Virtual Goods (avatar skins, digital art, etc.)
  • Color Schemes
  • Particular Sounds (The coin grab ding from the classic Mario Brothers game comes to mind here.)
  • Slogans

What Cannot be Trademarked?

The United States Patent and Trademark Office (USPTO) has a set of guidelines that lists some of the following reasons for trademark rejection:

  • Likelihood of Confusion – If you create a game called GranD Turismo 7, you could not trademark that name because people could confuse it with Gran Turismo 7, the newest addition to PlayStation’s highest selling video game franchise. Sony owns the trademark to protect against competitors who seek to profit off of its name recognition by creating a similarly named game. Thus, you cannot trademark GranD Turismo 7.
  • Merely Descriptive and/or Intentionally Misleading – For example, you can’t trademark the words “fun and entertaining.” Even though your game is both fun and entertaining, these only describe the game itself and don’t necessarily make your game unique, so you can’t trademark them. Likewise, the USPTO will reject your trademark if it is intentionally misleading. For example, if your game’s name is “Play with Cryptocurrency,” but the game does not play with cryptocurrency, the USPTO reviewer could consider this game name intentionally misleading and deny your trademark.
  • Primarily a Surname – For example, Smith’s Play-to-Earn Game is primarily a last name (and merely descriptive) would not be suitable for a trademark.

How do I file a trademark for my game or NFT?

Whether you’re filing a trademark for an NFT, a digital avatar, a slogan, or your business name, Artaev at Law has the professional expertise to help you do it right. Artaev at Law, together with the specialized trademark attorneys at Mighty Marks, now offers a fixed fee, all-inclusive trademark service. Contact Dan Artaev at dan@artaevatlaw.com for additional information.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional. Any link to or reference to any specific project is not an endorsement of or validation of that project and is for solely informational purposes.

Ask the Crypto Tax Lawyer: What’s New for ’22?

2022 is a marquee year for anyone who took got involved in cryptocurrency during the 2021 market boom. The start of the new year means the start of tax preparation season and many individuals and companies are working to understand the tax treatment and implications of digital asset investments. In 2021, the IRS and the Department of Treasury announced increased efforts to track cryptocurrency transactions and enforce the perceived underpayment of tax in the crypto world. However, the government’s guidance has been limited. There are many uncertainties and questions in this evolving area of law. Read on for a summary of the key issues:

Cryptocurrencies Are Taxed As Property Subject to the Capital Gains Tax.

In the ever-changing world of crypto, one thing has stayed the same (since at least 2014): Cryptocurrency is property subject to the capital gains tax. In its FAQ guidelines, the IRS addresses a number of situations (such a hard forks and airdrops) to explain its position on basis and gain/loss calculation. If you received, sold, exchanged, or otherwise disposed of “any financial interest in any virtual currency,” the IRS requires you to disclose this on the first page of the 1040. If you check “yes,” expect to file a 1040 Schedule D (“Capital Gains and Losses”) and an 8949 supplement.

What does this mean in practice?

  • If you bought cryptocurrency in 2021 for cash and are holding it (or HODLING), there is no transaction subject to capital gains and nothing to report.
  • If you sold cryptocurrency for cash, traded crypto for another crypto, used crypto to buy an NFT, or paid someone for goods or services using crypto, you have a reportable capital gains transaction. The “gain” is the difference between the initial value (basis) and the sale value. If the period between acquisition and sale is less than a year, the short-term rate applies, which treats the gain as ordinary income. If the period is more than a year, the long-term rate applies and is either 0%, 15%, or 20% depending on your annual income level.
  • Exchanging crypto for other crypto (for example, you exchange BTC for ETH) is also subject to capital gains tax. The IRS treats the exchange as if you sold BTC for cash and used that cash to buy ETH. That means that any “gain” you realize on the sale of BTC is reportable and taxable, even if you use 100% of your proceeds to buy another cryptocurrency.
  • If you use crypto to buy an NFT or pay for some other goods or services, the IRS treats the transaction as if you sold the crypto for cash (incurring a capital gain) and then used the cash to buy the NFT or pay for the other goods/services.
  • What if my corporation or LLCs bought, sold, or exchanged virtual currency or digital assets? There is no guidance to suggest that business entities are treated any different. Record and report crypto and other digital asset transactions like you would physical property or assets.
  • Best practice remains to record all of your cryptocurrency transactions in a spreadsheet or accounting software, including the type of asset, the basis price, the date, and any gain/loss (as well as transaction fees). Alternatively, bigger exchanges like Coinbase make reports available to their customers and integrate with several popular crypto tax reporting platforms.

The IRS Has Not Issued Guidance on Taxing NFTs, Utility Tokens, Security Tokens, or Any Other Types of Digital Assets.

What about NFTs? Or utility tokens that you may have bought and sold as part of a play-to-earn game? Or security tokens (STOs) that becoming a corporate financing alternative for high-tech startups? The IRS has not issued guidance or taken a position on any of these particular instruments. In its FAQ, the IRS defines “virtual currency” as follows:

 Virtual currency is a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (“real currency”), that functions as a unit of account, a store of value, and a medium of exchange.  Some virtual currencies are convertible, which means that they have an equivalent value in real currency or act as a substitute for real currency.  The IRS uses the term “virtual currency” in these FAQs to describe the various types of convertible virtual currency that are used as a medium of exchange, such as digital currency and cryptocurrency.   Regardless of the label applied, if a particular asset has the characteristics of virtual currency, it will be treated as virtual currency for Federal income tax purposes. 

https://www.irs.gov/individuals/international-taxpayers/frequently-asked-questions-on-virtual-currency-transactions

Although this definition gives some guidance on the IRS’s position, it is still not clear whether NFTs and non-cryptocurrency tokens are “virtual currency.” For instance, NFTs (non-fungible tokens), represent a wide range of things. They can be art or basketball trading cards, but also can be virtual metaverse real estate or video game magical items. Some commentators have suggested that NFTs will be taxed at the 28% “collectibles” tax rate – but that hypothesis presupposes that all NFTs are “collectibles,” which is simply not true for all NFTs. At the same time, the IRS’s definition of “virtual currency” appears to require the asset to be used as a “medium of exchange,” which is also not true of all NFTs. At this time, the NFT tax analysis is best done on a case-by-case basis, with a careful evaluation of what the NFT represents and how the real-world equivalent would be taxed.

Utility tokens are digital tokens that have non-investment uses (or utility) and fall outside of the federal definition of “security.” Play-to-earn video games (like Axie Infinity and its imitators) use native digital tokens for in-game currency and rewards, but the tokens can also be bought and sold on a secondary market. These tokens are more in line with the IRS’s “virtual currency” definition – and while the IRS has not expressly opined that utility tokens are property subject to capital gains tax, they most likely are. In other words, keep records and be prepared to report your sales and exchanges at tax time.

Security tokens (security token offerings are called STOs) are the digital equivalent of traditional corporate financing instruments like SAFE notes or seed round equity. However, the IRS does not consider STOs (or any other tokens) as stock or securities, even if the Securities and Exchange Commission (“SEC”) does. In other words, you sell or buy a security token, you must do so either as a registered security or one that meets an exemption (for example under Regulation A+, D, or S). However, neither the investor nor the selling company gets to claim any sort of tax benefit from the “security” token – because the IRS likely treats it as property and not securities. This means that when you invest in a security token (even one that is registered with the IRS), the tax breaks or advantages that apply to the purchase and sale of stock do not apply.

The Wash Sale Rule Still Does Not Apply to Cryptocurrency, But Might Apply Next Year.

There is a silver lining to the fact that cryptocurrency (or other tokens) are not considered “securities” for the purposes of tax law. The wash sale rule does not apply to crypto and allows for loss harvesting to offset capital gains (and even up to $3,000 of ordinary income.) For example, right now crypto markets are down from their highs and many investors may be showing a loss. If you sell at a loss and buy the asset back immediately, you can claim the “loss” on the sale on your taxes. The wash sale rule – which is applicable to securities – requires a 30 days period before repurchasing the same or substantially the same security.

Congress is aware of and is working on closing this so-called “loophole,” but right now the wash sale rule likely does not apply. It is unclear whether you will be able to claim a loss on 2022 returns if you sell at a loss in 2022, but as of the date of this article, crypto investors can still take advantage of loss harvesting opportunities.

The 2021 Infrastructure Bill Has Not Killed Cryptocurrency.

In the summer and fall of 2021, there was a lot of concern in the cryptocurrency community over certain reporting requirements that Congress wanted to impose on cryptocurrency market participants. Although much of the “hype” was overblown, the main issues were with the new reporting requirements, the definition of “broker,” and how the reporting requirements would affect miners and other participants who are not in the direct sales business.

President Biden signed the Infrastructure Investment and Jobs Act on November 15, 2021, and needless to say, the U.S. cryptocurrency markets are very much alive and functioning. The Act extended the $10,000 cash reporting requirements to “digital assets” transactions, meaning that businesses that receive more than $10,000 in cryptocurrency have to file a Form 8300 with the IRS. The form requires the disclosure of the payor and payee’s name, address, Tax ID, and other information.

The new reporting requirement will not take effect until 2024. By then, expect the IRS and the Treasury Department to develop regulations and provide guidance to market participants, so stay tuned for future developments in this area. It is likely that the scope of the regulations will be limited, as $10,000+ crypto and NFT transactions are much more common than cash transactions, and (unlike cash) also may take place without the parties ever even seeing each other or meeting.

Additional regulation of digital assets in the U.S. is to be expected given their popularity and increasingly prominent role in the economy. However, the U.S. is not about to “outlaw” cryptocurrency, NFTs, token, or any other digital assets. The blockchain tech market is alive and well, but with better defined taxation and regulation may even become more mainstream.

The bottom line is that cryptocurrency markets and derivative digital assets are here to stay. Regulation is constantly evolving and there are many uncertainties for investors and companies working in this emerging market in 2022. Professional legal guidance is always a good idea.

Want to know more? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2022 Artaev at Law PLLC. All rights reserved.

What is a Security Token Offering (STO) and How Do I Use It In My Business?

Photo by Alesia Kozik on Pexels.com

A security token offering (or STO) is a 21st century blockchain-based alternative to a traditional equity or debt sale to raise company funds. Instead of selling units or shares, a company sells digital tokens to investors. Instead of selling SAFE (simple agreement for future equity) notes, companies can offer a SAFT (simple agreement for future tokens).

But why would a company want to sell tokens in the first place? STOs and traditional equity offerings fall within securities laws and must either be registered with the SEC or comply with exemptions (Regulation A+, D, or S for example). State-level “blue sky” laws may also apply. Also, like traditional securities, STOs represent fractional ownership in a tangible asset, either an equity interest in the company, a profit share, or debt instrument.

An STO does have certain benefits over selling traditional securities:

  • Unlike traditional securities, the STO eliminates third parties and middlemen inherent in a traditional securities offering, leading to greater efficiencies, lower costs, and a faster issuance process.
  • Blockchain technologies are inherently transparent, as the digital ledger is public. This makes the offering inherently more secure.
  • By selling tokens, companies can tap into financial markets across the world that would not be normally accessible. An investor from Asia or Europe can easily buy into a company STO, just as an investor from the United States.
  • Security tokens are considered more liquid because investors can buy, sell, and trade tokens around the clock.
  • The digital nature of the tokens makes corporate governance and voting easier and more transparent.

Another distinguishing characteristic of an STO is that a company can tokenize and sell fractional ownership in almost any real world asset – such as real estate, a machine, or even intellectual property. This opens up a host of possibilities and financing options that would otherwise be limited or unavailable with traditional securities. This is especially attractive to high-tech startups whose business model is already based on or related to the blockchain.

STOs should not be confused with ICOs (initial coin offerings). ICOs boomed in 2017, as some companies turned to unregistered token sales to raise funds outside of the traditional securities disclosure, registration, and other legal requirements. In 2017, the SEC issued an investor bulletin and clarified that these digital token sales constitute “investment contracts” that meet the SEC v. W.J. Howey Co., 328 U.S. 293 (1946) test and therefore must be registered as securities under federal law. ICOs also are associated with several high-profile “exit scams,” where cryptocurrency promoters claimed big plans for a new crypto project, collected funds from investors, and then simply disappeared with the funds. Other ICOs purported to be “high-yield investment programs” that turned out to be nothing more than Ponzi schemes.

As cryptocurrency, NFTs, and other blockchain-based technology became more mainstream in 2021, it is important to recognize that the STO is a new way for innovative companies to raise funds. While these are still securities offerings that must comply with applicable regulations, the flexibility, transparency, and efficiency that these digital instruments offer are certainly attractive.

Want to know more? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2022 Artaev at Law PLLC. All rights reserved.

What Every Business Owner Must Know About Cryptocurrency Systemic Risk

Whether your business is a full-scale investor in cryptocurrency and blockchain technology or whether you are simply using cryptocurrency to diversify your balance sheet or facilitate international transactions, you are assuming systemic risk. Systemic risk is basically the risk that the “system” in question will fail. The 2008 financial crisis is a recent example of the financial system’s failure due to overleveraged institutions and opaque and risky lending practices. Cryptocurrency and blockchain tech are quickly growing and becoming an integral part of the global financial markets – essentially evolving into another system. For example, sophisticated investors can self-direct their retirement accounts into cryptocurrencies and stake their entire savings on this growing tech.

Risk is part of any business. However, so is effective risk management, which particularly critical in the blockchain/cryptocurrency context, which operates outside of the safeguards and regulatory oversight common to traditional financial institutions. At the same time, existing tax, securities, commodities, and finance regulations still apply to crypto, and compliance is critical to the smooth functioning of your business. At a minimum, any business involved with blockchain tech should involve an experienced business attorney to develop their internal risk management protocols and have a plan for legal compliance, as well as systemic risk.

1. Existing Tax, Securities, and Other Laws Still Apply to Cryptocurrency.

First, and foremost, cryptocurrency is an asset and blockchain enterprises are businesses that are subject to general state and federal laws. While there is no central authority in the United States responsible for policing crypto markets, that does not mean that crypto business operate independent of the law. Government regulators are playing catch-up, and have repeatedly asserted their authority over cryptocurrency and related tech under existing laws. For example, 2020 was the first year that the IRS asked taxpayers about their crypto holdings. Enforcement units are gearing up to address tax evasion and close the multi-million dollar gap between actual income and what is reported to the IRS. The SEC and CFTC are also stepping up enforcement actions to head off fraudulent activity and lack of transparency in certain financial offerings. The Department of Treasury (through FinCen) is also stepping up oversight to enforce existing anti-money laundering frameworks.

The existing regulatory framework is far from perfect and is not well-suited to the unique characteristics of cryptocurrency. For example, why are some ICOs (initial coin offerings) securities, but established coins like Bitcoin and Ethereum are not securities? Capital gains taxes apply to cryptocurrency and stablecoins. But the IRS has not issued any guidance on NFTs. Are they going to be taxed like “property” or like collectibles, art, gold bullion, or something else? Will NFT tax rates depend on what the NFT is supposed to represent?

Stablecoins are a whole separate issue. Recently, a group of Treasury, SEC, and CFTC officials urged Congress to pass legislation to regulate stablecoins. In the “Report on Stablecoins,” the group noted existing SEC and CFTC authority to regulate these markets, but urged reform and legislation that is specific to the new technology.

For investors and innovators, legal compliance is the essential first step. Nothing stifles innovation like an IRS audit or an SEC investigation. Make sure to consult with an experienced attorney for guidance on the latest state of the quickly changing law in this area.

2. Decentralization Does Not Mean Risk-Free or Safe.

Second, the decentralized nature of cryptocurrency and blockchain tech in general lends itself to a false sense of security among investors and businesses. Some crypto advocates consider regulation unnecessary because blockchain tech is “decentralized.” The public ledger system purportedly means total transparency, equity, and fairness. In reality, a decentralized system is not immune from tampering or malfeasance.

For example, blockchain at its core is software that depends on coders and engineers upgrading the “chain,” fixing bugs, and making improvements. Someone somewhere determines forks and chain upgrades. Also, what about miners? What precludes off-chain influence (i.e. bribes) to miners that would impact the whole chains or cause them to verify certain blocks or transactions out of sequence?

Stablecoins are considered “safe” because the tokens are purportedly backed by fiat or equivalent reserves. But there is a lack of transparency between various stablecoins, different liquidity thresholds between reserves (for example, cash vs. money market vs. short term bonds), and variable redemption mechanisms and minimums. Additionally, is your stablecoin of choice based on a public blockchain or a permissioned blockchain? Permissioned blockchains limit access to the blockchain, providing more certainty as to who is responsible for the chain’s operation and integrity. At the same time, they reduce transparency and accountability.

Further, the federal government does not insure stablecoin or cryptocurrency deposits. If you stake cryptocurrency for a return, you are not insured or protected against the coin’s failure, a run, or illiquidity. If you are using a stablecoin to facilitate DeFi transactions, have a plan in case of network problems, chain disruptions, or backing failures. For instance, use several stablecoins to diffuse the risk.

As illustrated by the recent examples of the SQUID token and the Evolved Apes NFT, crypto tech is full of bad actors. The chain itself is not immune from malfeasance. Any business that fully depends on the integrity of the blockchain for its day to day operations must have safeguards. At a minimum, a crypto company must have a robust security system and team dedicated to detecting network health and chain anomalies. Financial hedging that diffuses the risk over multiple chains, cryptocurrencies, and other assets is also critical. Finally, established and documented due diligence protocols to assure investors, regulatory authorities, and lenders are a must.

3. Do Not Take the Internet For Granted.

Third, there is an inherent systemic risk to anything that depends wholly on the operation of the internet. Outages of certain sites or even network-wide service providers are not uncommon. Just recently, Facebook and Instagram were down for almost a full day. Comcast made headlines for its network outages across the United States on November 9, 2021. Directly related to cryptocurrency markets, exchanges like Coinbase have connectivity issues and other disruptions in times of market volatility. This can have direct adverse financial consequences for a business that depends on access to the crypto markets.

Due diligence protocols and internal safeguards are essential in this context. Offline copies of books and ledgers, at least backing up transactions history on a periodic basis. If you are storing crypto, look into offline (hardware) storage options for your code and data. Consider hedging and diversification.

Most important of all, have a plan. Cybercrime and ransomware insurance options are also worth looking into. Crypto and blockchain are existing, but are not without substantial risk. While government regulators are playing catch-up and are urging Congress to pass a risk control framework, legislation is not an instant process. In the meantime, plan for systemic risk as part of your business plan.

Want to know more? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

Are Real-Money Video Game Tournaments Legal?

Video games are quintessential contests of skill and online multiplayer modes are a must in most modern video games. And yes, playing skill video games for real money prizes is legal in the majority of U.S. states. Some of the most popular video games (Call of Duty, Fortnite, Magic: Arena, and others) frequently feature official in-game tournaments with real-money prizes for the top finishers. Fueled by the global popularity of esports, there is also a growing number of third-party esports tournament sites and apps. These third-party offerings are essentially on-demand, which means that there are always head-to-head challenges waiting and frequent “cash cups” with winners able to win a hundred dollars or even more.

Real-money game tournaments and contests serve as a more casual alternative to professional esports. Not everyone has the time (or the reflexes) to go pro or even compete at the collegiate level. But, you may be skilled enough to dominate your local group of friends at Call of Duty or FIFA and there are plenty of offerings to let you win real money prizes against online opponents. Some of the most innovative companies even integrate streaming (for example through Twitch) to add an exciting “audience” element to real money play. Anyone can feel like an esports pro. There is also a growing opportunity for market crossover, with streamers getting involved in real-money play and adding a whole new dimension to their entertainment potential, audience, and branding opportunities.

What kinds of legal issues will a contest or tournament organizer/developer encounter? As with any business, there are several distinct legal areas in play.

Esports competitions or tournaments are not expressly regulated or prohibited under U.S. federal or state law.

First, from a government regulation perspective, no states expressly prohibit esports or video game tournaments. However, there are several jurisdictions that prohibit any sort of real-money gaming. This is the case even if the game involves a pure contest of skill (even offline, like a hole-in-one contest). Accordingly, tournament organizers and app developers stay away from those restrictive jurisdictions.

In the remaining states, game contests, tournaments, and esports are not licensed under any sort of “gambling” or “fantasy sports” regulatory scheme. The largely unregulated market means that there are a number of service providers out there that disagree on where their product can be offered. Some are more conservative than others, but there is not a definitive list of where gaming competitions are legal or illegal. At least one state – Nevada – passed legislation to create an esports advisory board (within its Gaming Commission), to recommend best practices for maintaining integrity of esports competitions and related betting. According to Nevada lawmakers, they recognize the value in the esports competition industry and want to ensure Nevada remains an attractive investment environment for this burgeoning industry. At this time, the potential advisory committee is the closest any state has come to any sort of esports-specific legislation.

A lot depends on the specific competition and tournament model, as well as the types of games being played. For instance, are shuffled cards involved (Magic: The Gathering)? Or some other element of randomness (like team or opponent selection)? Are bots or AI players involved? How do all these elements interact and do they introduce a significant chance element that may affect the outcome? Does the randomness element render the game illegal “gambling”?

Third-party video game websites and apps implicate the intellectual property rights of the underlying game’s developers and may be subject to DMCA takedown notices or federal trademark lawsuits.

Second, esports competitions and tournaments do implicate intellectual property rights, specifically the rights of the game developers. A game’s developer (like Blizzard, Riot, or Epic) owns the copyrights in its games and underlying code. Third-party apps and websites operate without any sort of license from the developers, which may be a violation of copyright or trademark law. Disclaimers alone may not be enough – using game imagery, logos, or even gameplay footage may constitute copyright or trademark infringement. A player or streamer may be protected by the “fair use” copyright law exception, but a company that organizes and monetizes game tournaments is unlikely to prevail on this argument. At the same time, a properly run game tournament organizer may not have sufficient interaction with the game itself to violate IP rights. After all, the players are the ones playing. Each situation is highly fact-specific and there is certainly no bright line rule.

As real-money video game tournaments become more widespread, expect to see pushback from the game studios. At least one studio – Epic – has announced an aggressive stance towards third-party platforms that facilitate playing Epic’s games for real-money prizes (particularly Fortnite). However, as of the date of this article, no lawsuits have been filed.

Combining real-money tournaments with streaming is an attractive business model, but may involve complex licensing and contract issues.

Third, streaming tournaments and competitions, as well as partnering with known streamers, involves a number of contract law and licensing issues. Each streaming service has its own set of terms. Players (and organizers) streaming real-money game content must ensure that they are compliant with the terms or risk being banned from the platform. Further, who owns the streaming content? Normally, the creator has the intellectual property rights to their own content, but it is not so clear-cut when streaming a tournament or other organized contest. Tournament organizers should ensure that rights and expectations are clear from the outset, especially if a well-known esports streamer or player is involved. If the streamer is granting the organizer a license to showcase their gameplay, the license should at a minimum be in writing. Any royalties, cross-promotions, and sponsorships likewise need to be negotiated ahead of time. Even the best intentioned relationships go awry when money becomes involved.

For developers looking to launch a new esports or game tournament app or website, an experienced gaming attorney is a must-have. Artaev at Law has worked with a number of gaming companies from across the world and has the expertise you need. Reach out today to set up a meeting with Dan.

Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

Categories
Uncategorized

In-App Purchases No Longer Mandatory for Developers: Federal Court Issues Injunction As Part of Epic v. Apple Ruling.

There is no question about Apple’s dominance in the smartphone market. The iPhone accounts for approximately 50% of all smartphones in the United States and there are an estimated 1 billion iPhones across the globe. For developers looking to distribute their apps or games to as many customers as possible, the Apple App Store is a must. Of course, Apple tightly controls access and requires developers to comply with Apple’s terms and policies, including with respect to customer payments. For real-money skill-game developers, the App Store is even more important because it is essentially the only way to get their product onto mobile phones. In May 2021, Google banned real-money skill games from its Play store. Setting aside sideloading (risky) and progressive web apps (not familiar to all), if you want real-money skill games on a smartphone, Apple is your only option.

One of the more controversial App Store rules is the 30% commission on all transactions. In essence, whether a developer sells their app for a one-time fee, offers a reoccurring subscription, or provides an option for in-app purchases, 30% of the payment goes to Apple. In the gaming market, this model is especially profitable in so-called “freemium” games, which are free to download and play, but offer players the option to unlock additional content, levels, and other upgrades for an additional fee. The insanely popular game Fortnite is a great example of a game that’s free to download and play, but brought an estimated $5.1 billion in revenue from cosmetic and other optional items in 2020 alone. In response to increased media and regulatory pressure (including outside the United States), Apple modified its rules to allow for a reduced commission of 15% for “small” businesses that make less than $1 million in annual revenue. Recently, Apple further amended its polices to allow certain “reader” apps like Netflix or Spotify to redirect their users to outside the app for additional payment and subscription options. The out-of-app payment option was added in direct response to laws passed in South Korea and Japan.

In the United States, the recent court decision in the Epic v. Apple antitrust lawsuit unlocked the out-of-app payment options for all. In early 2020, Epic (the owner and developer behind Fortnite) decided to deliberately circumvent Apple’s rules against out-of-app payment options and offer mobile players a discounted option to purchase in-game currency directly through Epic’s website. Apple predictably responded by pulling Fortnite from the App Store, and Epic sued, alleging anti-competitive behavior and violations of various federal and state antitrust laws. Apple countersued for breach of contract, accusing Epic of deliberately breaching the terms of the App Store agreement and diverting Apple’s share of app revenue.

After a 16-day trial, the United States Court for the Northern District of California issued a 185 page decision largely in Apple’s favor and ordered Epic to pay Apple $6 million in breach of contract damages. However, the Court also found that Apple’s “steering” provisions that prohibited developers from offering alternative out-of-app payment options violated California’s antitrust laws. The Court issued a permanent injunction that precludes Apple from implementing these “steering” provisions, leaving developers free to include buttons, external links, and “other calls to action that direct customers to purchasing mechanisms, in addition to In-App Purchasing.” The injunction will take effect on November 10, 2021.

What does this ruling mean for real-money skill-based game developers? It certainly opens up more options to direct customers to your external website, advertise promotional pricing, and innovate your business and pricing model without direct involvement from Apple. Additionally, the Epic v. Apple ruling also frees developers to communicate directly with customers through information obtained via the in-app registration process. At the same time, developer guideline 5.3.3 already prohibits in-app purchases from being used to “purchase credit or currency for use in conjunction with real money gaming of any kind.” In other words, real money skill games were treated like casino gambling apps and excluded from the in-app purchase mechanism. The Epic ruling simply means that all app developers will have access to a flexible business model and be able to determine how to best monetize their game without Apple dictating the business terms and imposing a mandatory 15-30% commission on revenue.

Nevertheless, real-money skill-based games remain subject to heightened review and scrutiny from Apple. Advertising through Facebook, Instagram, Twitter, etc., also requires a specialized (and sometimes lengthy) approval process. Skill-based real-money gaming operates in an unregulated area, and applicable laws and regulations change frequently. For example, the IRS recently signaled that it intends to tax daily fantasy sports wagers the same as sportsbook bets. Although DraftKings and FanDuel will likely fight the IRS’s interpretation of the Internal Revenue Code, any resulting ruling may impact the skill-gaming industry as well. Stay vigilant and retain an experienced gaming attorney to guide and consult your business the right way.


Have more questions? Do you need help getting your app through the review process? Contact Dan Artaev today by emailing dan@artaevatlaw.com or by phone or text at (269) 930-0254.

Disclaimer: This guide is not intended to be and does not constitute legal advice. It is for informative and promotional purposes only. Do not take any action or refrain from taking any action based on this guide, and always consult with a qualified professional about the circumstances of your particular case. Each set of facts is unique and different circumstances apply to each individual business.

© 2021 Artaev at Law PLLC. All rights reserved.

Categories
Uncategorized

Business Law Essentials for the Modern Video Game Company.

As a game developer, unless you are working on the new Ace Attorney game, law and lawyers are the last thing on your mind. But no matter how high-tech, innovative, and cutting-edge your product, video games and mobile apps are still a business and there are industry-specific legal areas to consider. Doing it right will protect your investment and ensure that your business grows in the right direction with minimum risk and liability. Artaev at Law specializes in legal issues facing video game and mobile app developers and also has extensive general business experience to help you run your company the right way.

The Fundamentals.

1. Form Your Corporation or LLC.

When starting your business, the first thing to do is to form a business entity. It is important to choose the right type of entity depending on your future goals and needs in mind. For example, if you are planning to solicit investors and venture capital, a Delaware corporation is likely your best option. In other situations, a limited liability company (“LLC”) may be a simpler approach, but at the same time may create unintended tax consequences in the future if you decided to merge, reorganize, or consolidate your company with others. Whatever form you choose, incorporation is critical for all business owners because it creates a separate business entity with its assets and liabilities independent of its owners. A formal business organization also helps address important governance, financial, and succession issues right at the outset.

To officially form your company, you file articles of incorporation (or organization) in the state where you want to be registered. An experienced business attorney can advise you on the right type of entity, as well as the advantages and disadvantages of incorporating in various states (i.e. should you form a Delaware corporation?) Every state requires an initial registration fee, an in-state registered agent to serve as your official point of contact, as well as an annual filing and renewal fee to keep your company current and in good standing.

2. Have an Attorney Draft Your Bylaws or Operating Agreement.

The next step is to have an attorney draft the bylaws or operating agreement. This internal governance document is absolutely critical. It spells out who owns the company, how decisions are made, how money is distributed, how shares are transferred, what happens if an owner dies, and many other important considerations. Even if you are a one-person business, the bylaws or articles of organization are still necessary when you want to open a bank account, obtain a business loan, sell all or part of your business, and otherwise ensure that you are running your business the right way. Having formal documents and procedures, as well as keeping written records of corporate meetings are also critical to maintaining the corporate form for liability protection purposes. Aggressive creditors have successfully argued that a business that does not observe such formalities is a “sham” and that a court should “pierce the corporate veil” to allow them access to an owner’s personal assets.

3. Separate Your Business Money and Assets.

Maintaining a separate bank account and finances for your business is another vital step. Virtually all business problems are linked to money. A separate business finance setup (including a bank account) avoids commingling personal and business funds, which is another circumstance that could expose you to liability. Further, failing to separate business and personal expenses and properly account for distributions creates a very difficult and unpredictable tax situation at the end of the year. For example, if you use personal credit cards for business expenses, make sure to keep records and promptly and accurately reimburse yourself. Also, if you apply for an SBA or other loan, make sure that the loan is disbursed to your business account and not to your own personal account (yes, this actually happened with one of my clients). Otherwise, you are creating an accounting, tax, and legal nightmare – and risking an IRS audit.

Make sure to reserve adequate money for income taxes from any operational income. Also, state and federal taxes must be paid on a quarterly estimated basis, since as a business owner there is no employer automatically withholding taxes from your paycheck. If you have employees, you will need to make sure to pay the appropriate payroll, worker’s compensation, and unemployment taxes. If you do not have employees, self-employment tax is still something that must be calculated and paid periodically.

Finally, on cryptocurrency or “crypto.” If you are planning on using crypto as part of your business, there is a whole separate set of considerations. The IRS considers crypto taxable property, including stablecoins. Taking payment in crypto may be innovative and position your business as “high-tech,” but there are obstacles to using crypto instead of fiat currency in running your business. For example, even if a vendor allows you to pay them for goods or services in crypto, each transaction is a taxable event. The IRS considers you to have sold crypto and incurred capital gains tax liability each and every time. There are also state and federal laws that preclude you from paying wages in crypto, but bonuses and other discretionary pay are another story. Crypto may have promising implications for the future, but there are many practical obstacles for business owners interested in integrating crypto into their day-to-day business.

Intellectual Property.

Intellectual property or IP law is of paramount importance to game developers and designers. On one hand, you want to protect your own creations and inventions against unscrupulous competitors seeking to copy your product. On the other hand, you have to be able to protect yourself from others’ IP claims, including DMCA copyright takedown notices and cease-and-desist letters.

Intellectual property generally consists of three main categories: (1) patent; (2) copyright; and (3) trademarks.

1. Patents.

Patents are most often associated with scientific discoveries and mechanical devices. In the video game context, a so-called utility patent may be available to protect a game’s unique mechanics or a specific gameplay methodology. The protected design must be unique and non-obvious. But patents do not protect the code itself, the game concept, or idea. For example, Skillz.com, a leader in the real-money skill-game market, has over 50 patents, including a patent for technology that ensures fair and level asynchronous play. Skillz does not have a patent for any specific game played on their platform and in fact, there are a lot of copycat apps on the Apple App Store that are essentially the same games as those available through Skillz. The downside of patents is that patent protection is fairly expensive to obtain and to police, involves publication and public disclosure of the technology, and may even be waived by playtesting certain concepts.

2. Copyright.

Copyright law protects creative works like books, movies, music, and yes, video games. The underlying code for a game is also protected by copyright and pirates who illegally copy the code and sell copies of the game are violating federal copyright law. Most recently, copyright claims have come up in the context of streaming and whether streamers are allowed to use certain music and other creative elements during their broadcasts.The creative concepts – or the “theme” of the game – are also protected. This means the storyline, the characters, art, music, box design, and other distinct creative and thematic elements. But not everything is protected by copyright.

Distinct from the “theme” of the game are the game mechanics, which cannot be copyrighted. “Game mechanics” is the actual gameplay – this can be as simple as moving the joystick to move an avatar around in a virtual environment. The United States Copyright Act codifies this concept and expressly states that copyright protection does not extend to “any idea, procedure, process, system, method of operation, concept, principle, or discovery, regardless of the form in which it is described, explained, illustrated, or embodied in such work.” 17 USC 102(b). The distinction between the copyrightable theme and the non-copyrightable game mechanics is not always clear and there may be some overlap. Additionally, the concept of “fair use” protects certain commentary, criticism, and parody from an infringement claim.

3. Trademarks.

Trademark protection exists chiefly to prevent customer confusion and to protect the integrity of a brand. In the video game context, trademark will primarily protect the name of the game, but can also protect unique “trade dress” elements that constitute unique menu or box designs, or user interface elements. A trademark can also protect a slogan or recognizable phrase associated with a game.

Trademarks are relatively easy to obtain and the USPTO website allows you to search for existing trademarks to ensure that your branding does not infringe on existing products. Trademarks also vary in strength depending on whether they are more generic and descriptive, or unique and arbitrary. For example, the game name “Grand Theft Auto” is also the term for a certain felony associated with vehicular theft. The name literally describes a core game concept (stealing cars), so it would be considered either a “suggestive” or “descriptive” mark. On the other side of the spectrum, an entirely unique “fanciful” or “coined” mark enjoys the strongest protection – for example the terms “Skyrim” or “Warcraft” (at least arguably) do not have any other meaning outside the game context.

4. Other Intellectual Property Issues.

The most two common questions facing game developers are: (1) How can I prevent someone from copying my game? and (2) How do I avoid getting in trouble for copying someone else’s game? While you may have taken steps to protect your intellectual property, the fact is that games are especially vulnerable to knockoffs and plagiarism. International law may even become an issue if an overseas company takes and repurposes your idea. By hiring an attorney as part of your team, you can ensure that you have taken the right steps to obtain copyright protection for your user interface, graphics, art, etc., and that you have properly registered your trademarks. An attorney can also ensure that any contractors – such as artists, coders, or composers – properly assign all rights back to the game developer through “work for hire” agreements. Licensing agreements with any publisher must also delineate the rights and responsibilities of all parties. Royalties and assignments must be fair, clear, and definite. If you have a co-designer or a business partner, you must absolutely have a business agreement before your idea starts making money, so there are no surprises or hard feelings. If there are copyright concerns or knockoffs, a DMCA takedown notice or demand letter is often an effective tool to dissuade would-be thieves. Conversely, if you are receive a takedown notice or demand from another designer, you need to have an effective and prepared attorney ready to respond.

Regulatory Concerns.

Most game developers are not going to encounter regulatory issues or attract the attention of state or local prosecutors. However, if you are considering real-money play (such as skill games) you will need a legal opinion as to where your game may be offered. Payment processors, advertisement platforms, and distributors may all require additional information and assurances as part of their internal review and approval process.

Finally, if you are distributing internationally, you need to be aware of the region-specific laws and regulations. Some regions are more friendly to gaming than others – for example, real-money skill-games are popular and abundant in India, but there is no uniform national-level law. Hong Kong is a haven for real-money gaming, yet at the same time, China does not allow them. Plus, there are international tax treaties and financial regulations to navigate.

Whatever your game and whether you are a veteran or just starting out, an experienced gaming attorney can be a great asset to your business.

Contact Artaev at Law PLLC to set up your initial consultation. We are Michigan’s gaming law firm and we specialize in the unique concerns that you may encounter as a game developer.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.


© 2021 Artaev at Law PLLC. All rights reserved.

A Guide to Getting Your Skill-Based Real-Money Game Approved in the United States.

Skill-based real-money gaming has been a popular form of entertainment across the world for hundreds of years. From Roman legionnaires wagering on an early version of backgammon to $5 eight-ball games at your local pool hall, skill games have always attracted players looking for a chance to win real money. With smart phones in every pocket, skill-based gaming has entered a new era where anyone with an internet connection can play various money skill games through their phone or computer and stake anywhere from $0.25 to hundreds of dollars on the outcome.

Gaming is a rapidly growing industry and the skill-based real-money market is no exception. Indeed, there is already at least one publicly-traded California-based company (Skillz.com; SKLZ) investing substantial resources in the real-money skill-based U.S. market. However, any sort of real-money gaming business implicates federal and state-level regulation. While a government license is not necessary in most states, your game must still pass private sector review. Apple’s App Store is indispensable in the current market; advertising through social media like Facebook is another must. Banking and payment processing is likewise an integral part of your ability to run a business.

I have advised a number of companies, both international and U.S. based, on the legality of their skill-based real-money games. Through Artaev at Law, I have prepared detailed memorandums and analysis for a number of companies, as well as provided consultation to investors seeking more information about the real-money skill-games market. As a game developer, here is what you need to know:

1. Get Your Game to the Players.

If you were to get into the full-scale casino gambling market, you would have to comply with stringent state-level regulatory requirements, pay substantial application and licensing fees, and otherwise deal with an intricate governmental regulatory framework. Further, in the few states where casinos are even legal, there is only a limited number of licenses that a state will issue. In other words, it is impossible. But real-money skill gaming operates outside the gambling regulatory framework, which means you don’t have to go through a government licensing or regulatory approval process to offer your product (in most states).

Instead, real-money skill game providers find themselves faced with so-called private company gatekeepers. The popularity of real-money skill gaming is in large part due to the ubiquity of the smartphone. Apple’s App Store is the only practical way to get real-money skill games onto iPhones (no, people will not “unlock” their iPhones to sideload your real-money skill game, especially when the App Store already has a robust selection of these games that are easy to download and use). Google’s Play store does not currently allow real-money skill games, so there developers must either provide sideloading options or use a Progressive Web Application (PWA).

The bottom line is that developers must pass Apple’s “gatekeeping” to even get their app on the market. That means complying with the App Store Review Guidelines. Section 5.3.4 is particularly important:

5.3.4 Apps that offer real money gaming (e.g. sports betting, poker, casino games, horse racing) or lotteries must have necessary licensing and permissions in the locations where the app is used, must be geo-restricted to those locations, and must be free on the App Store.

Apple considers real-money skill games to fall into this category, even though skill games do not depend on chance like the “sports betting, poker, casino games, horse racing” examples. This guideline can be distilled into three requirements: (1) The app must be legal where you are offering it; (2) The app must be geo-restricted to only those locations where it is legal; and (3) the app must be free.

The first requirement is the most important and the most confusing for app developers. How do you demonstrate that your app has “necessary licensing and permissions” if the states where you are offering your real-money skill games do not regulate such games? This is a situation where a legal opinion or memorandum from an experienced gaming attorney is helpful. In general, such a legal opinion will describe your game, explain how the game fits within existing federal regulations, and then present a state-by-state analysis (supported by applicable statutory and case law citations) to show that the skill game does not violate those states’ anti-gambling prohibitions or any other law.

The second requirement of geo-restriction is self-explanatory. Your app can only offer real-money gaming if the user verifies their location in a state where such gaming is legal. You can still offer practice or play-money games without geo-restriction (or if the user does not want to or cannot verify their location).

The third requirement is that the app must be free. Section 5.3.3 of the review guidelines further clarifies that “in-app purchase” cannot be used to purchase credit or currency for use in the real-money gaming app. That means that you will need to set up some sort of external mechanism for deposits, link the user’s existing account and balance to the app, and ensure compliance with the external payment processors’ requirements.

Once submitted, the review process can take between several weeks to more than a month. A lot depends on whether your app is similar to other apps already approved or whether it is something completely new. Other factors, like the reviewer or the law firm reviewing the legal analysis may also impact the timeline.

2. Advertise Your Game.

Advertising is critical to your app’s success and online advertising platforms have special rules for real-money games. Social media companies like Facebook and Twitter require prior approval and permission before running your gaming ad. The process is similar for both platforms and generally involves filling out a questionnaire, selecting the geographic areas you are targeting, providing a link to your app’s website, and submitting a legal opinion that your app comports with the law where it will be advertised. Google and YouTube (owned by Google) do not currently allow real-money skill game advertising.

This process may be a bit more lengthy than getting approval from the App Store. Depending on the nature of your product, your location, and the platform, the process may take several months. The social media platform may also come back with additional specific legal questions for your counsel to answer. The level of follow up and scrutiny is hard to predict because the social media companies farm out the review to outside law firms, which have their own standards and review processes.

3. Set Up Your Payment Processor and Bank.

Once your game is live and advertised, it’s time to start making money. There are a lot payment processors out there (PayPal, Square, etc.) and each has their own set of rules and guidelines for business accounts. The federal Unlawful Internet Gambling Enforcement Act applies to payment processors, so they must be especially careful not to facilitate illegal gambling activities. Credit card companies present another potential obstacle, as credit card companies often lump skill-based gaming with gambling into the 7995 merchant code.

For example, after states started rolling out regulated sport-betting options, Visa issued guidance that made its payment services available for “all transactions that are consistent with local, federal, and international laws.” Visa introduced new 7800-series merchant codes for legal gambling, but none of those codes apply to real-money skill gaming transactions. Practically, this means that skill-gaming transactions may still fall under the blanket 7995 code and Visa may not authorize the transaction. Nor does Visa issue an MVV (merchant verification value) for 7995 merchants, meaning that skill-based real money gaming companies are limited as to their direct-pay options.

This essentially requires skill-game companies to explore options through payment providers like PayPal. Provided you are based in the United States and can link a bank account, the process should be straightforward. If you are based in another country however, there is a whole another set of hurdles to overcome.

There’s More.

Getting your game approved, advertised, banked is only the first step. You will also need robust terms and conditions that govern your relationship with your users, which is especially critical when dealing with real-money gaming and facing potential payout disputes. A privacy policy is also a must, especially if you are offering your game internationally. Then there is the issue of taxation and whether you should be paying excise tax on skill-based game wagers. Real-money skill-based gaming is a hot market, but requires experienced legal counsel to get through these various issues.

Have more questions? Do you need help getting your app through the review process? Contact Dan Artaev today by emailing dan@artaevatlaw.com or by phone or text at (269) 930-0254.

Disclaimer: This guide is not intended to be and does not constitute legal advice. It is for informative and promotional purposes only. Do not take any action or refrain from taking any action based on this guide, and always consult with a qualified professional about the circumstances of your particular case. Each set of facts is unique and different circumstances apply to each individual business.

© 2021 Artaev at Law PLLC. All rights reserved.

Stablecoin Taxation and Securities Regulation: What Every Investor Must Know.

Stablecoins are cryptocurrencies backed by other assets like fiat currency reserves, precious metals, commercial paper, and even portfolios made up of other cryptocurrencies. By pegging their value to another asset, stablecoins attempt to decrease price volatility and achieve a more “stable” price than uncollateralized cryptocurrencies like Bitcoin and Ethereum. As I previously wrote, stablecoins may be particularly useful for international trade and business due to their predictable value and the ability to avoid wire delays and to minimize transaction costs. Stablecoins are also not targets of speculation or artificial price increases due to external events like Elon Musk’s SNL appearances or even China’s clampdown on Bitcoin mining. If the stablecoin is pegged to the value of the dollar, it will still be worth $1 regardless of whether there is a sudden spike in demand or supply.

Other than potential business use, stablecoins are also a popular investment medium. Certain exchanges have offered attractive interest rates on stablecoin holdings, ranging from Coinbase offering 4% on USD Coin (USDC) to double-digit returns on some lesser exchanges and stablecoins. As always, do your due diligence and make sure you know where your money is going before transferring any significant amount of cash. Also, it may be worthwhile to test the liquidity or withdrawal time with smaller deposits before investing any large amounts.

Just like with traditional cryptocurrency, there are two main legal areas that affect stablecoins: tax and securities regulation. Here are the latest “must knows” in each area:

Stablecoins are taxed like property and are subject to capital gains tax. Cryptocurrency is not “currency” as far as the IRS is concerned – rather, for taxation purposes, it is treated like property and subject to capital gains tax. This gets tricky, especially with stablecoins that are pegged 1:1 to the dollar. Buying stablecoins (or any crypto) for dollars is not a taxable event. However, using stablecoins to purchase goods and services is a taxable event that must be reported, even if your capital gains are zero.

For instance, if you buy 1,000 USDC for $1,000, that is not taxable. Then, when you pay a Romanian engineer 1,000 USDC in exchange for a circuit board design, the IRS deems that you have sold the USDC at the market rate in exchange for the engineering services. The difference between your cost basis and your sell price is the capital gain. Where the stablecoin is pegged 1:1 to the dollar, the capital gain will be $0 (your purchase price and sale price are the same). In fact, you may even realize a loss that you can use to offset your income if you paid a transaction fee. Transaction fees are added to your cost basis, so if you paid a $10 transaction fee to buy 1,000 USDC, your cost basis is $1,010 and when you sell for $1,000, you just netted a $10 loss. Also, you can end up with capital gains or losses if you are transacting large amounts of stablecoin – for example if you sell 50,000 USDT (Tether) when it’s price fluctuated slightly to $1.01, you just received a $500 capital gain.

Additionally, if you are earning interest on your USDT holdings, interest is taxable like ordinary income. In other words, buying stablecoin for fiat currency is not taxable, but earning stablecoin through staking is taxable. Just like you pay income tax on interest earned from your savings account, you will incur income tax on cryptocurrency gains. Finally, when you use your earned USDT to buy something or convert to cash or another cryptocurrency, that is a reportable taxable event subject to capital gains tax because for IRS purposes, you just sold property – your cryptocurrency.

Some stablecoins may be regulated like securities. The Securities and Exchange Commission (SEC) enforces U.S. securities laws, which apply to a wide range of publicly-available investment products like stocks, bonds, mutual funds, and investment contracts where investors provide capital in exchange for expected returns. Cryptocurrencies like Bitcoin and Ethereum are not considered securities because they are exchange mediums and in the SEC’s view, are no different than a foreign currency like the Euro or the Japanese Yen. At the same time, the SEC has scrutinized new coin offerings (also called initial coin offerings or ICOs) and concluded that they may constitute investment contracts if there are facts that indicate the buyer is “expecting a profit to be derived from the efforts of others.” See generally SEC v W.J. Howey Co., 328 US 293 (1946) (where the Supreme Court held that shares in a citrus grove operation were investment contracts subject to securities laws because the investors provided capital with the expectation that workers’ efforts in harvesting oranges would yield profits). Certain stablecoins, especially those that seek capitalization through ICOs and promise a percentage return through “staking,” will be considered “investment contracts” required to register with the SEC and provide public information like any other security.

There are also some stablecoins that are backed by securities like corporate and municipal bonds, mutual funds, and other publicly-traded instruments that are themselves regulated by the SEC. There is little doubt that these security-backed stablecoins are considered derivatives because their value is derived from the value of regulated securities. SEC regulation will require stablecoin issuers to disclose additional information about their companies to the public. Already there is some concerning information release ahead of Circle’s (the issuer of USDC) intent to go public – USDC reserves are only61% cash and money market funds, with the rest divided between U.S. and foreign treasury bonds, municipal, and corporate debt. Previously, the 1:1 stablecoin issuers represented that each coin was backed by actual cash reserves, which were regularly audited. Apparently, that is not the precise reality.

Finally, stablecoins are also facing increased regulatory scrutiny from central bank authorities. Federal Reserve officials have expressed their concerns about the effect of stablecoins on the credit markets. Stablecoins also threaten the ability of the Federal Reserve to regulate monetary supply to stimulate the economy and control inflation. For instance, if a coin like USDC gains widespread adoption, a private company like Circle will be able to regulate monetary supply by increasing and decreasing interest rates. Expect to see increased guidance and regulation from the U.S. Treasury and the Federal Reserve in the near future. It would not be surprising to see stablecoin issuers to be treated as banks in certain circumstances.

Want to know more? Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

Ask the Crypto Tax Lawyer: Offsetting Capital Gains Through Loss Harvesting.

Update: As of November 10, 2021, Congress is in the process of considering legislation to preclude loss-harvesting through cryptocurrency sales. Congress is also considering other amendments to the Tax Code and other laws to address cryptocurrency specifically. As this is a rapidly developing issue, it is critical that you consult with a tax attorney or other professional about your specific situation and the current state of the law before making any transactions or business decisions.

More than half-way through 2021, cryptocurrency remains an extremely popular investment. Although volatile and subject to unpredictable regulation (yes, that means China), the market has experienced substantial growth. Exchanges like Coinbase and integration with PayPal make owning, trading, and speculating in cryptocurrency easy. Sophisticated investors have even added cryptocurrency into their self-directed retirement portfolios, banking on the continued growth and popularity of the decentralized exchange medium.

As I have previously written, the IRS is keeping a close eye on cryptocurrency investors, transactions, and markets, looking to capture taxes on hundreds of millions in underreported or unreported income. In other words, crypto taxes are going to be an issue for many in the coming tax years, especially after the Biden administration’s mandatory $10,000 or more transaction reporting rule goes into effect in 2023. However, with proper planning and strategy, there are ways to reduce your tax liability even if you are planning to liquidate your crypto positions in the near term.

As a basic matter, know that the IRS classifies cryptocurrency as “property,” which means that it is subject to capital gains tax. General capital gains reduction strategies work for cryptocurrency as well as they do for more traditional property like investment real estate, stocks, and bonds. For instance, waiting at least 365 days to sell lets you take advantage of the lower long-term capital gains tax rate. Selling in a lower income year where your overall income puts you in a lower tax bracket is another strategy.

One advanced tax strategy involves taking advantage of the so-called wash sale rule. Or rather, it is taking advantage of the fact that the wash sale rules does not apply to cryptocurrencies (yet). Under Treasury Regulation 26 CFR 1.1091-1, an investor cannot sell “stock or securities” at a loss, use the loss to reduce taxable income, and then immediately repurchase the stock or security. Under the wash sale rule, there is a 30-day waiting period before purchasing the same or substantially the same stock or security – if an investor repurchases the security within the 30-day restricted period, the loss will be added to the cost basis of the repurchased security and reduce capital gains on the sale of the repurchased security, but it will not be treated as an investment loss to reduce general tax basis. In other words, you cannot manufacture losses in a bear market to reduce your taxable income that you receive from other investments, rentals, or wages.

The IRS has been clear that cryptocurrency is treated as “property” for tax purposes. However, whether it is a “stock or security” remains unanswered and both IRS Notice 2014-21 and the recently amended FAQ are silent on the issue. There is no express definition of “stock or securities” for the purposes of the wash sale rule. Looking elsewhere in the Internal Revenue Code, the definitions of stock and securities in various other sections include traditional shares, notes, bonds, and the like. Indeed, in 1988 the United States Tax Court adopted a narrow interpretation of the Code, holding that stock options were not considered “stock or securities.” Gantner v. Commissioner (91 T.C. 713 (1988). Congress responded by amending the wash sale rule to expressly include stock options, but still did not enact a definition of “securities” for the purpose of the rule.

Based on the current Code and Regulations and the lack of IRS guidance on the issue, there is a strong argument that cryptocurrencies are not “stock or securities” for the purposes of the wash sale rule. What this means is that crypto investors can take advantage of loss harvesting to accrue losses and use those losses to offset income. For example, if you buy one Bitcoin for $30,000 and the next day the price drops to $20,000, you can sell the Bitcoin at a loss of $10,000, “harvest” the loss, and repurchase the Bitcoin for $20,000 shortly thereafter. You still own 1 Bitcoin, but now you have accumulated a loss that you can use to offset capital gains income.

If your losses exceed capital gains, you can use up to $3,000 of loss to reduce regular income. Any excess loss can be carried over to future years to offset future gains.

At the same time, the Securities and Exchange Commission (“SEC”), the Commodities Futures Trading Commission (“CFTC”), and certain United States courts have ruled that cryptocurrencies are indeed “securities” within those Commissions’ regulatory scope. This regulatory effort was generally to stem the fraud and abuse through “initial coin offerings” or ICOs that sought to evade strict regulations designed to protect investors. While there is currently no indication that the IRS would consider cryptocurrency as “stocks or securities,” there is precedent for that conclusion from these other agencies and remains possible that the IRS could issue supplemental guidance and interpretations to that effect.

At the time of this writing, the IRS has not issued any such interpretation and savvy investors can consider the loss harvesting strategy if appropriate for their particular situation. As with all cryptocurrency transactions, good record keeping is paramount. It is especially critical to have accurate records to substantiate your losses if you are repurchasing the same crypto. Good and accurate records are the best tool in defending your position to the IRS, should the IRS take a position and disallow your claimed losses.

Contact Dan Artaev by email or call or text to set up your initial consultation.

Disclaimer: This guide is for general informational and promotional purposes only. Nothing herein constitutes legal, investment, or tax advice. Every situation is different and faces its own unique set of challenges. Do not take any action or sign any contract until you have obtained specific guidance from a qualified professional.

© 2021 Artaev at Law PLLC. All rights reserved.

Exit mobile version