GameFi developers may be facing big fines and hard time if they don’t speak up

GameFi developers may be facing big fines and hard time if they don't speak up

Are cryptocurrency games harmless fun? Are they Ponzi schemes that are likely to be rescinded by the United States regulators?

As of mid-August, tokens for cryptocurrency games (commonly known as GameFi) were worth nearly $10 billion. The number could vary depending on whether or not you include partial projects and how you count tokens in circulation. Investors are often unaware of the $10 billion question about whether games are legal. This is a mistake they might soon regret.

This is because there appears to be a bipartisan consensus among U.S. legislators that the industry should be shut down. Although they have not addressed the issue directly — it is difficult to find a member of Congress who has used the term “GameFi” — there are at least two bipartisan suggestions among senators that would effectively expel these gaming projects from American soil.

In June, Senators Cynthia Lummis (Republican, Wyoming) and Kirsten Gilbrand (Democrat, New York) proposed the Responsible Financial Innovation Act. This would, Lummis stated, make cryptocurrencies, which Lummis called a “majority”, securities that are subject to regulation by Securities and Exchange Commission (SEC). The Digital Commodities Consumer Protection Act was also proposed by Senators John Boozman (Republican, Arkansas) and Debbie Stabenow (2Democrat, Michigan). Similar to the previous proposal, the Digital Commodities Consumer Protection Act would place a greater emphasis on Ethereum being classified as a commodity and put it under the control of the less shrewd Commodities Futures Trading Commission.

Securities classification for Axie Infinity and DeFi Kingdoms, as well as other games

According to the SEC definition, tokens in which users have “an expectation of profits” are likely to be security. Let’s discuss what this could mean for your favorite tokens.

This definition will likely include projects that encourage liquidity pools. Axie Infinity, which offers interest payouts through AXS, is an example of a project this could affect. DeFi Kingdoms (DFK) also incentivizes liquidity pool using its native tokens JEWEL, and CRYSTAL.

Related: 34% want crypto in the Metaverse despite backlash

Why liquidity pools are important? Merav Ozair, Rutgers Business School fintech expert and blockchain expert, said that users “treat it as an investment.” It’s not considered a security if it’s used to purchase artifacts for the games. She said that the token can be used to invest in securities, but it could also be used for other purposes.

The Tavern in DeFi Kingdoms

This definition could also cause problems for projects that have made a profit from initial coin offerings (ICOs), private token sales or nonfungible tokens sale (NFTs). This includes Axie, which sold 15% of AXS in pregame or private token sale — and DFK which sold over 2,000 “Generation 0” characters to kickstart the game last year.

Ozair stated that once they use [something] to generate capital they are considered a security.

The precedent suggests that SEC prosecutors will likely find many additional reasons to classify gaming tokens securities beyond the obvious. The agency claimed that Coinbase tokens were securities because developers refer to investors as “shareholders”. One project featured a photo of its CEO, pointing to an advertisement mocking Goldman Sachs.

Consequences – Fines, Registration and Disclosures

Consequences – Fines, Registration and Disclosures

The severity of penalties game developers may face will depend on how accommodating the SEC is. Developers will have to comply with the same disclosure laws as public companies in the U.S. This means that developers will be required to disclose public officers and principal stockholders (or those who own more than 10% of the token supply) and submit an annual report with an audited balance and cash flows.

Many developers have grown accustomed to managing projects that are worth millions, and sometimes billions of dollars without having to disclose their identities. Disclosure requirements could be a wake-up call for them. A securities classification could lead to large fines for violating projects.

Related: Crypto Unicorns founder claims that P2E gaming has entered a long “maturation phase”.

The SEC reached a settlement with a project this month that participated in an ICO but failed to register it as a security. This case could be a good indicator of regulators’ approach. Developers agreed to file the SEC and to compensate investors for their losses or face a $30.9 million penalty.

Christos Makridis is a tokenomics expert who is also an adjunct associate researcher at Columbia Business School. He stated that “intent matters.” “Some NFT or GameFi projects can be so complicated that it’s clear that the rules are being evaded.”

He also stated that if you think about how tokens can be used in gamifying education, an too rigid and narrow definition will exclude many value-creating projects, and deter many inventors, from building in the U.S.

Labama, Hawaii and Utah, as well as 47 other states, may wish to exchange a word

For cryptogaming enthusiasts, regulation out of Washington, D.C. will be just one problem. The late U.S. Defense secretary Donald Rumsfeld called “unknown unknowns” a less obvious problem.

An example is provided by an unlikely trio of U.S. States — Alabama, Hawaii, and Utah. Canada is also included in this list, if anyone is counting. Most jurisdictions prohibit gambling. This includes raffles, which are becoming increasingly popular in the crypto gaming world.

For instance, Axie held a month-long raffle in January and February this year, promising users the chance of winning a variety NFTs if their characters were “released”, meaning they were burned or deleted. DFK followed the lead and asked users to risk losing their characters (or burning them) in March to win better, more expensive “Generation 0” characters. In recent months, DFK has been offering smaller raffles with the option to take part in daily or weekly contests.

Experts believe that the raffles are a problem for U.S. officials even if they aren’t illegal in the three states.

In an interview with Cointelegraph, David Klein, managing partner of New York’s law firm Klein Moynihan Turco LLP stated that sweepstakes must be legal. This means that there is an alternative to paying to enter that offers equal chances to win.

Klein said that if you have to place a $200 item on a line, which would mean you ruin it, to enter, then that is considered consideration. There is no other 100% free way to enter, such as by mailing a postcard or calling 1-800 numbers or visiting a website and filling in information.

There were many other problems. Disgruntled participants have long criticized DFK’s raffle system, including a promise that 800 “amulets” would be awarded randomly to those who had between $1,000 and $50,000 worth of JEWEL tokens between Dec. 15 and Jan. 15. The amulets were not awarded until mid-August, seven months after the end of the raffle. Developers promised that the equipment was still being developed.

Klein stated that there are many problems. It’s essential to communicate when you have contests. Before the contest starts, the start date of the raffle must be announced. Contest rules cannot be changed. In terms of awarding prizes, you have to do exactly what you promise. You must notify the state authorities that won, and provide them with a list within X days. You will be charged with violating state statutes if you fail to do so.

Coinbase is hit by 2 new lawsuits in the SEC probe

This is in addition to any legal or regulatory hazards developers might have created by making their projects global before creating legal teams to investigate potential hazards.

Declining players, expanding token supplies, dropping prices

Developers face an even more obvious problem than the legal implications: a rapidly decreasing user base. According to DappRadar blockchain data, the number of users who interact with Axie Infinity dropped from 744,190 at its peak on Nov. 26 to 35,420 on August 20 — a drop of 95%. DFK players declined by 85% from a peak at 36,670 on December to 5,290 as per Aug. 19.

This decline is due to a rapid increase in circulating token supply. DFK’s JEWEL stock has increased from approximately 60 million to more that 100 million during the same time period. By mid-2024, the supply is expected to rise by 500% to 500,000,000. This does not include a new token called CRYSTAL which was launched on the Avalanche chain (AVAX).

Klein, who manages compliance for a number of big-name NFT projects, declined to answer questions about the possible years of hard prison time that developers could face for conducting improper raffles. He said, “I want the industry to do it right.” He said that projects that don’t comply with the regulations could be charged by a regulator with violating state gambling laws, which would be a criminal offense. A private litigant could sue you if they are upset. Oder a combination of all three.

Axie Infinity has 80 million tokens, and another 190 millions are scheduled to be released over the next three-and a half years. It is worth noting that developers may be altering official circulation figures. This could lead to additional scrutiny by securities regulators.

A rapidly expanding supply of tokens, combined with a decreasing number of buyers, means that prices are constantly falling. This could lead to a shortage of legal funding for developers when they need it most.

Are devs capable of doing something?

Lummis, Gillibrand, and other legislators have indicated that Congress will likely adopt legislation clarifying securities law related crypto by mid-2023. This sea change raises the question: Who are these developers? The $10 billion industry has not been heard of. (Keep in mind, however, that this figure does not include tokens associated with gaming projects, nor characters or land.

Related: GameFi industry will see a $2.8 billion valuation within six years

CoinGecko’s top 16 play-to earn projects have made their identities public. Sky Mavis, the Axie Infinity developer, is included in this list. The majority of the people involved with DFK have chosen to remain anonymous and not reveal any information about their countries. (Fairness be told, DFK did in fact incorporate a Delaware legal entity called Kingdom Studios this year. The entity didn’t respond to our request for comment.

Developers have less than 365 days to lobby legislators to get their congressional proposals changed. They’ve remained radio silent so far. It seems more likely that GameFi investors will be bankrupt every day that passes.

Rudy Takala serves as the opinion editor at Cointelegraph. In the past, he was a reporter or editor in newsrooms such as Fox News, The Hill and Washington Examiner. He is a graduate of American University in Washington, D.C. in political communication.

These opinions are solely the author’s and do not necessarily reflect those of Cointelegraph. This article is intended for informational purposes only and should not be construed as investment or legal advice.

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