Web3 Gaming Regulation
Regulating web3 games, which use blockchain technology and cryptocurrency, can be complex due to the additional challenges around money transmission and securities laws. In this article, we'll explain how to navigate AML (anti-money laundering) regulations in the web3 gaming industry.
AML and KYC (know your customer) regulations are important for preventing illegal activities like money laundering, which means sneaking money obtained illegally into financial systems by disguising the sources. If users can find ways to exchange in-game items (like virtual money, artifacts, tools or clothing) for real-world currency, those items will become attractive for criminals looking to launder illicit funds. Developers need to understand that there can be serious consequences for not following these regulations, including fines and criminal charges. When creating a product, service, or transaction for your game, it's important to consider whether it might be subject to federal, state, or country regulations. If it is, you may need to partner with a regulated third party or register and get a license. Having said that, there are ways to provide a great gaming experience while mitigating the regulatory risk, as we will shortly discuss.
To understand AML regulations in the gaming industry, we need to define money transmission; This is when you accept money (or something similar with value) from one person and send it to another person or place, or keep it for the same person at a different time. Companies that facilitate money transmission are required to have AML and KYC programs, as well as tracking and reporting obligations like filing suspicious activity reports and following the Travel Rule.
In the web3 gaming industry, there are two additional categories of money transmission: issuers and exchangers.
Issuer is someone who creates and has control over a centralized cryptocurrency. As a generalization, gaming companies typically offer some form of game currency to transact in game (World of Warcraft’s Gold, Second Life’s Linden Dollars, or Fortnite’s V-Bucks), and/or digital assets to supplement and enhance gameplay (skins, weapons/accessories, pets, land, etc.). An issuer does not only issue these currencies or assets, but are usually able to revoke access from the player and take them out of circulation from the game. For example, in the game Axie Infinity, players can purchase Luna (the in-game currency) with real money to buy in-game items and assets. Axie Infinity's issuer, Sky Mavis, controls the distribution and redemption of Luna.
The analysis of whether you are an issuer usually surrounds the launch event (who launches the smart contract). Decentralized tokens created by a DAO (decentralized autonomous organization) do not fall under this category.
Exchanger is someone who exchanges cryptocurrency for fiat currency (regular money) or other tokens. If a game takes custody of currencies and assets and facilitates their purchase and sale, either directly or through a marketplace, it may be considered an exchanger. This is usually determined by whether the game takes custody of the currencies and assets or simply provides a platform for players to transact directly with each other (peer-to-peer).
If you determine that your game is conducting a regulated money transmission activity, you have the option to partner with a regulated third party or seek your own registration and license. Mythical Games is a good example of a gaming platform that includes built-in regulatory KYC/AML compliance and indemnity.
But what if the game's token doesn't have monetary value?
Even if a game's token doesn't have monetary value, it can still be subject to AML regulations if it's being used to purchase goods or services. In this case, the token would be considered a "convertible virtual currency." This means it can be easily exchanged for real or virtual currency. If your game offers micro-transactions, in-app purchases, or loot boxes (virtual containers with randomized items that can be bought with real or in-game currency), it's important to consider whether these transactions fall under AML regulations.
However, potential issues may arise when we look at web3 games that operate under the principles of open economies. To minimize the risk, it’s best to structure the economy and the currency as in-game utility and lack of outside of game value (means it’s harder to “cash out”). In addition, not providing an option for fiat on-ramp to the game’s token significantly minimizes the regulatory risk.
What about NFTs?
NFTs are unique digital items that can't be exchanged for other items of equal value. They can represent in-game items, art, and other virtual assets. If an NFT is being sold for a high price, it may be considered a security and subject to securities laws. It's important to consult with a lawyer to determine whether your NFT sales need to comply with securities regulations.
In summary, it's important for web3 game developers to understand and follow AML regulations to avoid fines and legal issues. Make sure to consider whether your game's activities, including micro-transactions and NFT sales, fall under the regulatory definitions. If you do, you have the option to partner with a regulated third party or seek your own registration and license.
The information provided in this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this article are for general informational purposes only. Information in this article may not constitute the most up-to-date legal or other information. Please reach out to your attorney for guidance.