play-to-earn Archives - ARTAEV AT LAW PLLC

Are Play-to-Earn Video Games Legal in the United States?

Are play-to-earn games legal? The answer depends on the specifics of the game. For many gaming developers, play-to-earn is a lucrative business model in 2023 and beyond. These games let players compete against other players (PvP) or against the the game itself (PvE) to earn rewards that have real-world value. For example, players may pay real money to buy in-game currency to purchase virtual gear or real estate, but players also have the option to redeem the in-game currency for real-world money. Players can trade resources or earn the in-game currency through gathering, completing tasks or quests, or other gameplay. However, any company looking at play-to-earn should retain an experienced gaming attorney to consult on their game. It may be an attractive business model, but any real-money gaming implicates multiple legal areas, including taxes, securities law, and both state and federal-level anti-gambling prohibitions.

Earning real-world cash for virtual goods or gameplay is not a new concept. In fact, the first generation of massively-multiplayer online roleplaying games (MMOs or MMORPGs) like Ultima Online, Runescape, and Everquest had robust real-money economies for in-game items. Resource “farming” – where one would gather virtual resources and then transfer them to another player for a real-world money payment – became even more popular with World of Warcraft and the next generation of the MMOs like EVE Online. However, the developers did not officially sanction these in-game economies. Anti-RMT (real-money trading) provisions are prevalent in most end-user license agreements. Real money components in video games may be too close to gambling, which is obviously problematic. Developers are generally reluctant to assume additional liability and risk associated with any real-money economic component.

Play-to-Earn is Hot, But Rife With Legal Pitfalls.

However, it is the end of 2022, and making money playing video games is a real and viable career choice. Esports and video game tournaments are mainstream events, with their own ESPN page, multi-million dollar teams, and celebrity-status professionals. Many colleges offer esports scholarships. Casual video game tournaments (Call of Duty, FIFA, Gran Tursimo) are also a thing. For the more casual gamer, there are also real-money skill-based games (timed solitaire, bingo, etc.) available on the web or from the App Store. Daily Fantasy Sports giants like DraftKings and FanDuel also offer skilled players an opportunity to win real money by drafting the best fantasy sports teams.

There are also a number of NFT-based collectible card games, horse racing simulators (like Zed.Run), and countless other permutations of games where players are able to own in-game assets that they can sell and trade like their real-world counterparts. This sector of the gaming economy continues to grow, as the relatively low cost of cryptocurrency makes entry a lot more accessible. Many players also see the current “bear” market as a prime opportunity to enter some of these projects at low cost and potentially see significant growth in their in-game assets as the economy rebounds.

Modern play-to-earn games are simply another variation of the real-money gaming business model. Developers in this space fully embrace the concept of a virtual economy and the ability to earn real-world compensation for game play. The most prominent example is Axie Infinity (a Pokemon-type trading, collecting, and battling game), which has integrated blockchain technology (crypto and NFTs). Investors around the world, including Mark Cuban, quickly embraced the play-to-earn gaming model. Even in the times of the “crypto winter,” Axie is still worth many millions of dollars.

Advertising and Onboarding May Require a Legal Opinion.

Any real-money gaming business (including play-to-earn) needs experienced gaming counsel to guide them through various compliance issues. Advertising a real-money game on social media and getting through Apple’s approval process on the App Store requires a legal opinion that the game is truly skill-based and not illegal gambling. Is your game structured so that they are providing a service to you in exchange for compensation? Depending on the nature of your game, you may have unintended labor law obligations and even tax filing (W-2 or 1099) obligations to the IRS and state tax authorities.

Make Sure Your Game is Not Selling Securities.

Another potential pitfall is with the Securities and Exchange Commission (“SEC”). When designing your game and reward system, you must make sure that you are not inadvertently marketing a security and violating federal law. Securities are not just traditional stocks and bonds. An “investment contract” is also a regulated security and broadly includes any scheme where individuals pay money with the expectation that their money will be invested and they will earn a return. In the cryptocurrency world, initial coin offerings (“ICOs”) face heavy SEC scrutiny, especially after several high-profile cryptocurrencies turned out to be pyramid schemes.

The “investment contract” analysis is highly specialized and requires a thorough legal opinion. Each game is different, the laws are quickly changing in this area, and regulatory agencies are especially sensitive to crypto-related businesses in light of the numerous 2022 failings, bankruptcies, and rug pulls – with FTX being only the most recent example.

Beware Tax and Other Regulations If Your Game Uses Cryptocurrency or Other Blockchain Tech.

Speaking of crypto, if you are utilizing cryptocurrencies, tokens, NFTs, or other blockchain technologies as part of your game, there are more legal issues in play. Tax reporting and tracking are essential because the IRS considers cryptocurrencies to be property subject to capital gains tax. Does the game involve any crypto staking? If so, is your company now considered a bank subject to the FDIC’s jurisdiction? Are you involved in the business of money transmission and required to be licensed in each state where you do business?

Despite the slow regulatory change in this area and continued lack of centralized regulation, this area remains in the public eye and something of continued interest to regulators.

The bottom line is whatever your game and whether you are a veteran or just starting out, an experienced gaming attorney is a necessary asset to your business team.

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, tax, or investment advice. Every situation is different and has 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.

Do Play-To-Earn Games Sell Unregistered Securities?

What do securities laws have to do with gaming?

Securities are traditionally associated with stocks and bonds traded on various exchanges. However, “securities” is actually a much broader term and includes virtually anything that a company sells to raise funds, whether to the general public or to a select group of high net worth individuals in a private placement. In the play-to-earn context, either the in-game currency token or the game asset NFT can be considered securities. Crypto/blockchain/NFT regulation is still at the early stages, but the SEC has taken an active enforcement role in pursuing fraud and illegal token offerings in the digital assets market.

Not all tokens or digital assets are securities. The uses a four-prong analysis called the Howey test to determine whether an offering is a security. More precisely, courts apply the Howey test and examine whether something is an “investment contract,” which is a type of security. The United States Supreme Court created the test in SEC v. WJ Howey, 328 U.S. 293 (1946), when it determined that a company selling shares in an orange grove farming operation was actually selling unregistered securities. If a token does not qualify as a security under the Howey test, it is generally considered a “utility token” and may be sold without the constraints of securities laws (but may still be subject to other regulations).

How do securities laws apply to gaming tokens or NFTs?

An “investment contract” has four elements: (1) an investment of money; (2) in a common enterprise; (3) with the expectation of profit; (4) derived from the efforts of others. With digital assets, the SEC generally assumes the first two prongs are met. Most, if not all, play-to-earn tokens involve an investment of money (either fiat currency or cryptocurrency with value) in a common enterprise (i.e. the game project). Thus, whether an offering is an exempt “utility token” or an unregistered security depends on whether the purchasers are led to expect profit derived from the efforts of others. In other words, does the purchased token function as a passive investment that pays dividends?

Of course, this is a very fact-specific inquiry. The SEC’s Strategic Hub for Innovation and Financial Technology (“FinHub”) has a rather complex set of guidelines and guideposts for the analysis, called the “Framework for Investment Contract Analysis of Digital Assets.” The SEC also relies on the DAO Report, which was a 2017 investigation of the Swiss-based DAO Project that explains the SEC’s application of Howey to digital assets.

In general, the determining factor is how the tokens are used. Do players actively use the NFTs they acquire to play the game and earn rewards? For example, an owner must manually enter the racehorse NFTs in Zed.Run (a hugely popular play-to-earn horse racing game) into various races, deciding on the best course type and distance suited to that particular “racehorse.” If the NFTs “wins,” the owner wins a prize, just like in real-life horse racing. Axie Infinity is another example of where players must actively manage their NFTs and “battle” them before earning rewards. Active in-game management likely negates both the third and forth prongs of Howey, as players purchase the tokens for in-game use and any rewards are not from the efforts of others – they come directly from the efforts of the player/owner. The same logic applies to in-game currencies that can be used to acquire in-game assets, pay entry fees, upgrade NFTs, and for other purposes. Simply put, while the in-game currency may certainly fluctuate in value on the secondary market, it is not a passive investment vehicle. It is an active “utility” component of a play-to-earn game.

Do staking and lending features affect the securities analysis under Howey?

As play-to-earn games become more sophisticated, so does the analysis. Many games now offer “staking” – which rewards players with in-game currency for parking their tokens or removing them from circulation for a set period of time. Additionally, NFT renting and lending are becoming more common, where owners let third parties to borrow their NFTs, actively use them within a game, and in return, receive a share of any winnings. The staking and lending mechanisms effectively enable passive income for token owners. Passive income is a hallmark of a security under the Howey test.

Play-to-earn games are a rapidly growing sector of the overall crypto and NFT market. It is critical for developers to ensure legal compliance, not only to protect themselves and their companies from crippling lawsuits, but to also make their product attractive to potential investors. In 2022, a comprehensive legal analysis of the play-to-earn project is a must-have for any pitch deck. Note that even if the token or NFT is not a security under federal law, state level “Blue Sky laws” may apply. Additionally, a token or NFT may be regulated as a commodity or under money transmission laws. In other words, the securities analysis is only part of a full legal evaluation.

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.