Tag: internet law

How to Advertise Real-Money Skill Games on Facebook in 2022: A Legal Opinion is Necessary.

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In August 2022, Facebook updated its real-money gaming and gambling advertising application process. The updated form streamlined some of the required information and still requires a legal opinion from a law firm. Additionally, Facebook requires details about protective measures like geo-location and KYC and detailed geographic targeting information, including states or territories being targeted. Skill-based gaming that awards real-money prizes is not considered gambling in a majority of the United States – but that conclusion requires a state-by-state legal analysis, as each state’s anti-gambling laws are different. Further, the laws change frequently in response to innovations like fantasy sports, legalization of online gambling, and the latest skill-based gaming tables.

Facebook considers all types of real-money gaming “restricted” content, meaning that Facebook must expressly approve your ad before it runs. Whether it is full-scale online casino gambling, poker, fantasy sports, or pure skill prize contests, the requirements are the same:

  • Ads that promote online gambling, and gaming where anything of monetary value (including cash or digital/virtual currencies, e.g. bitcoin) is required to play and anything of monetary value forms part of the prize, are only allowed with our prior written permission. This includes games where purchases are required to continue game play and/or provide advantage in winning prizes, in cases where the prize is of monetary value. Authorized advertisers must follow all applicable laws, including targeting their ads in accordance with legal requirements. At a minimum, ads may not be targeted to people under 18 years of age.

Clicking on “Apply for Permission” takes you to the recently updated Online Real Money Gaming Onboarding Application Form. Advertisers are asked to submit their ID numbers, ad account numbers, the name of their business, and to select whether they are an “operator,” “aggregator/affiliate,” or an “agent/intermediary.”

Facebook then asks the applicant to submit the URLs they are seeking to advertise. This is a particularly important part of the review process, as the review team and Facebook’s lawyers will closely look at the website to ensure legal compliance.

Next, the applicant must select the specific “protective measures” that they implement to gate access to their product:

  • Geo-blocking (gating) of the URL
  • Age-gating of the URL
  • Address verification software or process
  • KYC checks
  • Local cell phone number
  • National tax ID number
  • Any other measures, which must be specified

Applicants are then asked to select the country or countries that they targeting. Note that Facebook’s new rules allow only the following 36 countries to be targeted:

  • Australia, Austria, Belgium, Brazil, Bulgaria, Canada, Columbia, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, India, Ireland, Italy, Japan, Kenya, Mexico, Netherlands, Nigeria, Norway, Peru, Poland, Portugal, Romania, Serbia, Slovakia, South Africa, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States.

Selecting a country is not enough. Applicants must then select the specific states or territories they are targeting. For example, selecting the United States requires the applicant to select the states in which they plan to advertise. Selecting some of the European or South American countries requires information about the specific type of gaming or gambling to be promoted.

The next question is “Do you require a gambling license?” If no, the advertiser is required to submit “a reasoned legal memo by a law firm attesting to the legality of the advertised gambling/gaming without a need for a license.” If you need such a legal opinion, contact Artaev at Law, as we have analyzed a number of skill-based games and have been providing “where is it legal” opinions to Facebook (and other platforms) since 2020.

What goes into a legal opinion? At a minimum, the legal opinion will set forth a legal analysis of each state’s applicable laws and regulations (including case law) that support skill-based gaming in that state. The legal opinion should also address the applicable federal statutes and explain why they do not prohibit the game in question. Also, the legal opinion needs to explain the particular game’s mechanisms, why the outcome is not determined by chance, and how the various laws apply or not apply to the game in question.

A lot depends on the specifics of your game – for example, is the game more like fantasy sports or a pure skill contest? Also, even the bigger companies in the skill-based gaming industry disagree on the states where their games are permitted. Many states are currently addressing unlicensed skill-based gaming and regulations are constantly changing. For example, Michigan recently passed comprehensive online casino legislation and in the course of enacting the sweeping gambling laws, Michigan also included licensing requirements for skill-based real-money games.

Facebook remains a powerful advertising medium. Access to that medium is not free nor easy, especially if you are advertising a “restricted” product like skill-based real-money gaming. Ultimately, Facebook and its legal teams determine what ads meet its advertising policies. To minimize the review time and increase your chances of an approval, contact the experienced gaming attorneys at Artaev at Law PLLC.

Have more questions? Do you need help getting your app through the Facebook review process? Contact Dan Artaev today by emailing dan@artaevatlaw.com.

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.

© 2022 Artaev at Law PLLC. All rights reserved.

Categories
arbitration

Does Your NFT or Play-to-Earn Project Need Terms of Service?

Yes. In fact, well-drafted Terms of Service are critical to a successful blockchain business. Terms of Service (also known as terms and conditions, T+C, or TOS) are essentially a contract between you and your users that set out the terms on which they are allowed to use your product, interact with your game, buy your NFTs, or otherwise participate in the community. Importantly, the Terms will contain dispute resolution provisions, including mandatory arbitration and class action waivers. Properly drafted waivers and disclaimers are a business’s strongest defense against so-called “disappointed investors” and overzealous plaintiffs’ lawyers.

As the blockchain industry is currently in a “bear market,” there are a lot “disappointed investors” looking for someone to blame for their losses. Where lots of people lose money, litigation soon follows. For example, high-profile cryptocurrencies have collapsed – LUNA’s value went to zero overnight and its sister “stablecoin” TERRA is trading near zero despite being touted as pegged 1:1 to the U.S. dollar. Voyager Digital filed for Chapter 11 bankruptcy protection in July 2022, tanking its native VGX token. Celsius froze transactions (including withdrawals) in June 2022 and followed up with its own Chapter 11 filing in July 2022. Days before the Celsius bankruptcy filing, a high-profile investor filed a lawsuit against the company (and its affiliates) accusing them of fraud and running a Ponzi scheme. The same law firm is also spearheading a class action lawsuit on behalf of Solana (cryptocurrency) holders against its founder and associated companies, claiming that Solana is in fact an unregistered security and its sale to the public violates Section 12 of the federal Securities Act.

Even though a failed project or business is not enough for a cause of action by itself, the bevy of lawsuits claiming “fraud” are certainly enough for developers to take notice. As any business owner, blockchain developers must weigh risk and potential economic exposure, especially when it comes to launching a product in the largely unregulated blockchain space. Luckily, with the help of an experienced and knowledgable attorney, developers can leverage well-established contract law and “clickwrap/browsewrap” concepts to ensure maximum control and protection.

How can I use an arbitration clause to my advantage?

A mandatory arbitration clause is not a magic shield – it does not eliminate liability for selling unregistered securities for example. It does not eliminate liability for fraud. However, it makes the dispute resolution process more predictable, more efficient, private, and even potentially less expensive than litigation. Arbitration is a dispute resolution process conducted by a third party neutral (or a panel of neutrals) who act as the fact-finders and decision-makers in a dispute, much like a court. Arbitration decisions are binding and enforceable the same as a court order – the Federal Arbitration Act ensures that an arbitration decision can be taken to a court and transformed into a judgment. However, there is no jury, the parties can engage neutrals with specialized knowledge, and cost and outcomes are generally more predicable and manageable.

Back in 1989, the United States Supreme Court confirmed that a contract can compel investors to arbitrate their Section 12 securities claims against the broker or seller. In Rodriguez v. Shearson, 490 U.S. 477 (1989), the Court determined that an arbitration clause was enforceable because federal law generally favored arbitration and an arbitration clause did not limit the rights of injured parties under the Securities Act. Rather, the arbitration clause was construed as a forum or venue selection clause and procedural, rather than a substantive limitation on an injured party’s rights.

Another significant advantage of arbitration is that it eliminates conflicting state laws or decisions. The Federal Arbitration Act preempts state laws and court decisions that disfavor arbitration. Further, the Terms of Service will have a choice of law provision, as well as a choice of forum where disputes are to be resolved. This allows developers to exercise more control over disputes over their services, as well as deprives “disappointed investors” of the opportunity to forum shop and abuse procedural tools to increase cost and pressure on the business.

Do class action waivers really work?

Class actions are another potentially devastating consequence of disappointed investors. Section 12 claims may be brought as class actions and there are many examples. However, provided a class action waiver does impair substantive rights, it will likely be enforceable in the securities context. Section 14 of the Securities Act states that “Any condition, stipulation, or provision binding any person acquiring any security to waive compliance with any provision of this title [15 USCS §§ 77a et seq.] or of the rules and regulations of the Commission shall be void.” In Rodriguez, the Supreme Court interpreted this provision to preclude substantive remedy waivers (such as damage caps), but to permit procedural provisions like arbitration clauses. Arguably, a class action waiver is a procedural mechanism and will be enforced the same as an arbitration clause.

In a more recent case, AT&T Mobility LLC v. Concepcion, 563 US 333 (2011), the Supreme Court confirmed that class action waivers as part of arbitration agreements were enforceable. The Court explained that parties are free to agree to procedures for their dispute resolution processes, including limiting with whom a dispute will be arbitrated. The Court reiterated the goals of efficiency and specialization that arbitration provides, concluding that arbitration promotes those goals, permits for individualized (rather than class basis) dispute resolution, and the Federal Arbitration Act favors such individualized dispute resolution, especially in a highly-technical field.

From a practical perspective, even if a court ultimately rejects arbitration and class action waivers, they raise the bar for a successful lawsuit and provide the developer with an opportunity to file a motion to dismiss. An early motion to dismiss may also dispose of some of the plaintiffs’ substantive arguments. In any case, increased procedural hurdles disincentivize overzealous plaintiffs’ lawyers, increase the opportunities for settlement, increase predictability, and reduce the chances of an outlier jury verdict.

Remember that well-drafted Terms of Service are not a shield for wrongdoers and will not prevent liability where it is warranted. However, they do offer some protection against “disappointed investor” lawsuits and give developers substantial control over disputes that may otherwise result in potentially devastating class actions and jury awards.

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

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.

NFTs: Investing in Virtual Real Estate and Other Digital Assets.

Disclaimer: This article is not investment advice, tax advice, or legal advice. It is for informational and promotional purposes only. Do not take any action (including investments) until you have consulted with a professional about your specific situation.

I have previously written about investing in cryptocurrencies through a self-directed retirement portfolio and about using them in day-to-day business transactions. There is no doubt that crypto and blockchain technology is here to stay. As evidence of this, the U.S. government will increase reporting of and tax enforcement for cryptocurrency transactions, which are currently treated like property for tax purposes, but not the same as stocks or securities. Increasing regulation and taxation certainly indicate how much the technology is being used and adopted across the world.

What about NFTs or non-fungible tokens? There was a lot of buzz in early 2021 about NFTs after Christie’s auctioned off a digital-only artwork for $69 million and suddenly everyone from Nike, to Hasbro, to Cervelo (a racing bike manufacturer) was selling digital-only versions of their collectibles or attaching NFTs to physical world assets. The hype has since subsided, at least from the mainstream media sources. However, spend enough time on the various social media platforms, and NFT proponents (sellers) will be quick to offer “virtual estates,” “one-of-kind avatars,” “priceless digital art,” and various other exotic and futuristic-sounding assets. Often, you will be directed to an auction site where you will have to place bids on the NFT, sometimes even using a native cryptocurrency or token like MANA or SAND.

Suppose you got caught up one night, cashed out your 401k, and bought $100,000 worth of NFTs – a virtual castle in Decentraland, some art tapestries to decorate, and a digital collection of Luka Doncic basketball cards. The next morning at breakfast you have to explain to your spouse – NFTs? WTF did you just buy? Read on.

  1. NFTs as personal or business investments.

Before investing in anything, it is generally a good idea to understand exactly what you are buying. NFTs are digital representations of unique items based on the Ethereum blockchain. When you buy an NFT, you basically just bought computer code. The simplest description of blockchain is that it is a decentralized public ledger or database. Data is entered into a block – in the case of an NFT, it is specific code that signifies the “object” and its owner – and then that data becomes part of the public ledger that is replicated and stored across a vast, decentralized computer network. An NFT can have a real world counterpart, but it does not have to. As will be discussed below, an NFT can be sold together with or separate from the work’s copyright. The “non-fungible” aspect of the token means it is unique and not interchangeable with other items. Traditional fiat currency is inherently fungible because a dollar bill is interchangeable with other dollar bills. Cryptocurrency is also fungible – one Bitcoin is the same as another and has the same value. On the other hand, an original Monet, your grandmother’s jewelry, or even a pair of Nike shoes are all non-fungible because they are unique.

One big difference between NFTs and cryptocurrency is liquidity. One of the reasons why crypto is so popular right now is accessibility. Exchanges like Coinbase make it easy for anyone to buy and sell cryptocurrency right from their phone, while keeping records, and facilitating exchange of almost any cryptocurrency. Whether you want to cash out into fiat dollars to cash out or exchange cryptocurrencies for other cryptocurrencies, you can do it on your phone or computer in a very simple and quick process. NFTs are not as liquid – to sell one you have to find a willing buyer and negotiate a price. For example, OpenSea is a large marketplace for NFTs, allowing listings at auction, fixed price, or declining price settings. The market determines the price of NFTs, meaning supply and demand. In the NFT market, there may be only a couple of willing buyer and sellers, which is quite different from the millions who buy and sell cryptocurrencies every day. Also, tthe Securities and Exchange Commission does not regulate NFTs or most cryptocurrencies at this time. While a company selling stock or bonds on the open market must follow filing and disclosure requirements to ensure a transparent public offering, crypto and NFTs offerors do not. Proceed with caution.

2. What are the legal implications of this “wild west” of NFTs?

NFT investors face two areas of legal issues: copyright law and tax law. Copyright law protects the creator’s rights in computer code, as well as art, music, and other creative works. Tax law is involved whenever you buy, sell, or invest in anything.

A. Copyright.

NFT ownership is not copyright ownership.

When buying or investing in an NFT, it is absolutely essential to understand what it is you are buying – in other word, what “bundle of rights” are you getting in exchange for your cash? In the physical world, when you buy an asset like a painting or a car, you are at least getting the physical thing. In the all-digital world of NFTs, it gets a little bit complex.

Under U.S. copyright law, the creator of art, music, movie, or other creative work owns the copyright, which attaches at the moment of creation. Transferring the physical object alone does not necessarily transfer the copyright with it – a written agreement transferring copyright is required to separate the creator from the copyright. In other words, the physical work and the copyright to that work are distinct and separate. NFTs are no different – the fact that the work is digital or consists of computer code does not matter. There is still the ownership of the original work (piece of code) and the copyright to that work. Do not assume that you are buying the copyright to the NFT when you purchase it on an online auction site unless there is a specific agreement to assign the copyright to the buyer.

If you bought an NFT without the copyright, you essentially bought a unique piece of computer code that you cannot display, duplicate, or republish without the original creator’s permission. You need the copyright to reproduce, copy, license, and otherwise do pretty much anything with the NFT. Creating derivative works based on the NFT likewise requires the copyright. In short, know what you are actually buying, as copyright gets particularly complex in the digital world. An attorney may be needed to review the agreements, especially if the transaction involves a substantial sum of money.

B. Tax.

The IRS issued guidance as far back as 2014 that cryptocurrency is taxed like property and subject to capital gains tax. But there has been no guidance on taxing NFTs. Because NFTs and cryptocurrency rely on the same underlying blockchain technology, it is likely that NFTs will also be taxed like property and subject to capital gains tax. That means if you buy an NFT for U.S. Dollars, you do not pay tax on that transaction (unless a state decides to enact a sales tax on digital assets). But when you sell that NFT in exchange for cash or cryptocurrency, or trade it for another NFT, you have a taxable event. Any “gain” will be treated as reportable taxable income.

It can get especially complex if you involve cryptocurrency in the transaction. Some NFTs can only be purchased in exchange for a specific token – for example, virtual real estate in Decentraland can be purchased only for MANA tokens, which are an Ethereum token. The price of the MANA token fluctuates, just like the price of BTC or ETH or DOGE. If you pay cash for MANA, that transaction is not taxable. But then when you exchange MANA for an NFT, you are “selling” the MANA, taking a capital gain or loss, and then acquiring the NFT at the market price, which establishes the NFT’s cost basis for future transactions. When you sell the NFT for cash, you have a capital gain based on the difference between the cost basis and the sale price. But if you trade the NFT for another NFT or for Bitcoin, you again have a double tax event because you are selling “property” (subject to capital gain at the time of exchange) and acquiring “property” (subject to capital gains at the time of subsequent sale or exchange) at the same time. This is why good record keeping is an absolute must and is especially critical if you are engaging in a large number of transactions.

All of this assumes that NFTs will be taxed like cryptocurrency. But it is possible that NFTs will be taxed differently based on what the NFT represents. Will the sale of digital land be treated as a sale of physical real estate? All of a sudden state transfer taxes may come into play. Will the sale of digital art or collectibles be treated the same as physical art of collectibles and subject to special tax rates? There are many unanswered questions at this time, but as the IRS zeroes in on crypto and blockchain assets as sources of tax revenue, there will certainly be regulation and litigation on this subject.

3. Future applications for NFTs beyond collectibles and investments.

One of the most fascinating things about NFTs and blockchain tech in general is unlimited potential. The decentralization and immutability aspects are extremely potent in a number of applications. For example, in the business setting, smart contracts that automatically enforce performance and payment can eliminate many costs and inefficiencies related to international trade. Escrow accounts and associated fees may very well be a thing of the past. If performance under a contract can be reduced to code and automated, costly contract disputes can be avoided.

Blockchain can also be used in software licenses as well as licenses for other intellectual property. Concert or other event tickets are another application. Corporate governance and shareholder meetings can be accomplished through blockchain – for example, a corporation could issue a token for each share and then ask its shareholders to vote by transferring the voting tokens to a specific address. The transparency and security of the blockchain are especially valuable in this context. Some commentators have even suggested blockchain as a way to secure and democratize political elections. With a publicly-verified chain, election fraud would virtually be eliminated and election results would become indisputable.

Whatever the future holds, blockchain is exciting technology. As with all emerging technologies, the law is an a state of flux. Government regulators are playing catch up to address the application of existing law to new tech and to propagate new laws to address emerging problems. If you are investing in NFTs or using blockchain in your business, contact an experienced attorney to answer your questions and ensure that you are being proactive with your regulatory and tax obligations.

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: Are Play-to-Earn Games Taxable?

Disclaimer: This article is not investment advice, tax advice, or legal advice. It is for informational and promotional purposes only. Do not take any action (including investments) until you have consulted with a professional about your specific situation.

At the end of 2021, Ubisoft announced its plans to add NFTs (Non-fungible Tokens) into Ghost Recon: Breakpoint. Players’ in-game weapons, vehicles, and other rewards will be tradable and sellable on a secondary market, adding a real-world value component to the game. Ubisoft will become the first mainstream videogame developer to incorporate NFTs into its video games, although other A-list developers like SquareEnix are also planning to transcend the virtual and real worlds through blockchain technology.

Ubisoft follows in the wake of some popular Play-to-Earn (P2E) games like the global sensation Axie Infinity. According to a January Business Insider article describing the P2E crypto gaming model, Axie Infinity increased the value of its native AXS cryptocurrency (an Ethereum token) by a staggering 18,000% in 2021. Metaverse platforms that promise fully functional virtual worlds in the near future like Decentraland and Sandbox also saw explosive growth. For example, Decentraland’s native MANA token increased in value by 4000%. The main draw of these virtual worlds is that they allow users all over the world to earn cryptocurrency and NFTs that tradable for mainstream crypto or fiat money. Obviously, the returns and growth potential have captured the attention of many.

However, real world earnings mean real world taxes. As crypto and NFT earnings become more and more mainstream, more tax payers will have to consider the tax implications of cryptocurrency. The IRS considers cryptocurrency to be property, which is subject to capital gains tax similar to stocks or bonds. While the IRS has had guidance on cryptocurrency transactions since 2014, NFTs are a much more recent phenomenon without official guidance. Which then creates a number of questions for P2E players about how their winnings are reported and taxed.

Do I owe taxes on my play-to-earn winnings?

Absolutely. Because play-to-earn games allow users to earn cryptocurrency or NFTs, which then can be exchanged for fiat currency (e.g. U.S. Dollars), these earnings are considered income. In general, real world earnings mean real world taxes; however, the way your earnings are taxed will depend on several different variables.

To understand how the IRS will tax play-to-earn gains, you must first apply a few basics:

Are all P2E earnings the same?

No. Although both cryptocurrency and NFTs exist on the blockchain, they are two very different things and have different tax implications. Non-fungible tokens or NFTs are unique digital-only objects or unique digital versions of real-world objects. This is basically computer code. Mostly associated with collectibles and art, NFTs use blockchain technology like cryptocurrency but can represent almost anything, including virtual real estate, in-game vehicles or weapons, and personalized avatars. In the case of Ubisoft’s Ghost Recon, the “in-game earnings” will be in the form of NFTs. Similarly, the Pokémon-like Axie creatures that players acquire in Axie Infinity are also NFTs. These in-game items are pieces of unique computer code stored on the blockchain. These NFTs can later be exchanged for other NFTs or cryptocurrency.

Cryptocurrency, however, is not a unique collectible, but rather, a virtual currency. The IRS, in its Frequently Asked Questions on Virtual Currency Transactions, defines crypto as a type of virtual currency or “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.” Play to Earn games like Axie Infinity will commonly use crypto. In fact, Axie Infinity, much like Decentraland (which is more of a general attempt at a metaverse, rather than a stand-alone game), developed its own crypto token (AXS). AXS is tradable and exhcnagable into more mainstream currencies like Bitcoin or Ethereum (which are easily convertible into fiat), giving them value – not only within the game sphere itself – but also within the real world.

How do P2E gamers make money?

To fully understand taxes, it is first important to understand the basics of the P2E economy. Play-to-earn games give players an opportunity to win both cryptocurrency and NFTs by playing a game. Most often, the game will use its own native token as an in-game currency. The in-game currency and NFTs have value on the secondary trading market. To use Axie Infinity as an example, a player can earn value in several different ways:

  • First, a player acquires NFTs known as SLPs (Smooth Love Potions) through monster battles, player versus player fights, or by completing daily missions and quests. The player can then exchange those potions for cryptocurrency or even cash by selling them on an NFT exchange or DEX.
  • Second, a player can use SLPs to breed rare magical creatures (NFTs) known as Axie. Depending on the Axie’s traits and characteristics, an Axie NFT can fetch $200 or more on the secondary market.
  • Third, a player can stake AXS tokens in exchange for a particular return rate. Staking with crypto tokens is akin to holding money in a certificate of deposit (albeit, much riskier).
  • Finally, the game may award tokens or NFTs via airdrops. Airdrops are giveaways that the game may send its players as part of random promotions or in return for doing specific tasks.

What (and how) the game pays the player determines the type of taxes that particular player will owe. Is the income in the form on an NFT? Tokens? Staking income? An airdrop?

Are there taxes on tokens?

Whether it is called a token, cryptocurrency, or virtual currency, a native game token is taxed like intangible property and is subject to capital gains tax. The IRS has had a consistent position on this since at least 2014. When you purchase cryptocurrency or tokens with fiat currency (e.g. U.S. Dollars) you do not pay tax on the transaction. So if you buy AXS directly for USD, this is not a taxable transaction. However, if you buy AXS for ETH or BTC or another cryptocurrency, stablecoin, or token, you have incurred capital gains because the IRS considers you to have sold cryptocurrency you have traded – even if the transaction is a direct exchange.

If you earn crypto tokens as a part of a Play-to-Earn game, the value of such crypto is taxable as ordinary income. Likewise, when you sell crypto tokens on an exchange, you are taxed on the gain (if any) just like you would be if you sold a stock or investment real estate. Again, when you exchange one cryptocurrency for another (for example, you buy AXS with stablecoin) the exchange is taxable. Accordingly, it is critical to keep accurate and clear records of every transaction involving cryptocurrency, regardless of gain or loss.

How are NFTs taxed?

The IRS has not issued definitive guidance on how NFTs will be taxed, but most experts agree that NFTs will probably be considered property like cryptocurrency and be subject to capital gains tax. When applying this framework, NFT investing generally involves three different taxable events:

  • The Purchase of a NFT with Crytpocurrency. Play-to-Earn games often require a buy-in. Axie Infinity, for example, requires players to buy three Axies to start, which currently costs around $1,500. If you “buy-in” with cryptocurrency like ETH, the IRS will consider you having sold the ETH and have earned income equal to the difference between your purchase value and sale value. The acquisition of the NFT itself is not taxable for the buyer – but, is taxable for the seller as income.
  • The Sale of the NFT in exchange for Crypto. Selling an NFT creates a taxable capital gain or loss equal to the difference between purchase and sale price. Simply put, if you bought an NFT for $1,500 and sold it for $2,000, you incurred a $500 gain. If you bought the NFT for $1,500, but sold it for a $1,000, you have a $500 loss that you can use to reduce your other capital gains or even your ordinary income up to a certain amount.
  • The Exchange of the Crypto proceeds for U.S. Dollars or other fiat currency. Like the sale and purchase of NFTs, the exchange of a cryptocurrency into USD or other fiat currency will also trigger a taxable capital gain or loss depending on the difference between the original purchase price of the cryptocurrency (or token) and the price at the time of its sale.

Currently, there are no tax exemptions or safe-harbor periods that allow traders avoid capital gains tax on exchange type transactions.

Are NFT investors taxed differently than NFT creators?

Yes. Let’s say you’ve found a way to farm massive amounts of SLP (Smooth Love Potions) in Axie; these are NFTs. The initial creation or the minting of the NFT is not a taxable event. However, the sale of the NFT is taxable. However, in this case, since you are the creator and also the seller, and you technically “did the work” to earn the NFT, the IRS will likely consider the proceeds from your NFT sale ordinary income for tax purposes.

Is staking taxable?

Yes. Sure, my staked sheep in Wolf Game owe a 20% tax to wolves on all sheered WOOL; everyone knows that. But do I also have to pay WOOL taxes to the US government? Yes. Many taxpayers currently consider staking the same as crypto mining income, which means they will owe taxes on the fair market value of the WOOL the moment they receive the WOOL in their wallet – not just when they sell it.

The IRS is currently in litigation regarding this issue. The question being considered is whether the cryptocurrency or token has taxable value at the time of minting ( in my case “shearing”) or whether it should be taxed only upon sale of the WOOL – similar to the way traditional manufacturing companies operate. (For example, factory owners don’t pay income tax on a manufactured table, even though that manufactured table holds value, until the table sells.) This is one of the many unanswered questions in the blockchain sphere that regulators are catching up to answer.

Are Airdrops Taxable?

Yes, generally airdrops are considered ordinary income based on the fair market value of the drop at the time you get it. As with everything else, crypto-related, be sure to keep detailed records of all your crypto transactions to make sure that you account for them properly.

So, Do I Owe US Taxes on My Earnings from Play to Earn Games?

Yes. Real world earnings mean real world taxes. Whether you earn NFTs, native tokens, or Bitcoin, those assets have value and therefore subject to income tax. You, as the taxpayer, are still obligated to report income just like you would be if the game paid you in stock. As always, it is important to consult a crypto tax expert to see how the specifics of your situation apply to current IRS guidelines.

Further reading:

https://artaevatlaw.com/2021/10/05/play-to-earn-games-legal/
Is Playing Video Games for Real Money Legal? It May Depend on the Game.
Ask the Crypto Tax Lawyer: What Are the Tax Implications of Cryptocurrency and NFT Investing?
Categories
trademarks

Does My Game or Gaming Company Need to Register a Trademark?

Yes! A trademark is an essential part of protecting your business and is especially critical for high-tech innovators in the competitive gaming industry. Best of all, a trademark registration does not have to be expensive or time-consuming. Artaev at Law has partnered with the expert trademark attorneys at Mighty Marks to offer a fixed fee, all-inclusive trademark service.

But what is a trademark exactly? And why do you need one? Do you need one now or later? Can you rely on a U.S. trademark in other countries? Read on:

So what is a trademark?

A trademark is your brand. It can be the name of your company or your product, a slogan, or a logo. Designs or other unique brand elements can also be trademarked. Trademarks, along with patents and copyrights, comprise valuable company intellectual property rights that distinguish and protect your unique product and innovation. The purpose of trademark law is to prevent brand confusion – for example, to stop unscrupulous competitors from copying your brand name and misappropriating your customer goodwill. In the highly competitive gaming space, this is particularly critical, and as explained below, a registered trademark is essential to an effective legal response.

How do I pick a trademark?

There are different “strengths” of trademarks that vary as to the level of protection they provide. In general, the law does not favor trademarking generic terms or product descriptors. For example, if you made a solitaire game and called your game “Solitaire,” your trademark application would likely be rejected. Descriptive marks are those that literally describe the product – for example “Fun” puzzle games or “Challenging” platformers. These descriptive trademarks generally cannot be registered unless they have acquired a secondary (distinct) meaning.

Suggestive marks are those that are not merely descriptive, yet hint at the nature of the product. For example, the name “Playstation” suggests that the brand is home gaming console – and is sufficiently distinct from the generic or descriptive category of marks to be given protection. The strongest category of trademarks are arbitrary and fanciful marks. Arbitrary marks are those that use a word out of context or to describe something completely different than the word’s ordinary meaning. Blizzard to describe a software company is a good example. Blizzards are weather phenomena that have nothing to do with games – and therefore the mark “Blizzard” has acquired a distinct, protectable association with computers. Fanciful (or “coined”) marks are completely new words that have no separate meaning other than their brand. For example, NVIDEA graphics cards or perhaps the xBox home console (although it could be argued that xBox is suggestive.)

Experienced trademark counsel can assist with choosing the right trademark for you and evaluate strengths and weaknesses.

Why do I need a trademark and do I need it now?

Early registration translates to stronger protection.

Games, gaming, and software in general are highly-competitive industries. Once you have your game or product out there, there is not much precluding a competitor from blatantly copying your design and profiting off your hard work. In the wrong hands, your brand can suffer irreparable damage and dilution of your business reputation. For example, if you have a game called Minecraft that you painstakingly developed, and someone copies your game and calls it “MineRcraft” what are you supposed to do? What if MineRcraft is a terrible product, but customers mistakenly leave negative reviews for Minecraft? Or worse – what if MineRcraft takes off and becomes more popular, simply because of your investment into the original game?

Another nightmare scenario for any developers is receiving a cease-and-desist from a competitor attacking your brand. Trademark registration with the USPTO is critical evidence in any sort of priority dispute that may arise. Also, while it is technically possible to register a trademark and obtain priority after-the-fact (retroactively) – it is much cheaper and simpler to do it at the outset. Therefore, it is best practice to file for a trademark registration as soon as possible. The benefits of a properly registered mark far outweigh the negligible costs.

Can my trademark protect my brand in other countries?

Yes, provided that you also apply for international registration. The USPTO provides the forms and application process for an additional fee. 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.

Want to know more? Contact Dan Artaev by email or call or text with any questions.

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?

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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.

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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.

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