The rise of crypto-collectibles

Posted on 13 September 2018 by Anne Rose

The rise of crypto-collectibles

With Bitcoin's valuation at an average of US$7,000 in August 2018 (its highest valuation was at US$19,8321 in December 2017), everyone is talking about the burst of the 'Bitcoin bubble'. But is US$7,000 the burst of an asset 'bubble'? This all depends on whether Bitcoin is seen as equivalent to Digital Tulip Bulbs or Digital Gold: if you see Bitcoin as a worthless currency with no meaningful value, then you probably see a US$7,257 valuation as a sure sign of the burst of an asset bubble. If, on the other hand, you consider Bitcoin's intrinsic value to be comparable to gold, then you probably attach little significance to its recent valuation.

Whatever your school of thought on crypto-currencies and their usage, crypto-games and crypto-collectibles are on the rise. Last December saw the introduction of CryptoKitties - digital cats, with each one having different attributes, and with users breeding, buying and selling them on Ethereum (an open source, public, decentralised, blockchain-based platform) using non-fungible ERC-721 tokens. The most expensive kitten sold on Ethereum, was Founder Cat 18, a bug-eyed orange animal with purple spots which sold for US$122,095.

More recently, the Major League Baseball Players Association signed an exclusive deal with crypto-collectible start-up, 'Player Token' to introduce baseball fans to the world of crypto, offering users the first ever in-market athlete digital crypto-collectible. Each Player Token has a unique ID that is recorded to the blockchain to prove the authenticity of each asset.

According to Player Token's press release: “While the core value of the token is in the artwork that features images of Major League Players, the tokens are multidimensional. Each one also includes an individual history, consisting of its mint date and previous ownership. As more fan experiences are unveiled, the token will continue to memorialize those events.”

This latest venture continues the trend of an increasing number of crypto-collectibles, from Crypto Kitties to crypto-collectible marketplaces such as Rarebits. Due to the nature of the sporting industry and the number of fans it attracts, this may help the emerging technology in becoming more mainstream.

So what do you need to know about crypto-collectibles?

There are a number of issues that those in the crypto-currency space – from those using the currency in their distribution system to those wanting to set up a game which accepts crypto-currencies, or to deal in crypto-collectibles – need to be aware of:

  1. Are they a "security"?

The circumstances in which the offer and sale of "tokens" or "coins" (such as for example the trading of crypto-collectibles) may qualify as a "security" is of fundamental importance. In the UK, while cryptocurrencies are not, in and of themselves, securities/investments that are recognised and regulated by the UK's Financial Conduct Authority (FCA), it is all too easy to devise methods of issuing them, or rights that attach to them, which will be regulated (see the FCA Guidance on this here). Equally, how tokens are held out to the general public in a pre-sale or Initial Coin Offer (ICO) is a sensitive exercise which can very easily lead to a breach of the FCA’s rules on financial promotions.

In the US, the Securities and Exchange Commission (SEC) has issued guidance on determining whether a transaction is an "investment transaction" (i.e. a security). It tends to use the Howey test: if an investment of money is made with an expectation of profits arising from a common enterprise that depends solely on the efforts of others (i.e. a promoter or third party), then it is a security (SEC v. W.J. Howey Co., 328 U.S. 293 (1946)).

Given that issuing a security in breach of the rules and regulations that apply to it can involve criminal penalties it is important to pay attention.

  1. Gambling

In March 2017, the Gambling Commission published a paper 'Virtual currencies, eSports and social casino gaming – position paper'. It reiterated that digital currencies (sometimes referred to as cryptocurrencies) "which can be won, traded or sold can be converted into cash or exchanged for items of value, under gambling legislation they are considered money or money’s worth" . Any bets or games of chance offered using such a digital currency or token is therefore likely to constitute regulated gambling and an operator wishing to accept digital currency as a means of payments will need to ensure it holds the relevant licences to avoid committing offences under the Gambling Act 2005.

Further, any operator providing a social game (i.e. a game played online or on a mobile device with other players) needs to consider whether it needs a licence, which may depend on whether there is a prize of money or money's worth.  In paragraph 2.3 of the Gambling Commission's 'Social Gaming' paper it says: “[to] date, it has been accepted that winning additional spins/credits/tokens/chips (that can be acquired by the payment of real money) does not amount to a prize of money or money’s worth, which would make it licensable gambling”.

Regardless, one needs to be careful of how such gaming is structured. If not structured properly, some crypto-games  which involve crypto-currency or tokens which are transferable and if chance is present, could be caught by gambling legislation. It is important therefore to obtain advice on this before launching a crypto-game or crypto-collectible.

  1. Anti-Money Laundering

In June 2018, the Fifth Anti-Money Laundering Directive (MLD5) was published. For the first time, we now have an EU definition of 'virtual currency':  “A digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically”.

The replacement of the previous term “payment” with “exchange” clearly widens the scope of the definition to bring tokens into play, and would therefore cover any coin or token issued through an ICO.

MLD5 defines virtual currency exchange platforms as "providers engaged in exchange services between virtual currencies and fiat currencies”.  A fiat currency is a currency that a government has declared to be a form of legal tender often issued by central banks or public authorities, but is not backed by a physical commodity such as gold (e.g. US dollars).

On a literal reading, while MLD5 does not consider virtual currency exchange platforms that only offer pairs of coins or tokens (i.e. crypto-to crypto exchange services) to fall within the scope of MLD5, the changes in these definitions can only be the start of more regulation.

EU Member States have until 10 January 2020 to implement MLD5 into national law (i.e. after the UK intends to leave the EU, but during the proposed Brexit implementation period which may run until 31 December 2020). While it remains to be seen how the UK will choose to comply with MLD5 after Brexit, given the UK’s commitment to anti-money laundering and counter terrorist financing, it is likely that it will implement terms at least similar to MLD5 (and perhaps even before the implementation date).

So to sum that up…

Anyone considering creating a game which involves crypto-currency or tokens that are transferable and where chance is present, could be caught by gambling legislation.

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